Bitcoin has been unstoppable in 2017
Bitcoin has moved up a whopping 1,600% to reach $15,600 YTD in 2017. This astronomical return is after taking into account the recent correction of 28% from the highs of $20,000. A number of factors have pushed bitcoin higher. At the top of the list is the potential of the blockchain technology that underlies most virtual currencies, including bitcoin. Blockchain has the potential to fundamentally change and lower transaction costs. According to analysis by the Economist, annual revenues earned by the banking system for processing payments were approximately $1.7 trillion in 2014, or 2% of global GDP at the time. Hence there exists significant potential for blockchain technologies to capture a large portion of this opportunity. Blockchain will fundamentally alter today’s platforms for finance, insurance, and governance, among others.
Given the increased investor interest, the Bitcoin price is expected to scale new highs in the coming days. However on the flip side, there are several reasons it could come crashing down, so let's take a look at some of them
- Increasing Transaction Costs
One of the USP of bitcoin as a payment mechanism was its low transaction costs. After all, if it costs a merchant 3% of the transaction amount to accept a credit card, but just a few pennies to accept bitcoin, that solves a real problem. However, this hasn't been the case recently, especially as bitcoin soars in value. People are paying $30 for the average bitcoin transaction right now, and are even paying exorbitant fees on small transactions, like sending $100. By becoming expensive and slow, bitcoin is at risk of losing its competitive advantage unless a solution is found.
- Slow Transaction Speeds
One of the biggest obstacles to bitcoin's widespread adoption as payment method is the increasing transaction times on the network. Simply put, the blockchain network is not equipped to handle large numbers of transactions in its current form, and the surge in interest in bitcoin is leading to delays. It takes 78 minutes to process the average bitcoin transaction, according to Blockchain.com, but this has recently spiked to as long as 1,188 minutes (almost 20 hours) during peak volume times. So, such a delayed processing can affect bitcoin’s popularity and stop its mainstream acceptance.
Bitcoin's price has gone nearly straight up for much of 2017, so it's fair to say that there are quite a few people out there sitting on some major profits. At the end of the day, bitcoin's price is governed by the same basic dynamic that determines the price of almost everything else: supply and demand. It's also fair to assume that at some point, people who bought bitcoin a while ago are going to start taking some profits.
If a significant amount of bitcoins are sold, to the point where the supply on the market exceeds demand, it could put significant downward pressure on the price of bitcoin until equilibrium is achieved.
- A major hacking incident occurs
Another critical risk for bitcoin is the potential for a cyberattack. In 2014, the Mt. Gox bitcoin exchange which handled 70% of all bitcoin transactions. However, this came to a screeching halt in early 2014 when the exchange suspended trading and announced that hackers had stolen about 850,000 bitcoins, which were roughly worth $473 million at the time and represented 7% of all bitcoins in circulation. Not surprisingly, bitcoin's price crashed. In fact, the Mt. Gox breach triggered the sharpest fall in bitcoin's price to date.
In recent times, bitcoin exchanges have taken steps to become far more secure than they were just a few years ago. It is highly unlikely that a theft of this scale, or even close to it, could happen anytime soon.
- Government regulations spoil the party
The prospect of government regulation is another potential wildcard, and could work for or against bitcoin and other digital currencies. Japan recently recognized bitcoin as a valid method of payment, which is a big reason for the current rally. On the other hand, many other countries around the world haven't regulated bitcoin much. The United States hasn't done much, other than labeling cyptocurrencies as capital assets and issuing warnings to investors. However, if a major country were to, say, outlaw bitcoin transactions as a way of cracking down on money laundering, it could have devastating effects.
- Brand-name businesses stop accepting bitcoin
Since 2014, a handful of brand-name businesses have accepted bitcoin as a form of payment, with smaller merchants latching on in recent years. Some investors view this growth in bitcoin's payment platform as a good reason to buy. However, it could also be a source of investor frustration. If bitcoin remains volatile (remember, it's had three declines of at least 29% in a very short period of time over the past five months), there's the real possibility that merchants could bow out of accepting the virtual currency. A potentially lengthy settlement period gives bitcoin time to move against the grain, which could mean converting bitcoin into a lot less cash than when a transaction was completed. If brand-name merchants bail on the virtual currency, bitcoin's price could tumble.
The above 6 reasons are only one side of the story. Sure, I believe that bitcoin could crash (and that everyone who buys bitcoin needs to acknowledge this possibility), but the digital currency could also soar to higher valuation if things go well. The point is that like any young and exciting market, there's an enormous amount of uncertainty surrounding bitcoin's future, and it's important to consider all possibilities before jumping in.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.