Is this the beginning of the end for Bitcoin?
On Tuesday, 16 January, almost all major cryptocurrencies fell in a market slump that continued into Wednesday. Bitcoin, the king of all cryptocurrencies, dropped below USD 10,000, which was almost 50% below its December 2017 peak, after the market entered a second day of a sell-off. According to CoinMarketCap.com, the combined value of over 1,400 cryptocurrencies in circulation fell to USD 460 billion from around USD 800 billion at the start of the month. The causes of the sell-off are not entirely clear, however, some have speculated that the threat of a regulatory crackdown on cryptocurrencies by some governments may have had something to do with it.
Indeed, heavy losses across all major cryptocurrencies—including Bitcoin, Ethereum, Ripple and Litecoin—in recent days have been a testament to investors’ newfound realization that stricter regulations in countries like China and Korea are going to weigh on global demand for the digital coins. Moves to curb domestic trading activity and ban initial coin offerings (ICOs) in China, home to the world’s largest Bitcoin mining community, and the possible shutdown of cryptocurrency exchanges in Korea by early next week are now being taken seriously by investors, when past regulatory actions were more casually brushed off as policies able to be sidestepped.
While Korea’s trading ban, if enacted, would hurt global demand given the country’s position as the world’s third-largest market for Bitcoin trades, a stricter Chinese regulatory environment would dent both demand and supply. Bitcoin mining is notoriously energy-intensive and operations initially exploded in China because of inexpensive electricity. Recent crackdowns and plans to curb Bitcoin mining-related energy use have, however, reshaped the industry and driven up costs. Confusion over the regulatory framework has increasingly incentivized moving operations out of China and into countries like Canada and the United States, where temperatures are cool, electricity is relatively cheap, and internet access is high-speed. Moreover, rumors that the U.S. Securities and Exchange Commission (SEC), which already tightened rules on token sales late last year, may begin a broader clampdown on cryptocurrency trading in the coming year could further upend these market trends. So that begs the question, is this the beginning of the end for Bitcoin and other cryptocurrenices after crossing over into the mainstream? Not likely.
What does the future hold for Bitcoin and cryptocurrencies in the mainstream?
December’s introduction of Bitcoin futures contracts on Cboe- and CME-run exchanges nudged the door open to cryptocurrencies for institutional investors. Previously, institutional money was locked out of digital currency trading on asset-class technicalities. Bitcoin’s appearance on the Chicago-based exchanges has, however, given traditional funds exposure to Blockchain technologies and the mania (and soaring profits) currently surrounding cryptocurrencies. Wednesday’s bearish close of the first Bitcoin futures contracts was likely the first step in what is expected to be the next phase of the digital currency’s mainstream adoption: options contracts.
An options market for Bitcoin would extend the digital currency’s reach into traditional finance and open up trading to an even wider swath of big-money institutions. Smooth closes on the Cboe- and CME-run exchanges over the next several months will be essential to ease concerns that Bitcoin options could actually succeed, however. Moreover, volumes and open interest in forthcoming futures contracts will broadly dictate the speed at which options contracts are unveiled.
Another anticipated avenue for the mainstream adoption of Blockchain technologies this year will be the appearance of cryptocurrency-based exchange-traded funds (ETFs), with 17 January’s launch of the first two Blockchain-backed ETFs on the NASDAQ and the NYSE Arca an early indication of what to expect this year. In the absence of a formal dismissal by the SEC, cryptocurrency-based ETFs have been tacitly legalized under current U.S. law. Reacting to pent-up demand, the number of Bitcoin-backed ETFs is likely to explode this year as institutional investors rush in on fears of being left out of the market’s meteoric rise.
Establishing exchange-traded Bitcoin futures went a long way toward cementing cryptocurrencies as an asset class, and this should open up opportunities for other major digital currencies to also go mainstream this year. Ethereum and Litecoin, in particular, have been tipped as the next digital coins likely to get exposure to traditional investors on futures exchanges in the U.S. Moreover, broadening the futures market to include more digital coins should induce investor confidence in the burgeoning Blockchain-based market as it expands opportunities for institutional investors to diversify their cryptocurrency portfolios away from first-mover Bitcoin.
Will the Bitcoin bubble pop this year?
Having gone mainstream last year with its appearance on traditional exchanges, there is no doubt that enthusiasm for Bitcoin will remain strong in 2018. Despite a volatile start to the year in which cryptocurrencies shed almost half of their collective market cap, seen by many as driven by the recent regulatory push across Asia and possibly some selling-off ahead of Wednesday’s close of the first exchange-traded futures contracts, the long-term potential for Bitcoin still appears largely intact.
Underpinning these longer-term prospects is the promise of the underlying Blockchain technology to upend traditional financial markets. Moreover, as Blockchain technologies are explored and fine-tuned, new coins will appear in the cryptomarket over the medium term. As a result of Bitcoin’s first-mover status and name recognition, these developments are likely to translate—for now—into higher closes for the de facto reserve currency of the cryptouniverse. Backstopping these gains will be the perceived reliability and security of the currency in recent years, an about-face since 2014 when hackers brought down the Mt. Gox exchange and threw the market into a tailspin, as well as scalability improvements in the way of the Lightning Network. Moreover, the ongoing legitimization of Bitcoin through regulation, including Japan’s legalization of the currency last year and Austria’s recent push to tax the currency, should make the digital coin more palatable to both institutional and retail investors.
Existential threats to the currency will not remain limited to a stricter regulatory environment and digital security issues, but these concerns will loom the largest. The ongoing push for regulation worldwide will almost certainly threaten demand more than supply this year. The possible shuttering of exchanges in major crypto-trading countries will present major hurdles to the longer-term evolution of the currency. As seen since the outset of the year, threats of regulatory crackdowns have the ability to spur massive volatility. A possible upside to regulatory pushback could be the taming of increasingly frivolous ICOs, which threaten both the reputation of and investor sentiment for cryptocurrencies. These fluctuations will keep Bitcoin from digging in as a means of exchange, with the digital coin remaining best-suited as a store of value. Interplay between established cryptocurrencies will be an unknown this year as Bitcoin and other digital coins—including Ethereum and Ripple—gain further name recognition.
Although the global regulatory push in the short term will increase volatility, the massive longer-term potential of Bitcoin should keep the digital currency on an enviable upward trajectory this year. That said, higher closes will not come without worrying levels of volatility. Given current investor appetite for cryptocurrencies and the as-yet untold potential for growth in futures contracts, a number of bullish analysts believe there is a strong possibility that Bitcoin will hit between USD 50,000 and USD 100,000 at its peak this year while even more predict a year-end price above USD 25,000.
What could it mean for the global economy if the Bitcoin bubble pops?
Given the nature of an emerging asset class and recent historical precedent, anything appears possible in cryptomarkets this year. That said, in the absence of any massive security breaches or major regulatory pushback from major-player countries this year, it appears unlikely at this point that Bitcoin would dip below USD 7,500. Although stricter regulations in heavy-trading countries are a real risk and could send the currency spiraling in the short term, the systemic risk to the global economy—as this is the first truly global asset boom, or bubble—currently appears limited. Combined global market capitalization in recent weeks for all cryptocurrencies has been tracking well under USD 1 trillion, roughly the same market cap as Apple Inc., the world’s largest publicly-traded company. Given the comparison, most analysts argue the current macroeconomic implications of even the very worst Bitcoin crash would be contained given the market’s relatively nascent magnitude and absence of outright interconnectedness with the banking and shadow-banking sectors.
5-year economic forecasts on 30+ economic indicators for 127 countries & 33 commodities.
Author: Christopher Thomas, Economist
Date: January 19, 2018
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