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Electronic Payments, Monetary System And Why Bitcoin Is Falling


A disruptive technologic innovation and its application to the electronic payment industry.

Why Bitcoin price is falling.

What happen next including a target price for Bitcoin.

A Disruptive Technology

There is no doubt that block-chain is one of the most disruptive technologic innovation of the last decade. There is also no doubt that Bitcoin is and will be remembered as one of its earliest applications.

While block-chain will likely continue to develop and thrive, Bitcoin has lost its first mover advantage, is being attacked on all fronts and its price is falling at a dramatic pace.

So why is this happening and what is a probable way forward?

Let's start from blockchain. In very simple terms, blockchain is an accounting system, the distributed ledger, leveraging the power of the web to create a new way to exchange electronic payments. There is nothing wrong with this and, in fact, it has the potential to disrupt or, at least, improve the existing electronic payment systems.

Let's continue with cryptocurrencies. Cryptocurrencies are not only one of the first applications of blockchain and an attempt to create an alternative electronic payment system, they are also an attempt to create an alternative monetary system by creating alternative currencies. Bitcoin is the most famous of these alternative currencies but the list is long: Litecoin, Ethereum, Zcash, Dash, Ripple, Monero and so on the so forth.

Blockchain Application to the Electronic Payment Industry

So let's now start from dissecting some popular misconceptions. Blockchain has often been described as a way to process payments or transfer wealth bypassing the banking system. This is a faulty statement and belongs more to Bitcoin than to blockchain.

First of all, within the electronic payment industry, banks are mostly a distribution channel rather than an electronic payment infrastructure provider. Blockchain mostly aims at innovating the payment infrastructure rather than its distribution. Among other things, banks allow customers to deposit their savings in a secure way and draw on these savings electronically through debit and pre-paid cards. Banks also help customers exchange one currency for another, leverage on these savings by providing credit and so on and so forth. Banks employ millions of people globally and will continue to do so. Among the many things that bank employees do, the most important task is taking care of customer satisfaction. From answering questions about the functioning of current accounts, to re-setting account logins or dealing with mortgage applications. All this will not change with blockchain. Furthermore, among their many tasks, bank employees deal with transaction reconciliations, i.e. making sure that transactions are recorded properly and electronic payments are certain and reliable. This often happens in the background and can be a pretty complex task under the existing centralised payment infrastructure; even more complex and costly when errors occur and banks have to manually interact with each other to reconcile transactions and indemnify their customers. These tasks are often called back-office operations and are the areas of a bank business that will change most disruptively as a result of the adoption of blockchain technology.

So, which other players populate the electronic payment system?

The answer is not that complex and is in front of most people eyes every day. While banks provide customers with a secure way to store savings, there are companies like Visa, MasterCard and American Express that create the infrastructure to allow banks and, indirectly, their customers, to exchange electronic payments with one another.

Finally, on a less visible side of the electronic payment system, there are companies that help banks issue payment cards (the plastic electronic device), process payments and enable merchants to accept electronic payments through POS machines. There are traditional players, such as FirstData, and disruptors, such as Apple Pay. 

Will the electronic payment industry be disrupted by blockchain startups?

Building the electronic payment system has taken decades and will unlikely be completely disrupted by blockchain; the main reason is that the distribution of electronic payments is capillary and global and such capillary, global distribution is more powerful than blockchain itself. The bad news for those that are not only betting on blockchain but also on blockchain new entrants is that incumbents, such as banks and providers of electronic payment infrastructure and technology, are ploughing billions into developing, adapting and adopting their own blockchain technology. While it is not impossible that new entrants will gain market share in the electronic payment system, the additional bad news for those that are not only betting on blockchain but also on blockchain start-ups is that large, deep-pocketed behemoths such as Apple, Facebook, Google and Amazon, with their capillary and global distribution, are more likely to disrupt the electronic payment industry than blockchain startups. For the believers of blockchain start-ups, beware of the formidable competition and overvalued storytellers.

Alternative Monetary Systems and Why Bitcoin is Falling

Let's now move the discussion from the adoption of blockchain in the electronic payment industry to cryptocurrencies. We mentioned earlier that cryptocurrencies are attempting to create an alternative monetary system and we said that there is long a list of them. Bitcoin was the first mover and is currently the most pricy one, currently trading at between $7,000 and $8,000 per Bitcoin (5-2-2018). 

Isn't Bitcoin best placed to win the cryptocurrency race?

The author's answer is no and this is why. 

Anonymity: this is the first and most important fault of Bitcoin. Governments have been fighting for decades to ensure payments and transfers of wealth happen transparently. They have also been fighting for decades to convince offshore tax heavens to lift bank secrecy rules and accept the Automatic Exchange of Information. The reason why anonymity of electronic payments will never be accepted by governments is that it permits money laundering and tax evasion. The rise of Bitcoin has long been ascribed to the proliferation of illicit transactions. Narco-trafficants, smugglers and tax evaders had finally found an innovative way to transfer large amount of cash from one place to another with total anonymity! What a miracle of technologic innovation! It is no surprise that governments have decided to fight against Bitcoin and crackdown on illegal transactions. This means many of the recent beneficiaries of the Bitcoin market are exiting as fast as they can and this is one important organic reason for the fall of the Bitcoin price

Volatility: who would accept a currency that fluctuates in value as dramatically as Bitcoin? The price of Bitcoin increased from $13 per Bitcoin at the end of 2012 to almost $1,000 a the end of 2016 to more than $19,000 at the end of 2017 and then crashed to less than $7,500 at the date of this article. In the last weeks, the price of Bitcoin had daily price changes often in excess of $1,000. Some of the outstanding price increase occurred before the end of 2017 can be ascribed to illicit transactions. Part of it, including the most recent price volatility, can be ascribed to speculators and leverage (speculators borrowing from banks to purchase Bitcoin). The start of the crash of Bitcoin in January 2018 is mostly driven by governments starting to regulate the cryptocurrencies and fighting against illicit transactions. This is a completely legitimate action to preserve the rule of law and avoid that transactions in cryptocurrencies are used to launder money earned from criminal activities or evade taxes. As illicit bearers of the currency exits the market, the price of Bitcoin collapses. At this point, speculators, including highly levered speculators, start to make losses and start selling the currency. Price drops even further. The result of all this is a tremendous price volatility that makes Bitcoin completely unreliable to settle transactions in the real economy. Why should any merchant accept payments in a currency whose value could fall by more than $1,000 the day after?

Connection to illicit activities and refusal to exchange into other currencies or goods: as Bitcoin transactions are anonymous, if banks cannot track the source of the funds they won't exchange large amount of Bitcoin into other "real" currencies; as the price of Bitcoin is volatile, real economy market participants won't accept to exchange goods for Bitcoin; as Bitcoin is now well known as a currency used for illicit activities, banks in the US and around the world are starting to ban Bitcoin transactions completely.

Anonymity, price volatility and connection to illicit activities are three very strong reasons why Bitcoin is failing and its price is collapsing. In fact, there is a decent chance that, for these same reasons, Bitcoin could be completely banned by governments. Legality cannot be ensured with anonymous electronic payments. As Bitcoin is anonymous and this cannot be changed, the author of this article believes that a global ban on Bitcoin is possible. Politicians from around the globe attending the World Economic Forum in Davos have put cryptocurrencies such as Bitcoin under the magnifying glass and called for more regulation. Actions from regulators have already started.

I have been pretty negative about Bitcoin; what about the other cryptocurrencies?

Anonymity, price volatility and illegality will not cope well with the cryptocurrencies' mission. So any winner should take distance from this. Nonetheless, there are two additional weaknesses of cryptocurrencies that make the author of this article strongly sceptical about the possibility that any of them will succeed.

Lack of an interest rate: in typical monetary markets, savers can invest their currencies in securities earning interest. There is no institution in the world currently offering to pay an interest rate to receive any of the existing cryptocurrencies. This is an important factor as it means the exchange rate between such cryptocurrencies and real currencies is, at the minimum, destined to reduce in value on a permanent basis. Put it simply, if you borrow 100 US$ to buy a cryptocurrency at 2% borrowing rate and then re-exchange the cryptocurrency into US$ 1 year after, assuming no price fluctuation, you will have earned $0 on the cryptocurrency and you will have to pay $2 to the bank from which you borrowed US$100. Since most speculators borrow money with credit cards, at rate of between 10% and 20%, their loss, assuming no price fluctuation, will be even higher.

Lack of a cryptocurrency Central Bank: Central Banks play a critical role in our society as they control the monetary supply trying to achieve price stability in a certain region. As long as cryptocurrencies try to escape from the traditional monetary systems, they will play against the public interest of stability in prices and control of monetary supplies. So the author of this article believes that as long as cryptocurrencies will remain outside of the traditional monetary system, such cryptocurrencies will fail and will likely be banned by governments and regulators.

Conclusions and what happens next

In conclusion, the author of this article believes that blockchain is an outstanding innovation, will be adopted by the existing electronic payment industry and will cause some disruption in some existing areas including banks' back-office operations (these will likely shrink in size with some job losses at the benefit of banks' productivity).

Cryptocurrencies are born from the misconceived idea that they can: a) disrupt the electronic payment system b) disrupt the existing monetary system. Such idea is silly because cryptocurrencies and Bitcoin in primis has been playing against public interest. This will not be accepted by governments and regulators and will legitimately be banned in the interest of the broader population. A population that plays by the rules, that is against illicit traffic, that desires to earn an interest on its savings and that benefits from price and currency stability.

As such, the author of this article believes that a global ban on existing cryptocurrencies is becoming more and more probable. The idea of a cryptocurrency can be hugely beneficial for countries suffering from domestic currency volatility. The idea of a global cryptocurrency is enticing (imagine a world where you can pay in one single currency) but anachronistic (see how difficult it is to ensure a single currency in Europe; imagine how difficult it would be on a global basis). So that success of one cryptocurrency cannot be completely ruled out. However, if any cryptocurrency will ever prevail, it will be one that plays by the rules and cooperates with governments and central banks to find a solution that benefits the population globally.  

Price target for Bitcoin

It likely does not come as a surprise that the author's short to medium term price target for Bitcoin is in the region of between $0 and $100.

$0 in case a global ban on Bitcoin occurs.

$100 or less if a global ban does not occur but illicit bearers of Bitcoin sell as fast as they can and speculators continue to do the same to avoid losses.

The author of this article cannot find a single fundamental reason why Bitcoin  price should increase or recover and believes any bounce back in the price of Bitcoin is driven by speculation.

Disclosures: under the principle that I put my money where my mouth is, the reader won't be surprised that I am short on Bitcoin and I sell every day a little more.

Disclosure: I am/we are short Bitcoin.