The number of bitcoin (BTC) held in addresses tied to centralized exchanges slid to the lowest level in more than five years, partially reflecting a growing market sophistication.
The so-called exchange reserve dropped 4% to 2 million BTC ($54.5 billion) this month, the fewest since early January 2018, according to on-chain data analytics service CryptoQuant.
The decline represents both positive and negative developments, including the rising popularity of services like crypto custodian Copper's ClearLoop, which allows users to trade without moving funds to centralized exchanges.
"It partly reflects the increased demand for services like Copper's Clearloop, which requires only a minimum of coins to be posted on exchanges, that are a natural progression of the crypto market where exchanges will have to work with lower balances," said Markus Thielen, head of research and strategy at Matrixport. "Over time, this will make crypto currency's exchanges less important and exchanges might have to find new business models to keep profitability high."
Matrixport joined ClearLoop in May, offering institutional clients off-exchange settlement.
Lack of trust
Since Sam Bankman-Fried's exchange, FTX, went bust in November last year, investors have increasingly preferred to keep coins off centralized exchanges. From what we know now, FTX, formerly the world's third-largest exchange by volume traded, commingled user funds, denting investor confidence.
According to Thielen, the dwindling exchange balance represents that.
"The misusage of customer funds through the FTX leadership has reminded investors about the importance of self-custody," Thielen told CoinDesk.
PricewaterhouseCoopers' annual global crypto hedge fund report published last month showed that most industry players now prefer multiple forms of custody with "only 9% of the respondents leaving coins exclusively on exchanges."
Market-neutral, discretionary long-only strategies, quantitative long/short and discretionary long/short strategies overwhelmingly prefer third-party custodians. Among the four, funds with a long-only strategy hold the fewest coins on exchanges, in both commingled and segregated accounts.
"It seems the overwhelming majority of crypto hedge funds are seeking to mitigate as much risk as possible after the events of last year, keeping only those assets required for day-to-day trading on-exchange," the report said.
One interpretation of a dwindling exchange balance is that it indicates investor preference for taking direct custody of coins to hold them for the long term in anticipation of a price increase. In other words, it shows investor confidence in cryptocurrency's long-term prospects. That bullish interpretation is still valid, according to Thielen.
"After the 2022 price declines, investors are taking a buy-and-hold investment approach," he said.
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