Bitcoin’s price has exploded in recent weeks and with the most recent ramp-up, certain warning signs are beginning to emerge.
As the price in Bitcoin has moved up seemingly exponentially in recent weeks, many retail investors appear to be using cheap credit to accumulate expensive Bitcoin.
Another troubling signal is coming from Asia, where South Korea and other governments are beginning to express genuine concern about the escalating “Bitcoin Mania.”
Futures trading offers many favorable aspects for Bitcoin long-term; however, one big negative short-term implication is that Bitcoin can now be shorted on a mass scale.
I certainly would not take out a mortgage to buy Bitcoin at this level.
The Big Short Is Coming
Bitcoin’s (COIN) (OTCQX:GBTC) price has surged over the past few months. In fact, the price has roughly tripled just in the last month alone. It is up by a staggering 2,000% over the last year, and has increased by a mind-bending 34,000,000% from its price of just $0.05 in 2011. However, despite the seemingly endless run-up in price, certain fundamental elements are clearly materializing that suggest the current price level may be extremely difficult to sustain. These underlying elements coupled with the advent of Bitcoin futures trading suggest that a significant price correction exacerbated by short selling may ensue in the near future.
Personal View on Bitcoin
I want to express that I am a strong believer in Bitcoin and Blockchain technology. The decentralized aspect of Bitcoin, its popularity, and its potential multiuse function as a digital commodity, a form of global currency, as well as a digital store of value are fascinating. Having said that, it appears that widespread adoption of BTC as a credible alternative form of currency with the potential to challenge the current fiat monetary system is still far away. Therefore, it appears that many people may be accumulating Bitcoin for the wrong reasons right now, which will likely result in them driving the price up to an unsustainable level in the short term.
Stretching Credit Limits to Buy Bitcoin
The U.S. is already a very heavily indebted nation with both consumer and national debts at all-time highs. It appears one of the last things we need is people going further into debt to buy Bitcoin at current elevated levels. Nevertheless, we appear to be witnessing just that.
There have been an increasing number of reports that Bitcoin-buying is entering an irrational and plausibly an unsustainable phase. In fact, securities regulator Joseph Borg recently expressed concern citing that an increasing number of individuals in the U.S. appear to be taking out mortgages to invest in BTC. In addition to this, many consumers are using equity lines of credit and credit cards to purchase Bitcoin.
This is made possible by the fact that various exchanges such as Coinbase and others are accepting credit card payments for Bitcoin purchases. This phenomenon is exposing the public to enormous risk as people are increasingly using cheap credit to purchase expensive Bitcoin. The developments of retail investors rushing in to buy BTC due primarily to the apparent fear of missing out appears like an unhealthy development and is indicative of a bubble-like atmosphere.
Asian Mania and Government Intervention
A lot of the frantic Bitcoin buying is occurring in Asia, and as retail buyers continue to bid the price higher, the situation appears to be reaching a fever pitch. With prices appreciating at such a rapid pace and with so many consumers rushing in, there is a distinct possibility that a dramatic price correction could occur if the mania continues. The aftermath of such a correction has the potential to cause systemic damage to an economy, if a significant number of citizens end up losing substantial amounts of money they have invested in BTC. This understandably has various Asian governments and central banks concerned, and some appear to be taking measures to “cool” the rise.
South Korea, one of BTC’s most active and liberal markets, recently took a hard stance against the cryptocurrency, as it banned its banks from dealing in Bitcoin. The government is also exploring options such as a capital gains tax on BTC and other regulations in order to curb what it calls “an overheating of virtual currency speculation.” The South Korean justice ministry is also considering imposing a total ban on Bitcoin and other cryptocurrency trading, which could prove disastrous to current price sustainability.
One of the reasons behind the recent crackdown in BTC aside from the negative economic implications a crash in prices could pose is an increasing number of improperly set up underground Bitcoin mines popping up all over Asia. One such improperly set up mine in the basement of a hotel in South Korea recently led to huge blaze in the building.
So, as the Asian Bitcoin mania is literally on fire these days, governments are starting to react. China, Hong Kong, Indonesia, Vietnam, and others are cracking down on cryptocurrency exchanges, mining operations, and other aspects regarding Bitcoin and other digital currencies in an attempt to reduce speculation and prevent systemic risk to their economies.
It is very possible that if Bitcoin’s price continues to surge at this seemingly exponential pace governments will continue to react by imposing price cooling mechanisms, not only in Asia but in the Western world as well. Continued measures to control the cryptocurrency, and attempts to limit its ability to function independently of government intervention could create a sharp price correction to occur in the near future.
Is Bitcoin Still an Effective Cryptocurrency?
One of the most compelling aspects regarding Bitcoin was the ability to use BTC as an effective alternative medium of exchange. However, with drastic volatility in BTC’s price and skyrocketing transaction costs, it is becoming more difficult to view BTC as a legitimate currency right now. A currency needs price stability, and one of the elements that used to make BTC an attractive candidate for a world currency was its low transaction costs. Well, as prices have surged, transaction costs have followed.
BTC’s transaction fees have been rising all year alongside the cryptocurrency’s price appreciation. However, the average transaction cost surged from roughly $6 to $26 in a week recently. It was becoming increasingly expensive to use BTC as a currency leading up to the price hike but now it appears completely impractical to use BTC for anything other than extremely expensive purchases such as homes, cars, yachts, etc. The increasing fees are a problem, and for now are taking away one of the fundamental elements that made Bitcoin so attractive, to begin with.
There are now over 1,350 different cryptocurrencies circulating around the world. Moreover, there are 23 digital currencies that have a net worth of over a billion dollars by today’s valuation, 97 are worth over $100 million, and 573 have a market value of over $1 million. In total, the full market value of digital currencies has crossed the half a trillion-dollar mark and BTC accounts for more than half, $278 billion of that value. It is important to mention that Bitcoin is not the most efficient cryptocurrency to use, it is also not the most anonymous one, it is simply the first, and the most popular.
Does the World Need 1,356 Cryptocurrencies?
I highly doubt it. It does not seem likely that the world needs 1,356 digital currencies, a few of the most widely used and trusted ones should do. The fact that there are so many different digital currencies with new ICOs occurring continuously appears to be another byproduct of the so-called “Bitcoin Mania.” It is not a positive element that so many digital currencies are popping up. Their use may never be implemented, the space is not regulated, many may not be run by dependable administrators, and many will likely fail in an event of a significant market correction, increased regulation, or as a result of a number of other scenarios.
Once various cryptocurrencies begin to fail, the repercussions of this are likely to be felt throughout the industry and BTC’s price may be affected negatively as consumers are likely to panic and temporarily lose trust in the cryptocurrency space.
Why is Bitcoin Worth So Much in Relation to Other Cryptocurrencies?
The fact that BTC’s price represents such a high percentage of all cryptocurrencies is concerning. As I said before, BTC is not the most efficient, nor the cheapest, nor the most anonymous, nor the most stable form of cryptocurrency. So why is it worth so much in relation to the others?
The value of Bitcoin is worth roughly $278 billion, Bitcoin Cash is worth about $31.7 billion, and Bitcoin Gold has a market value of $5.17 billion. Since BTC Cash and BTC Gold were forked out of Bitcoin they should be counted as part of BTC’s total value. Therefore, once we add up all the components of BTC we arrive at a market value of roughly $315 billion. Thus, Bitcoin’s value is more than 60% of all the 1,356 cryptocurrencies currently on the market.
Moreover, the market value of Bitcoin has been increasing as a percentage of all cryptocurrency value in recent weeks and months, despite new ICOs coming to market. This suggests that people are accumulating BTC at an increasing pace more as a speculative asset and less as a potential currency, another troubling signal of the possible “Mania” effect we are confronted with.
Futures trading is a double-edged sword for Bitcoin. On the one hand, it’s very favorable, as it opens the market to many new market participants who were not partaking before. Furthermore, futures serve to legitimize BTC and down the line, the phenomenon could make it more difficult for governments to outlaw or delegitimize the cryptocurrency.
However, on the other side, it opens the door to shorting Bitcoin in mass, and there are a lot of people who have been waiting to short BTC. This was basically impossible to accomplish efficiently before the materialization of futures trading. Ultimately, futures trading is likely to add to BTC’s already volatile state over the short term to intermediate term, both on the upside and the downside. Furthermore, in a significant correction process short sellers will now be able to pile on and possibly coordinate their selling efforts, the results of which would likely bring BTC’s price sharply lower.
Abundance of Warning Signs
There are an increasing number of warning signs surrounding BTC that appear to suggest the current price trajectory may be unsustainable in the short term. There is an extraordinary amount of hype surrounding Bitcoin, as every news and business network appears to be fixated on BTC’s price. Even Janet Yellen was forced to field several questions regarding Bitcoin at the Fed’s conference on Wednesday. This level of publicity creates a certain level of mass hysteria amongst people. Due to this, individuals aren’t buying Bitcoin to use as a currency or as a store of value anymore, but are buying BTC in an attempt to get rich quick and because of the fear of missing out. Unfortunately, they seem to be buying BTC at a very high level, and this phenomenon is typically emblematic of a possible short-term top in the market.
Moreover, it is likely that professional speculators have been waiting for an opportunity to short Bitcoin. Now with the advent of Bitcoin futures trading, and with an abundance of warning lights flashing that the “Bitcoin Bubble” is here, market participants may get the chance to short BTC very soon. Once prices decline by 20% or so in a short time period and don’t bounce back right away, some kind of panic may ensue which will cause more sellers to get out and more shorts to pile on top. I would not be surprised if prices declined to $12,000 from here, then below $10,000, maybe even down to $6,000, and if the panic selling gets really bad, prices could conceivably fall below $6,000 in a relatively short period of time.
The Bottom Line
Although I am constructive on Bitcoin long-term and believe it can play an important role in the world economy down the line, BTC remains far from a sure bet. Bitcoin is still a very speculative investment vehicle, interest in which is currently largely fueled by a desire to get rich quick, and by the fear of missing out, a very dangerous market dynamic indicative of a bubble. I would not buy Bitcoin at this level and would definitely not take out a mortgage to invest in BTC.
Important Note: This article expresses solely my opinions, is produced for informational purposes, and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.
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Disclosure: I am/we are long COIN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long Bitcoin and plan to buy more on any significant pullbacks.