Bitcoin - Days Of Future Past

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Includes: BTC-USD, COIN
by: Dilantha De Silva

Summary

Bitcoin reached all-time highs in 2017 but the bubble eventually crashed.

Future outlook for Bitcoin should not be analyzed solely based on tech-specific parameters. Rather, the focus should be on the macro-economic environment surrounding the growth of its underlying technology.

Regulatory pressures remain the biggest risk for the future of Bitcoin and policy makers can become relentless to protect interests of market participants.

The blockchain technology can be considered as one of the most disruptive technologies invented in the modern history but this doesn't provide any assurance of the future growth of Bitcoin.

Investment Thesis

Technological advancements are taking the center stage and the general market assumption is that Bitcoin will revolutionize the e-commerce concept and how consumers will transact online and in person. On the contrary, I believe that Bitcoin will lag behind traditional payment methods and faces the risk of never becoming the store of value that it promises to be. Bitcoin’s future lies in the hands of regulators and its inherent risks far exceed its benefits at present.

Bitcoin boom in 2017

Since its invention in 2009 presumably by Satoshi Nakamoto, Bitcoin has had several euphoria filled trading seasons but none was wide spread than the most recent one of those that we experienced in 2017. Bitcoin traded close to $1,000 per coin on the 1st January 2017 and in December, reached an all-time high close to $20,000 per coin.

Bitcoin price movement in 2017

(Source – Coindesk)

Same with every other asset class, short-term price movements of Bitcoin are driven by demand and supply equilibrium and in 2017, demand for Bitcoin skyrocketed whereas the available count of Bitcoin increased at a much lower rate. In any case, the total capacity of Bitcoin is capped at 21 million coins.

Drivers of the Bitcoin boom in 2017

Legalization of Bitcoin in Japan

Japan legalized the use of Bitcoin on the 1st of April 2017 and this spiked the demand for Bitcoin considerably. Outlets in Japan started accepting Bitcoin as a valid mode of payment and Bitcoin exchanges flourished across the country. The importance of this legislation could be established by looking at the below table which shows how Japan took the front seat as the nation with the most reported Bitcoin transactions in 2017. Japan has accounted for more than 50% of the total Bitcoin transactions in 2017, which is proof of the rapid adoption of Bitcoin in the country.

(Source – Twitter)

Institutional inflows

Financial institutions around the globe had turned a blind eye on Bitcoin until the dawn of 2017 and they more than compensated for that by acquiring large stakes in Bitcoin in 2017. The entrance of institutional investors to an asset class or even a single security for that matter sends one message loud and clear; there’s money to be made! There were two major effects of institutional investing in Bitcoin.

  1. Demand for Bitcoin increased sharply.
  2. Boosted the confidence of the general investing public and created an additional demand for Bitcoin stemming from the general investing public.

The adoption cycle

With the entrance of institutional players, Bitcoin surpassed the awareness phase in the adoption cycle and moved on to the mania phase that saw market participants act in frenzy to grab a piece of “digital gold”.

Highlights of institutional investing in Bitcoin include:

  1. Development and rapid growth of Bitcoin ETFs such as XBT provider Bitcoin Tracker One.
  2. Introduction of Bitcoin hedge funds.
  3. Establishment of Bitcoin derivative exchanges such as LedgerX.

Increased media coverage

Prior to 2017, mainstream media outlets were not interested even in covering Bitcoin let alone dedicating a separate section of their websites for Bitcoin or allocating an important time slot to discuss Bitcoin. Few months into 2017, Bitcoin was the talk of the town and was increasingly being regarded as an alternative asset class that could even trump Gold as the most reliable store of value in times of economic distress.

For an example, New York Times, the Wall Street Journal and even CNBC took steps to dedicate a separate section of their respective websites to publish updates, articles and analysis on Bitcoin. By mid-2017, Bitcoin had established itself as an asset class in its own right.

Extensive media coverage on Bitcoin paved the way for Bitcoin to be considered as an investment option for the average investor as well and this brought in millions of dollars as investments from the general public who had the least understanding of how blockchain and Bitcoin operate.

Store of value concept

Bitcoin emerged as a potential candidate to replace gold as the primary store of value and prominent investors contributed to this theory by conducting analysis to depict how Bitcoin would act as a buffer to value erosion that could result from changing government policies and currency fluctuations. A distinct feature of Bitcoin is that it is not being managed by a central regulatory authority and this was cited as a catalyst which would enable Bitcoin to be foolproof against regulatory policy changes.

Peter Thiel, speaking at The Future Investment Initiative in Saudi Arabia cited “It’s like gold, and it’s just a store of value. You don’t need to use it to make payments

Whereas Bitcoin was initially recognized as an alternative payment mechanism, the most recent catchphrase has been the store of value theme.

Investors; small scale and large scale alike pounced on the idea that Bitcoin could one day spike like gold did in the past and this led to panic buying on exchanges around the globe.

Future outlook of Bitcoin

Like all bubbles, the Bitcoin bubble crashed in late 2017 and Bitcoin has never been able to recover meaningfully ever since despite the optimism supposedly spread by “Bitcoin bulls”. Warren Buffet went on to slam Bitcoin as “rat poison squared” and Charlie Munger followed suit by claiming “Bitcoin is worthless, artificial gold”.

Whilst there have been mini-rallies based on speculative reasons, the stand alone meaningful event for Bitcoin in 2018 has been its inclusion as a study area in the CFA curriculum.

YTD price movement of Bitcoin

(Source – Investing)

Regardless of all the positive claims by analysts and so-called analysts, the future value and even the existence of Bitcoin will depend mostly on the regulatory outlook for Bitcoin.

The most recent trend in the financial services industry has been to tighten regulations that govern investment related activities, products and services and this is true for a wide array of asset classes and investment solutions including equities, bonds, mutual funds and of course Bitcoin related products. The regulatory pressure exerted on Bitcoin has resulted in a significant reduction of the number of Bitcoin transactions carried out on a monthly basis.

Number of Bitcoin transactions per day

(Source – Quandl)

Investors should not have the perception that Bitcoin would be able to survive without the approval of financial regulators around the world. In fact, Bitcoin might cease to exist (at least on legit platforms) if this is seen as a necessary security measure by global policy makers.

In order to assess the future outlook of Bitcoin, its most distinct features should be analyzed individually.

Decentralized payment mechanism vs regulatory pressures

Bitcoin’s attractiveness is grounded from its open source platform which allows its users to execute transactions without the need of a third-party such as a bank or financial institute. This very feature of Bitcoin welcomed all kinds of fraudsters, money launderers and terrorists wanting to hide their identities and undoubtedly this drove the price of Bitcoin higher due to the insurmountable demand for Bitcoin whilst giving headaches to regulatory authorities.

The decentralized structure of Bitcoin means that the transactions carried out can never be traced back to its origin and this is a context that governments are intending to curb at all costs and in fact, history suggests that governments have been curbing such products and activities for the best part of the modern history. If one had thought that the story would be different with Bitcoin, it should be considered as a high-cost misconception.

Eventually, regulators intervened and the party came to an abrupt end. China made the first move by banning cryptocurrency exchanges in Beijing and went to the extent of banning all kinds of activities related to cryptocurrencies including hosting events to discuss about the technology involved in mining cryptocurrencies. The government of China is setting up plans to clamp down on cryptocurrency exchanges all across the country. China being the second most powerful economy in the world and one of the most technologically advanced countries, is an important destination for the growth story of Bitcoin. However, China does not welcome Bitcoin which sends a clear signal to other governments as well.

Elsewhere in the United States, the SEC rejected an application to list a Bitcoin based ETF on several occasions and is currently considering the matter further. Joseph Rotunda, director of enforcement at the Texas State Securities Board said “the market for cryptocurrency investments is saturated with fraud and our work is only revealing the tip of the iceberg” in a press conference in which he introduced the Operation Crypto-Sweep; an action plan to tackle suspicious Initial Coin Offerings and crypto-related investment products.

Bank of England on the other hand is of the view that Bitcoin and other cryptocurrencies are inherently risky.

During the G20 summit in Argentina, it was unanimously decided that Bitcoin poses a risk to the global financial services industry and that necessary steps should be taken to avoid Bitcoin damaging the trust of market participants but declared that the risk posed by Bitcoin to the entire financial industry on a global scale is not significant and a ban on cryptocurrencies is not required at this point in time. The aggregate value of cryptocurrency transactions even at the height of Bitcoin in December 2017 was much lower than 1% of the global GDP.

All these actions, comments and plans speak of one thing; Bitcoin and other cryptocurrencies will be exposed to unforgiving regulatory crackdowns in the future and the magnitude of these crackdowns might evaporate some cryptocurrencies out of the face of earth.

One argument for the decentralized nature of Bitcoin is that it allows innovation at a much larger scale since there is no focus on access control. Traditional payment methods facilitated by banks are limited for innovations since access control is a key focus. The real question is whether regulators would chose innovation over access control and the answer to this is leading only in one direction.

Speed – Bitcoin vs traditional payment methods

It normally takes a few seconds for a Bitcoin transaction to go through and sending payments could never have been faster than what Bitcoin brings to the table. Zero-confirmation transactions will be processed instantaneously whereas a verified transaction by the blockchain technology takes about 10 minutes to complete. Speed at which Bitcoin transactions can be completed addresses the long standing issue of bureaucratic delays we all experience time to time when dealing with banks.

Banking systems and processes have also improved considerably over time with technological advancements and the speed with which an online transaction could be completed has drastically increased. High penetration of smartphones in most countries around the world, developing infrastructure, high internet speeds and the paradigm shift to doing things online have all contributed to the growth story of online facilities provided by banks.

Online banking penetration in selected European countries

(Source – Statista)

For now, it would be fair to call that online banking systems are a legit and reliable alternative with which one could complete transactions with the same speed as Bitcoin.

The real difference between Bitcoin and banks is visible when check payments are considered in the equation. Written checks would take around couple of days to process and this makes the global payment process much slower and a need arises for an alternative payment solution to address this issue and Bitcoin fits into the picture nicely.

Overall, it is conclusive that Bitcoin has a much faster payment processing turnaround time but in my opinion, this is not sufficient to justify the additional security risks that I would have to bear if I decide to use Bitcoin instead of traditional banking services. I would rather let the technology advance further and be wishful of a day where check payments would be processed fully electronically with a much lower turnaround time. Speed over security of funds would never be a viable choice in my opinion.

Cost effectiveness – Bitcoin is the undisputed leader

Purely from a transactional perspective, Bitcoin is the undisputed leader since transfer costs have reached record lows. In addition to this, Bitcoin provides the flexibility of executing transactions as and when those are required rather than sticking to a schedule adhered to by banks. For an example, there are more than ten bank holidays in the U.S. for a year but even on such days, Bitcoin transactions could be completed hassle free.

Average transaction fee for transferring Bitcoin

(Source – Bitinfocharts)

Banks and financial institutions on the other hand are coming up with counter measures to tackle these issues and prominent banks are offering digital only banking options to embrace the online only sensation. Banks might never be able to catch up with what Bitcoin is offering its users but on the other hand, added security with acceptable turnaround times might be sufficient to stay ahead of the game against Bitcoin.

Conclusion

In this analysis, I have discussed the reasons that led to the Bitcoin price hike in 2017 and the future outlook as well. The underlying technology and the concept of cryptocurrency are appealing but the inherent risks are bringing in regulatory crackdowns. I believe that cryptocurrencies are here for the stay but governments might consider developing their own cryptocurrencies to ensure access control.

Factors that contributed to the unprecedented growth of Bitcoin price in 2017 are now taking a different trajectory. Goldman Sachs ditched their plans to introduce a cryptocurrency trading desk and cryptocurrency thefts are bringing in more regulatory pressure on cryptocurrencies around the world. On the other hand, consumers are questioning Bitcoin’s ability to act as a store of value due to its drastic short term price movements.

Contrary to the belief of cryptocurrency gurus, I believe Bitcoin will continue to fall in price based on;

  1. Regulatory pressures.
  2. Introduction of more advanced, robust digital banking facilities.
  3. Development of state sponsored cryptocurrencies.

Even if Bitcoin is to survive in the long term, the value of a coin could decrease substantially in the short to medium term. Claims of Bitcoin replacing the dollar and other fiat currencies sound mere optimism to me. The volatility in Bitcoin can erode the purchasing power within a matter of few hours and this fails to satisfy one of the basic characteristics of money; acting as a store of value.

It should be acknowledged that blockchain could be one of the most impactful and transformative technologies ever discovered but this does not mean Bitcoin will reach unimaginable heights.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.