Bitcoin’s creepy crumble creates cryptoccurrency cryptic puzzle
• Investors and analysts question future of digital currencies after many ‘investors’ burn fingers
Iwill no’ be tellin’ ye ‘I told ye so’, but I will be usin’ words to that effect ... I was right, aye? — Marcum, in bestselling author Suzan Tisdale’s Isle of the Blessed. Schadenfreude — the pleasure or self-satisfaction that comes from learning of or witnessing the failure or humiliation of others — is something many a “wise” investor will have experienced as the cryptocurrency market came crashing down last week.
Cryptocurrencies fell in value by more than 25% in 24 hours and about $100bn in “value” simply disappeared in one day last week, says the digital currency-tracking site CoinDesk.
Bitcoin, the leading cryptocurrency, was down more than 60% from its record high of only two months ago. The value of each unit of bitcoin dropped as low as $7,700 on Friday, compared to $10,000 on Wednesday and about $20,000 at its peak in December.
So, what happened? That’s a difficult one to answer — the drastic drop in cryptocurrencies is about as easy to explain as their insane rise in 2017.
Coindesk puts it down to a confluence of events that include government intervention, more sophisticated traders coming into the market, the debut of bitcoin futures and the strain of increased interest.
“By far, the most prevalent explanation is that harsh stances by governments in China and more recently, South Korea, caused many investors to flee,” say Marc Hochstein & Bailey Reutzel. “China, for one, has caused the markets to drop in the past. More recently, South Korea regulators have been hammering on the crypto industry all month, with banks facing scrutiny over crypto exchange relationships and investors facing fines for anonymous trading accounts.
“Secon, and perhaps interesting in its counter intuitiveness, is that far more technical people are a part of the cryptocurrency markets now, and while the interest by these sophisticated investors has been widely seen as a beneficial development, their use of complex market tools can have effects on the price that many might not see as positive. [Such as] more experienced investors putting stop loss triggers at support levels “… the debut of bitcoin futures on Cboe and CME last month was also viewed with optimism, as a sign of the industry maturing, although the expiration of the futures contracts was a source of some trepidation … The increased interest in cryptocurrencies has also put a strain on market infrastructure.”
“Pretty much all the companies in the space are facing the influx of new users and it’s taken a toll on most companies,” says Nejc Kodric, CEO of Bitstamp, a crypto exchange that has been around since 2011. “While most understand the ecosystem is still new and, as such, prone to problems, when market infrastructure goes down, many people get worried … Put all those together and it’s easy to create a narrative that “hey, the market’s kind of overheated and needs to take a break”.
Others blame Tether. The company that controls and issues Tether is meant to hold US dollar reserves to back up all the Tethers that have been issued. In theory, Tether holders can sell one USDT back to Tether Limited for $1. But fears have emerged in the cryptocurrency community that Tether Limited doesn’t hold sufficient currency reserves to back all the Tethers in circulation. Even if true, it’s unlikely that uncertainty around USDT’s alone would have such an impact across the board. Who then, you may ask, are the “wise” investors mentioned above? In this case, pretty much anyone who agreed with the likes of Robert Shiller and Warren Buffett in claiming cryptocurrencies have no inherent value, and are classic bubbles that are extremely likely to burst at some point. And, as Shiller put it to CNBC, “might totally collapse and be forgotten”.
That seems unlikely. Along with the veracity of Shiller’s claim that “bitcoin has no value at all unless there is some common consensus that it has value”. As Moody’s Investors Service concluded in October 2017, when it tried to reassure the US payments sector that the threat of cryptocurrencies was distant, “eventually businesses will adopt the technology”.
As Nassim Taleb says, “bitcoin is the beginning of something great: a currency without a government, something necessary and imperative”.
Milton Friedman acknowledged that years ago, when he said, “I think the internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing, but that will soon be developed, is a reliable e-cash.”
And, as Peter Diamandis pointed out, “at its core, bitcoin is a smart currency, designed by very forward-thinking engineers. It eliminates the need for banks, gets rid of credit card fees, currency exchange fees, money transfer fees, and reduces the need for lawyers … all good things.”
The problem is deciding what that’s worth, in today’s money. “If you try to aim for some sort of intrinsic value, as I did a while back, I don't think looking at mining costs is the way to go,” says Glenn Howell a portfolio manager at Unum Capital. “Many miners aren’t massive ‘capital investment scale’ projects. They are small ‘mom and pop’ outfits mining ETH on a few graphics cards. Many of them see BTC trading at $100K or more in the future, so even if they looked at their costs and realised they are making a loss, they wouldn’t care. Keynesian economics doesn’t apply here.”
While equity investors can look at price:earnings ratios and such to value companies, it is hard to find similar yardsticks for bitcoin. “We have a price per token, but it’s not a company so there are no earnings,” says Willy Woo at Woobull.com. “However, since bitcoin is a payments and store of value network, we can look to the money flowing through its network as a proxy to company earnings.”
Woo calls it the NVT Ratio (network value to transactions ratio), but it feels a little like trying to put a value on Volkswagen by simply counting the number of cars it’s producing. “Theoretically, the fair-market value of one BTC should simply be the dividend of its predicted future monetary base and BTC in circulation, discounted by a ‘hurdle rate’ an investor would require in order to invest in the speculative currency,” says Ryan Selkis at Investopedia.
How do you predict the “future monetary base” and come up with an appropriate discount rate for a speculative currency that will never generate cash flows?
“We need to make certain assumptions,” says Selkis, and these “make all the difference.” Needless to say, things are a lot easier for crypto-enthusiasts who simply take to social media to restate their HODL-ing patterns and declare that this, in fact, is a great time to buy.
MANY MINERS AREN'T MASSIVE ‘CAPITAL INVESTMENT SCALE’ PROJECTS. THEY ARE SMALL ‘MOM AND POP’ OUTFITS