Could Bitcoin Go Bust?

We started 2018 where Bitcoin at a value of $14,112.2, ending the year at $3,742.7, a bit over 73% decline. At the beginning of 2018 we were in an euphoria that Bitcoin can only go up with predictions (e.g., Spencer Bogart of the Hedge Fund, Bitcoin Capital) that Bitcoin will reach $50,000 and above, in 2019. But, here we are, looking at a 73% decline rather than 250% gain.

There are no big predictions for 2019. The “fortune tellers” have gone underground and went silent. What a drastic change from last year.

We are entering 2019 with more fear and pessimism.  We learned that nothing goes to the moon forever and any quick unordinary run up is not sustainable and destine to collapse. But…didn’t we see that already happening, twice, in 2016? What made us think that this time it’s going to be any different?  We should bear in mind that no asset has ever been able to sustain a rapid spike – be it equity or gold or grain. The reason being is that these spikes cannot be supported by fundamentals. When there is no foundation, no “tower” can stand steady and firm.

If we examine closely who has been predicting high valuation of Bitcoin price, it becomes clear that these exuberant valuations are made by people with a vested interest.  The likes of Roger Ver or Timothy Draper or the Crypto Hedge Fund managers such as Spencer Bogart or Thomas Lee. None of them has ever based any of their valuations on fundamentals. If it wasn’t a “gut” feeling, the best they could come up with was either “technical” or “mining costs”.

It’s time we stop guessing and start looking at the fundamental and economic drivers of Bitcoin.

One aspect that we should consider is the proliferation of altcoins in the past couple of years.  The increase in the number of altcoins has two economic effects: (1) Macro – depressing purchasing power; (2) Micro – competition. User’s perspective: users have more options to choose from. Let’s examine these two effects.

Macro effect – Depressing purchasing power

The bullish case of Bitcoin is that its nominal exchange rate with other cryptocurrencies will adjust in proportion to their relative supplies. This means that Bitcoin would appreciate relative to other altcoins and thus its market capitalization share would stay constant over time.  However, this bullish scenario is not what we have been observing in the past few years.

Source: CoinMarketCap

Looking at the above chart, we can see that in 2013 Bitcoin market share was around 95% and continued to remain significantly high until March of 2017 (a tad above 84%). But, its market share dropped sharply in the following three months to 39%, while Ethereum gained market share and rose to 32% around June 2017. In beginning of 2019, Bitcoin has been hovering around 50% or so market share.

What are the implications of this trend?

Consider the other extreme – the bearish case. Suppose that Bitcoin has no fundamental value and eventually the market will recognize that.  Bitcoin could still trade above its fundamental value (whether it’s zero or not), very much like other assets or securities. For example, gold trades above its industrial value. The premium people are willing to pay for gold reflects the value that it possesses as exchange media. If this premium vanishes, the market value of gold would decline but not fall to zero. Same can be applied to Bitcoin. It may carry a premium value whether due to its decentralized or permissionless features. Since some people value these features, they will be willing to pay for it and thus create a fundamental demand for Bitcoin. This demand provides a non-zero lower bound on the price of Bitcoin.

Economic theory suggests that price dynamic of an unbacked asset is likely to be highly volatile and inherently unpredictable. Bitcoin price may not fall to zero. However, the proliferation of new altcoins competing with Bitcoin, as alternative assets, held by investors, is likely to place a downward pressure on the purchasing power of all cryptocurrencies, Bitcoin included.

Micro effect – User’s perspective

In the past couple of years, many new altcoins, new protocols, new platforms have been introduced to the user. Whether it’s an individual seeking payment with cryptocurrencies or a business considering a platform to build its DApp, each has many more options to choose from. Some of these options offer faster and cheaper transactions, others offer more privacy. Whatever the use case is, they simply offer more competition. More competition also means pressure on prices to go down. But, this is all good for the user.

The new altcoins provide better alternatives to the user, in terms of both costs and efficiency. A user may pay $30 in transaction costs for transferring less than a dollar worth of Bitcoin (i.e., 0.0001 BTC), and transfer may take a few minutes until it is confirmed. In contrast, EOS transactions may take a few milliseconds and has no transaction cost. (EOS producers (the equivalent of miners on Bitcoin) are only paid per block produced, while Bitcoin’s miners are paid both per block and per transaction.) Another example, for a cost effective and fast blockchain is Stellar, which explains why IBM chose to build its blockchain on Stellar.

Bitcoin may have been the first blockchain, but it may not necessarily provide the best solution for users. It’s not uncommon that the first attempt in a new space is not the best solution and others that follow may rise to the top while the first project will become nothing but a faint memory in the pages of history. We have seen that with Google, Facebook and iPhone. They were not the first solutions, but they were most definitely the best in their field.  We don’t know yet, which platform is the “Google” of blockchain. It is quite likely, though, that it may not be Bitcoin.

Competition will increase as more altcoins and platforms continue to be developed and introduced to the public.  What does it mean for Bitcoin? Maybe bitcoin will be losing its “power” and thus its value.                                                                                                tags: bitcoin price prediction, bitcoin analysis, bitcoin investment

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