Crypto Whales: Is There a Concentration Risk?

Bitcoin, the original cryptocurrency, started with a very concentrated ownership structure because it was founded by an individual. It has become more distributed in the intervening years, but a number of large holders- known as whales- own a significant amount of the circulating supply.

The presence of these whales creates concentration risk and raises concerns about their ability to manipulate the markets. After all, their trades have the power to influence price action. But are they a threat to bitcoin’s efficacy, or does the data tell a more nuanced story?

Bitcoin’s wealth distribution commenced on 3rd January 2009 when Satoshi Nakamoto, the pseudonymous founder, processed the first batch of transactions, known as the genesis block. It took seven days, and the block only contained one transaction, the transfer of 50 BTC as a reward to a wallet from which it can’t be recovered (Satoshi never explained why). Incidentally, while those coins had no value at the time, they’re worth $1.368 million today.

Mining is the term used to describe the processing of bitcoin transactions. It involves solving a complex mathematical puzzle in return for a reward, so miners were among the early accumulators of this new form of digital wealth. The initial reward was 50 BTC, but it has since fallen owing to a halving mechanism designed to control the supply of coins entering circulation. The reward currently stands at 6.25 BTC, with the next halving occurring in 2024 and the last one in 2140.

One of the most infamous bitcoin transactions took place in May 2010. A programmer in Florida called Laszlo Hanyecz paid 10,000 BTC for two pizzas. A formal exchange rate had been established earlier in the year, but considering the pizzas cost $25, that valued each bitcoin at around 0.0025 cents. Mr Hanyecz could be forgiven for experiencing a strong case of buyer’s regret given 10,000 BTC is worth over $273.7 million today. The crypto community still celebrates Bitcoin Pizza Day every year.

A whale is an individual or entity that holds a large amount of crypto. Due to the vast differences in market capitalisation of the various coins, the size of the holding varies, but it has to be big enough to affect price in the event of a trade. So to qualify as a bitcoin whale (market cap of $535.825 billion as of 10/10/2023) requires a larger holding than a Polygon whale (market cap of $4.866 billion as of 10/10/2023).

Even within each crypto, there isn’t a universally accepted definition of what constitutes a whale. But for context, Blockchain data provider Glassnode classifies bitcoin whales as holding between one and five thousand coins. Anything above the upper threshold qualifies as a humpback.

• Individuals - One of the biggest crypto whales is Satoshi Nakamoto who holds one million bitcoin. Satoshi’s holding hasn’t moved since he disappeared from the scene in 2010. Other notable individual whales include Michael Saylor (over 17,000 BTC), founder of business intelligence provider MicroStrategy, and the Winklevoss twins (approximately 70,000 BTC), founders of the Gemini exchange.

• Corporates - Exchanges are among the largest corporate whales. Binance holds nearly 250,000 BTC, while Coinbase holds two million. MicroStrategy owns 14,000 BTC, separate from its founder.

• Governments - The US government holds 205,000 BTC which it confiscated from various criminal enterprises, such as the Silk Road black market. Elsewhere, the government of El Salvador, where bitcoin is legal tender, owns more than 2,500 BTC (according to Bloomberg).

Whales are important participants in the crypto ecosystem because of their influence over the markets. In the short-term, supply and demand drive this influence. If a whale sells a large amount of crypto, its price is likely to drop and vice versa. As a result, activity by whales can indicate a change in the market cycle, such as a big sale leading to a bear market. The effect of supply and demand is even more pronounced for coins with lower liquidity or a smaller market cap.

While most whales have legitimate reasons for building up their holding, the presence of major players increases the risk of market manipulation by bad actors.

A common method of manipulation is called a sell wall, where the whale opens a sell order for a large trade well below the current market price. This forces other participants to lower their selling price. When it drops sufficiently, the whale removes the sell order and buys the crypto at a discount. The opposite of a sell wall is a buy wall.

Of course, a key priority for regulators in the mainstream financial system is to avoid manipulation, so closer supervision of the crypto markets should reduce this risk.

One of blockchain technology’s main benefits is transparency. A blockchain is a public ledger, so anyone can view the history of every transaction which has taken place. Along with immutability (the records are nearly impossible to tamper with once processed), this feature promotes trust in the network.

Transparency makes it easy to monitor individual wallets. One of the easiest ways to track activity is using a blockchain explorer like blockchain.com for bitcoin and Etherscan for Ethereum. A block explorer is effectively a search engine which trawls blockchain data for transactions, wallet addresses and metrics such as fees. To track a wallet, simply input the address into an explorer.

Knowing the destination wallet can tell a lot about the potential impact on the market. For example:

• Moving holdings from a wallet to an exchange suggests the whale wants to sell, which could lead to a price drop.

• Moving from an exchange to a wallet implies the whale is planning to hold.

While sourcing individual wallet addresses requires expertise in blockchain analysis, websites like BitInfocharts publish lists of the biggest wallets by bitcoin balance, alongside other metrics such as the total percentage of circulating supply and the latest transaction. BitInfoCharts also labels the wallets where the owner is known.

As shown by the chart above, whale holdings have steadily declined since peaking in 2011 when they held 76% of the overall supply. There could be a number of reasons:

• Broader distribution, where whales split their holdings among different participants (reducing the risk of market manipulation).

• An opportunity to take advantage of greater liquidity through an increasingly developed crypto market structure.

• Rising demand from retail investors.

• The evolving regulatory landscape forcing whales to sell off some of their positions.

• A change in investment strategy leading to whales downsizing their crypto holdings.

• External factors such as geopolitical or macroeconomic events affecting the whales’ risk appetite.

This trend suggests concentration risk is declining. But it may reverse as demand rises among institutional investors, especially if the US Securities and Exchange Commission approves applications for spot bitcoin exchange-traded funds (ETFs) from mainstream financial institutions like BlackRock. The market experienced this effect in 2020 and 2021 when whale holdings increased for the first time since 2016 amid the initial wave of adoption by institutional investors.

The distribution of bitcoin has exploded since it launched in 2009, with the market cap of the original crypto alone growing to $535.825 billion. But there are concerns that the concentration of this wealth among a relatively small number of holders, known as whales, may adversely affect the sector, leaving it vulnerable to market manipulation.

Research by blockchain data provider Glassnode suggests concentration risk is declining as the overall supply held by whales has been steadily falling since 2011. However, this trend may reverse with greater institutional adoption, especially if spot bitcoin ETFs come to market.

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