As The Bubble Bursts: 3 Things You Should Know About Bitcoin

Daniel Carlson profile picture
Daniel Carlson


  • Bitcoin has just entered a bear market.
  • Fees and energy consumption make it a long-term loser.
  • Wall Street is short and will win again.

As I type this article, Bitcoin is flirting with entering a bear market. This week's newsletter highlights three relatively underfollowed, or misunderstood, stories in the background. Each of which alone virtually guarantees the arrival of a bear market. Altogether, combined with a bubble of tulip proportions, is setting the stage for an epic collapse.

The topics of the day are as follows:

  1. Bigger than Denmark...
  2. Fees???
  3. Wall Street versus Main Street...

But, first off, the background on how we got here. It all started with the development of the blockchain, the underlying code allows for users to transfer digital assets directly to other users, in a secure and verifiable format. In an ever-digital world, blockchain is truly revolutionary and, as such, investors are piling into blockchain-type investments.

The most popular of these, by far, is the original blockchain currency that kicked it all off: Bitcoin. Since its creation in 2009, the price of Bitcoin has climbed from its start at a few pennies, most recently going parabolic to hit close to $20,000 per bitcoin. This is, of course, the definition of a mania, or bubble, and is destined to end.

Bitcoin is trading today at $15,700, which means it's down over 20% since reaching its recent high. The definition of a bear market is down 20%. This is not, however, the first bear market for Bitcoin, which has had several, very short-lived, downturns in its past. This time, however, I think it will be different. But, we'll get to that in a little while. First, the issues that doom Bitcoin's relevancy in the long-term and guarantee the inevitable fall from glory.

Bigger than Denmark... in terms of power consumption

Few people (at least I believe them to be few) understand the way Bitcoin transactions are processed and, more importantly, the massive energy consumption behind them. In an article titled Bitcoin's Insane Energy Consumption, Explained, by ARS Technica, they lay out in great detail how it all goes down.

The skyrocketing value of Bitcoin is leading to soaring energy consumption. According to one widely cited website that tracks the subject, the Bitcoin network is consuming power at an annual rate of 32TWh—about as much as Denmark. By the site's calculations, each Bitcoin transaction consumes 250kWh, enough to power homes for nine days.

Naturally, this is leading to concerns about sustainability. Eric Holthaus, a writer for Grist, projects that, at current growth rates, the Bitcoin network will "use as much electricity as the entire world does today" by early 2020. "This is an unsustainable trajectory," he writes.

Realize that Bitcoin, at this time, is just a bit player in the global payments industry. The number of Bitcoin transactions processed each day is a tiny fraction of the number of Visa (V) or Mastercard (MA) transactions, which is itself just a fraction of the payments industry. The point being that it seems impossible for Bitcoin to become a true currency as it is currently established.

The article does go on to discuss three possible ways to reduce the energy consumption behind the digital coins...

While Bitcoin may not be a total environmental disaster, the Earth would certainly be a greener place if the Bitcoin network didn't consume so much electricity to process a relatively small number of transactions.

There are basically three ways this could happen. One way, as we've already discussed, is for Bitcoin's price to decline.

A second option would be to shrink the network's 12.5 bitcoin-per-block reward sooner than the scheduled 2020 reduction. But that's easier said than done. Bitcoin mining companies are not going to go along with this willingly, and Bitcoin traditionalists are likely to oppose such a move as well.

Governments may also be powerless here. If any one country tries to force a change, mining operations would simply flee to another jurisdiction. Changing Bitcoin by regulatory fiat would require a coordinated global regulatory effort, which doesn't seem likely to happen any time soon.

A third option would be to change the Bitcoin mining process altogether. Bitcoin's current mining algorithm is based on computing a supermassive number of cryptographic hash functions. But other cryptocurrencies have been exploring alternatives. Bitcoin Gold is a recently created variant of Bitcoin that uses a "memory-hard" mining algorithm that might prove to be less power hungry—though it would still consume huge amounts of juice. More exotic mining algorithms exist that could dramatically reduce power consumption. Switching to an alternative mining algorithm would also be controversial among traditionalists and would be strongly opposed by miners. It would wipe out mining companies' multi-million dollar investments in custom mining hardware. Such a step is not impossible, but it seems unlikely to happen any time soon.

All of which means that Bitcoin's power-hungry ways are unlikely to change any time soon.

So, Bitcoin is using more energy than Denmark and that is only going to grow. Unless, the price goes down. That doesn't sound too promising, does it?

Fees... the currency of the future charges more per transaction than the currencies of the past?

This doesn't seem logical at all, does it? Wasn't Bitcoin supposed to, as a true peer-to-peer network, allow micro-payments and the like? Yet, think about it. Someone is processing these transactions and using all the energy in Denmark or wherever. They are buying computers and "mining" coins, which basically means investing in the network so that the blockchain is maintained. There's an expense to all of this and it comes back in the form of fees.

In an article by CNBC, the increasing cost of trading in Bitcoin is detailed. It's eye-opening, what the expenses are to do a simple transaction.

Bitcoin's price isn't the only thing soaring to colossal levels.

People are currently paying $28 on average to make transactions using the digital currency, according to data by BitInfoCharts.

Users of cryptocurrency exchanges like Coinbase incur such transaction fees when transferring money to an external bitcoin address. Bitcoin addresses are like virtual bank account numbers where users can store their bitcoin tokens.

Last week, a journalist said on Twitter that he paid $15 to send $100 worth of bitcoin from a digital wallet to a hardware wallet.

And earlier this month, another person claimed on Twitter that he had to pay a $16 fee to send $25 worth of bitcoin from one bitcoin address to another.

Bitcoin transaction fees are proving to be profitable for so-called bitcoin "miners". Miners work out complex cryptographic puzzles to add transactions to the blockchain, a decentralized record of all bitcoin transactions. They are paid in bitcoin in return for their services. On Monday, the total value of all transaction fees paid to miners hit an astronomical sum above $11 million on that one day, according to data.

I find it next to impossible to believe that the fees associated with Bitcoin are this high, yet it's true. At $28 per transaction, they are unsustainable. And, like power consumption, there's really only one way they get reduced... with a lower price of Bitcoin.

Wall Street versus Main Street... the outcome never changes

This last week has seen the coming of many different financial instruments that allow investors more opportunity to place wagers on the future value of Bitcoin. Designed by Wall Street, these vehicles are bringing institutions into the playground that is Bitcoin trading.

There have been many jokes about how Wall Street is late to the game and that the average person has made the "easy money" in Bitcoin. As the price spiked to $19,000 on a vertical climb, this chatter got louder.

While it may be true that some people have indeed profited handsomely from the recent movement, let's be very clear about Wall Street. Just because the financial derivatives have come into existence at the heights doesn't mean that Goldman Sachs et. al. is backing up the truck here and buying digital currencies. Bitcoin's parabolic run of the last few weeks was very much Main Street piling in at the top of the bubble and Wall Street selling to them. And, now that they can short Bitcoin more easily, you better believe that they are the ones fading this move in bulk.

A few headlines from the last week should drive this point home.

The top of the market could very well coincide with the beginning of futures trading in Bitcoin. But, Wall Street will not be the ones going down with the ship. Instead, they are going to be shooting holes in the hull of the Bitcoin battleship, cheering as it goes to its watery grave. Sadly, the inevitable outcome is always the same.

As the bear market starts, Bitcoin's days of trading higher are likely over. Like your mother said, you shouldn't play in the street.

This article was written by

Daniel Carlson profile picture
At TW Research Group, we look for select micro-cap opportunities where we believe the market is misjudging of a company's potential. We employ Evidenced Based Investing to screen ideas. TW is NOT a broker dealer and we always recommend you perform your own due diligence before investing. TW works with and is compensated by many micro-cap companies.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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