Investing

How Will Bitcoin Explode? Let Us Count The Ways

By  | 

Whether Bitcoin is living a bubble or not is still unknown. It is very difficult to predict the bubbles when you are inside them and only when a few years have passed since the peak can you assure yourself that the past was irrational. But of course, all the bubbles have their gurus, those who correctly predict the future, and there are already experts who say that Bitcoin is living in one.

There is no consensus. There are multiple reasons why a bubble may explode and more in the case of a cryptocurrencies such as Bitcoin, with certain legal and technical peculiarities that other financial products do not have.

Panic and descent

The first way in which Bitcoin can be assessed is the classic mechanism by which all bubbles explode. Without there being a specific reason, many investors start to collect profits and then Bitcoin begins to fall in price. This forces other investors to sell. In the end, there is seller panic and the falls are abrupt (within what the system allows)

If a consensus is created that Bitcoin really does not make sense, that it is a simply a virtual “game” and that there was no sense in investing in it, the price does not recover. That is, just as there is a certain consensus that Bitcoin is a meaningful investment, if the consensus changes and there is no real support behind it, the price can plummet in a definitive and lasting way.

This does not happen when the financial asset has a backing. For example, there may be a stock market panic with Tesla’s shares, but if sales are still strong when the quarterly accounts are published, the stock recovers. Behind Bitcoin, there is nothing and therefore a panic can really be a bursting of the bubble.

Who thinks that something like this can happen? The great Bubble Guru, Robert J. Shiller, Nobel Prize in Economics for his work in the valuation of assets, predicted in advance both the dot com bubble and the real estate bubble in the US. And he thinks that Bitcoin is living a bubble and that its prices, sooner or later, will fall.

Regulatory problems

But Bitcoin is not a financial asset in the classical style. It may have other types of phenomena that push its price downward. And one of them is a great regulatory crisis. What does this mean? Well, the governments of the world think that it is necessary to fight against Bitcoin, since it can be used for criminal activities and evade capital controls.

It is not a slight risk, but quite the opposite.Some countries, such as China and South Korea, are actively combating the use of Bitcoin. For the moment in a mild way, prohibiting the ICOs in the case of China and prohibiting its commercial use in the case of South Korea, but could go further. In fact there are countries (yes, somewhat authoritarian) where Bitcoin are firmly prohibited.

Some experts like Joseph Stiglitz, winner of the Nobel Prize in Economics, propose to completely ban Bitcoin while it is anonymous and the transactions have no explanation. Others, like Mark Haefele, Chief Investment Officer of UBS Group AG, are also categorical: they do not invest in Bitcoin because it would only take a terrorist attack in the US, financed through Bitcoin, for regulators to take it much more seriously.

If Bitcoin is experiencing a regulatory crisis, all the euphoria we have experienced in recent months may fade and only the real fans of virtual currencies and anti-state groups will remain. Of course, the risk of such a crisis is very real.

Hacked

Another problem that can destroy the value of Bitcoin are hacks. It is not the first time that an exchange is hacked, in fact the case of Mt. Gox is several years old. The consequence of said hacking was clear, the value of Bitcoin plummeted. But the volume was still small and new investors not chastised continued to enter. To this day a hack of a large exchange can be more decisive and sink the value significantly and durably. And is that these hacks are quite common, the last one only a month ago.

Anyway there is an even greater risk than the hacks to the exchange (which are like the Bitcoin banks). And is that the Bitcoin algorithm, the design behind the blockchain, is not safe. It is based on SHA-256, which today is considered safe, but a vulnerability in this hash algorithm could cause the entire value to vanish. A failure of this style would surely sink the value of a definitive form, although it could be solved with an agile change of the algorithm (which is far from simple).

Scalability technical problems

Bitcoin has other problems, this time technical. And its growth is showing that it has scalability problems. On the one hand, the commissions on transactions at current prices are outrageous, so much so that a Bitcoin conference has decided to stop accepting Bitcoin itself as a means of payment.

Another debate is that of energy consumption to maintain the Bitcoin network. And although energy consumption is usually talked about very cheerfully, the truth is that the energy cost per transaction is significantly higher than other more traditional options such as credit card payment.

These limitations could reduce the use of Bitcoin and cause its price to be reduced, even to initiate a collapse of the supposed bubble. In fact, there are very well-founded criticisms about the implications of these technical problems.

Other reasons why Bitcoin could collapse

Although the above are the root causes by which the value of Bitcoin could sink, the truth is that there are some other reasons, although less powerful. The first is that a fork arises that makes Bitcoin become a minority (to eliminate or correct technical problems). The certain thing is that it is improbable, already there have been some attempts that have not congealed. And although it triumphed, it can not be said that the original Bitcoin has sunk if a Bitcoin B arises that continues to work.

On the other hand, the emergence of financial derivatives to invest in Bitcoin has been pointed out by some as a tool that can sink the prices of Bitcoin, since betting on the downside is simpler. Here there is much controversy since it is not at all clear that derivative products can affect the value of the underlying asset. My personal opinion is that no, they can not affect its value. And less in the case of Bitcoin, where there are much more grotesque manipulations, both by the exchange and by individual investors.

2 Comments

  1. JoeHx

    January 26, 2018 at 2:57 pm

    Out of all the fears about bitcoin, the thing the scares me the most is the amount of people who’ve mortgaged their houses in order to buy bitcoin. Hopefully it’s not as bad as the news makes it seem.

    If bitcoin keeps going up like it did last year, it won’t be a problem. But if it crashes and never recovers, it could have a domino effect beyond the sphere of cryptocurrencies.

    Oh, and there’s also supposedly people who’ve moved their traditional retirement investments into bitcoin. Truly scary stuff.

    • ADMIN2

      January 27, 2018 at 3:44 pm

      Yes, I agree, people who have gone all in are playing with fire. That said, pure speculators who only invest a small percentage of their assets have/can make some real money.

      Just important to distinguish between the two.

Leave a Reply

Your email address will not be published. Required fields are marked *