Bitcoin’s relentless rise is understandable given the drivers:
- Each day, Bitcoin is less “new” – New things are scary. This year a number of high profile investors, podcasts, and companies starting talking about Bitcoin and cryptocurrencies more generally. The more they talk the more Bitcoin becomes a household name. The less scary it becomes. The more likely folks are to know someone that uses it. All the publicity is forcing mainstream businesses, investors and others to learn about blockchains, how they work, and their potential applications. Its impossible to separate this learning from Bitcoin as the first gloabl application of the technology. As people learn more about something they tend to become less afraid.
- Each day Bitcoin becomes more useful – The technology, rise in price, and publicity have caused many talented individuals to stop whatever they were doing and start developing. Nerds from around the world are coming up with new applications, improvements in blockchain speed and efficiency, and methods for integrating Bitcoin into the broader economy.When nerds disagree on how to move forward, they simply fork the blockchain and try both until one dies or they both succeed.
- Gambling with Cryptocurrencies is really fun (and addictive) – Most people who buy Bitcoin are essentially gambling. They don’t know what they are buying but it has been going up so they take a chance. For this reason is makes a lot of sense to compare Bitcoin to the size of gampling industries. The total value online gambling revenues are expected to surpass $50 Billion by 2018 and are rising fast, and that is for playing games that, in the long run, you are guaranteed to lose. With cryptocurrencies, no one knows the odds. Therefore, if you love to gamble, cryptocurrencies might just be a better way to play.
- No one knows the true value – Today’s foreign exchange market trades $5.3 Trillion per DAY. By comparison, Bitcoin trading volume per day is only $660 Million or 0.0125% of total currency exchange volume. Even a very modest (and potentially underground) economy could justify current valuations. Without knowing the size of the crypto economy (or more importantly the future size) one cannot apply typical currency valuation methodologies such as those used to price traditional currencies like dollars and yen. Then there is the commodity like aspects of Bitcoin (including future version) such as smart contract applications. Currencies are very difficult to price. Currencies with potential smart contract applications with an economy that is largely anonymous is next to impossible to comprehend let alone price.
- Zero interest rates – Today’s low interest rate environment gives investors little incentive to stick with traditional investments. Stocks and bonds are trading at historically high valuations (as we have discussed in previous posts). The result is that many more investors today are iwlling to take a few thousand dollars and bet on something speculative like cryptocurrencies.
- Low adoption means room to grow – Estimates of how many adults have invested in Bitcoin range from 1-3%. The fact that Bitcoin market capitalization could exceed $100 Billion without an easy way to invest (ex. ETF) suggests that there is huge pent up demand. This is also evident from the value of the Bitcoin Trust which trades at a 70% premium to Bitcoin. As other options become available (such as the CME Bitcoin Futures market) the dam is likely to burst. All it takes is one pension or endowment making outsized returns and the rest will likely be pressured into following, even if prices have already reached a point of absurdity.
- Nearly impossible to short – Non believers just have to watch as prices rise. They have no effective way to bet against it. The only people holding Bitcoin are those that were willing to buy it in the first play and this group is disproportionately likely to believe in the potential of cryptocurrencies. Derivatives are being created but these do not directly impact spot prices in exchanges which is where price discovery occurs.
- Major shocks have had no lasting effect – China’s attempt to shut down crypto exchanges illustrated the resilience of the market. Last year China accounted for a majority of crypto transactions. Those looking for an event that would cause Bitcoin to fall longer than a few weeks need to imagine something way worse than the second largest economy making crypto illegal and forcably shutting down exchanges. A lot of money is simply waiting on the sidelines hoping for a big drop (you can see this in the order books; which unlike equity markets is perfectly transparent). When everyones waiting for a drop, drops rarely happen, because there are too many willing to catch the falling knife.
- Impossible to destroy – The word “impossible” has very few real world applications. That said, it is very hard to think of another idea that has suffered more than Bitcoin. Everything from Mt Gox, Silk Road, hackers, frauds, and now China banning it for the Xteenth time. The realisty is that Bitcoin is a decentralized and largely anonymous network that spans every country in the world with an internet connection. Developers from around the world are improving means of exchanging crypto like Bitcoin without the use of an exchange. Those expecting Bitcoin to somehow disappear just don’t know what they are talking about.
- No catalyst for forcing prices to fall – The Dot-Com Bubble burst when investors realized they were holding equities that would never pay dividends. Currencies don’t pay dividends so it is much harder to say whether valuations are unreasonable. There just isn’t an obvious metric one can use to say that Bitcoin is a bubble. Combine this with an inability to short Bitcoin and it becomes difficult to argue that prices have to fall.
Forecast: These drivers will likely cause Bitcoin to rise to some rediculous valuation (if it hasn’t already). Bitcoin traders are being conditioned to buy-the-dip, just like they did in the stock market after Brexit, the Trump upset, and the Italian Referendum. Every time that Bitcoin has fallen 20% below its mean price over the previous month it has recovered and risen in price. People learn. Those that sold tell themselves they won’t do that again. The result is likely to be fewer prices crashes and more rapid increases in price. The huge unrealized gains that investors make from this rise will be the catalyst for a bear market. Once prices fall materially month over month we expect them to fall. How far they fall will, again, depend entirely on investor psychology because valuation is nearly impossible.
We could easily be wrong. No one really knows. Time will tell.
Source: Facts/Figures from this short post largely come from here.
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Disclaimer: We are long #Bitcoin $BTC and #BitcoinCash $BCH. We also occassionally invest in other cryptocurrencies like #Ether (i.e. #Ethereum token), #Monero $XMR, and #Litecoin $LTC. These are our personal views. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. Our hope is that these observations will merely help you to more critically examine your own beliefs about finance and stimulate dialogue.