Bitcoin mania: what next?

During our stay in South Africa I was reading an article in Die Burger (newspaper for Afrikaners) where a spokesman of Cape town-based PWC gave his ideas on the recent rise of Bitcoin and the future of Blokketting (Afrikaans for Blockchain). This inspired me to write this blog.

Since I started writing about blockchain I categorically refused to use the term Bitcoin. But this time it is different. As Bitcoin nears the end of a record-breaking year, it seems an appropriate time to dive into this - by many traditional players said - over-hyped thing. Others describe this fascination for Bitcoins as a “speculative mania”. The broader public has discovered this phenomenon. I will not say it is (already) the end of the rise in Bitcoins or other crypto currencies. But let me be clear: Bitcoin is a lot not!

Recent developments

• Bitcoin rate explodes

Since April this year the Bitcoin (but also crypto currencies like Ether and Bitcoin Cash) is showing a continuous rising trend and in the past few months it even exploded to unexpected levels. In one month time the rate of the Bitcoin almost doubled. In the meantime the Bitcoin rate increased further to reach almost 20.000 dollar, before falling back to 16.000 dollar. But now it is back at  19.000 dollar. At the beginning of this year the Bitcoin rate was not even 1000 dollar. The total market capitalisation of Bitcoin is now exceeding that of a company like Boeing and that of New Zeeland’s GDP.

• Bitcoins traded on futures market

The recent firm rate rise of the Bitcoin has much to do with the launch of Bitcoin future contracts. Before that Bitcoins could only be sold or bought via internet platforms. Last week the trade of future contracts in Bitcoin started on the Chicago Options Exchange ( CBOE). These futures enable speculators (without having Bitcoins) to buy or sell Bitcoins by betting  via the leverage instrument on future increases of the Bitcoin or an eventual decrease thereby hedging against fluctuations. In total 500 contracts were traded on the first trading session. The rate of Bitcoins increased nearly 2.000 dollar to 18.700 dollar. On the American market place Coinbase the Bitcoin even reached 20.000 dollar, after having raised 40% in the two previous days. This indicates that investors do not (yet) expect a crash short term.

In the meantime also the Chicago CME, the world’s largest exchange,  started trading Bitcoin futures and the Nasdaq is also in the race to enable the trade in these future contracts. Many professional investors however did not yet enter this market because the difference between bid and offer rates is still much too large. This indicates there is too less liquidity in this market. There is also insufficient clarity of the required margins, trade limits, stress tests and clearing.

What is Bitcoin not?

1. Bitcoin is not a rational investment
Notwithstanding many warnings a growing number of private investors joined. The sole reason for this is simply because more and more people are flocking to put their money into it, not because they 'believe in the (blockchain) technology' (most even do not know how it works!) or want to start using it instead of cash. They are doing this purely because they see its value increasing and are speculating it will increase further. If your neighbour, friend or colleague says he is getting rich by investing in Bitcoins, why not you? It is this psychology – instead of becoming suspicious - that triggers more and more people to step in. Many people get the feeling that they otherwise will miss something.

This in turn causes the price to go up even more, bringing in even more people wanting to 'invest' (speculate), and the cycle continues until (eventually) something happens that spooks the market and it all collapses.

2. Bitcoin is not a stable investment
Bitcoin should not be seen as a stable investment. Especially for those private investors (or speculators) that only recently wish to invest or already invested in Bitcoins, driven by the stories of their friends, neighbours about the great future of this new tool, I want to say that  the price of Bitcoin will not only go up. Recent developments also showed that it is a very volatile one. It is no more than a speculative thing. And you already bought at a very high price. Only those who bought Bitcoins in a very early stage are the gold dickers.

3. Bitcoin investments are not riskless
Banks and professional investors are very reluctant to offer these bitcoin futures. They fear risks through the heavy fluctuations in the Bitcoin rate. At this moment almost thousand institutions and private persons have 40 percent of all Bitcoins in the world. Via the creation of demand and offer they could easily create great fluctuations or even manipulate Bitcoin rates. Banks also fear to find no counterparty. Business opportunities in the planned bitcoin-futures market are limited given the illiquidity in this market.

4. Bitcoins are not a safe investment
Apart from the great volatility there is also the digital security risk. While the system behind Bitcoins, the blockchain, is rather safe, the marketplaces and wallets are vulnerable for criminal activities including hacks, fraud, etc. There is no reliable system of guarantees. If things go wrong you may lose all your invested money.

Last week criminals hacked the Slovenian crypto currency marketplace NiceHash. They reported that the contents of its bitcoin wallet had been stolen in a security breach. About 4,700 Bitcoins, worth about $64 million at current prices, have disappeared. This is however not the first time that such a digital marketplace has been victim of hacking. Last year cybercriminals plundered tens of millions euro’s when attacking bitcoin exchange Bitfinex. The best known hack took place in 2014 at Mt.Cox, a Japanese trading house that at that time was responsible for the majority of all Bitcoin transactions. No less than 750.000 bitcoins were stolen which at present rates would represent Euro 9.5 billion. The clients lost all their money and Mt. Cox went bankrupt.

But there is also the risk that owners of Bitcoins lost the code of their digital wallet with a unique cryptographic key. Mostly this is a double lock with a unique code. Many Blockchain has put that on their pc or smartphone.  Here is however the risk of losing an app with the corresponding unique key. Those who have lost their key also lose their Bitcoins.

5. Bitcoin is not (yet) regulated

While regulators long time were reluctant to intervene, that is now rapidly changing. Countries such as Morocco, Bolivia, Ecuador, and Nepal already have banned Bitcoin. China earlier this year announced the closure of domestic cryptocurrency exchanges and even prohibit non-sanctioned cryptocurrencies .  But also Central banks are increasingly opposing Bitcoins including the ECB, The Dutch Central bank etc. while the US SEC firmly tightened their rules. If the Bitcoin rates further explode and many more new players enter this arena regulators certainly will step in. In that case the Bitcoin house of cards is expected to be crunched.

But as long as there is no world-wide regulation there is no guarantee that investors will be (partly) compensated when things go wrong. At this moment there are officially 16,7 million Bitcoins in circulation. But according to estimates 3,5 million Bitcoins are lost.

6. Bitcoin is not a (real) currency
Bitcoin is not a (real) currency as it is not a helpful unit of account (as not many  prices of goods and services are set in Bitcoin). Bitcoins are neither a relatable store of value, given its great price volatility and unpredictability. Bitcoins have no independent (intrinsic) sovereign value on its own. There is no firm fundament under Bitcoins such as an economy. The only value Bitcoin has is the market value, or what people are prepared to pay for. The rate just increases because of madness. Not because there is real value behind it.

It is unthinkable that Bitcoins will become a real, but non-controlled world-wide currency. There is no government that is going to exchange its fiat currency for the non-controlled Bitcoin or other crypto currencies (except some countries in Africa).

7. Bitcoin’s rise is not for long
Supervisors world-wide are warning for this Bitcoin hype. Some describe this Bitcoin mania as an example of collective idiocy. The whole system is based on “trust” and that “trust” is fragile. In the end the Bitcoin rate is based on demand and offer that is driven by emotion. That means that the self-fuelling way up could easily been turned into a drastic rate fall.

They predict a new speculative bubble (compared with the dot.com bubble burst) that will explode. And that for many reasons (explained in this blog). The price of Bitcoin is increasing rapidly despite little or no change in the underlying commodity itself.

Some compare this Bitcoin hype with a pyramid game. Increasingly number of people are joining the list and as long as everyone trust it will only go up, and everything goes well. But it goes well as long … !!! A soon as that trust fades away, this house of cards will collapse. And there is no central bank that will intervene or can help. Those that entered this game as the last, thus those that bought at the highest price, will lose most.

Others see similarities with the 17th century tulip mania in the Dutch Golden Age. At that time people thought that the value of tulip bulbs would increase for ever. The craze culminated in the price of a particular bulb reaching 4,600 florins. From there, the only way was down. It turns out that tulips lacked any sort of intrinsic value (just like Bitcoins).  

Some even say that this hype could lead to a “krach” comparable with 1929. That was followed by the biggest depression of the 20th century.

With bitcoin valuations steamrolling towards the $20.000 mark, Saxo Bank is forecasting a market peak price of $60,000 for the cryptocurrency and a market capitalisation of over $1 trillion. According to the bank the advent of the Bitcoin futures contract in December 2017 may lead to a “groundswell of involvement by investors and funds that are more comfortable trading futures than tying up funds on cryptocurrency exchanges”. But after  its spectacular peak in 2018, Bitcoin will crash and may return into 2019 close to its fundamental 'production cost' of $1,000.

8. Bitcoin is not suited for payments and other trading purposes
Bitcoins are not a great medium of exchange: who would want to accept them except speculators? With its volatile nature and high transaction costs, it seems not suited for official trading including payments transactions in the economy. As a result the amount of businesses where Bitcoins can be spend have not increased dramatically, there are no new uses for it nor have any new features been developed that improve its usability.

Besides, through this growing popularity of the Bitcoin the present network is not suitable for (payment) transactions. There are long queues and those who wish to be in front should pay a higher fee. One transactions could cost a number euros.

9. Bitcoins are not eco-friendly
Bitcoins are not sustainable and not eco-friendly. Bitcoins and other crypto currencies are created via a huge network of computers world-wide trying to solve complex cryptographic puzzles. The present extreme high Bitcoin rates ask for growing computing power to solve the increasingly complex puzzles and get Bitcoins. This so-called mining not only asks for very high energy costs but also absorb a lot of electronic power.  These computers collectively  consume now already more than 30 terrawatthours per year. That is already more than the annual use of whole Slovakia or that of Morocco. And the more Bitcoins are being mined, the more powerful computers are needed and the more electricity power is used by the world wide Bitcoin system. This enormous waste in electronic power shows that in this form Bitcoin is not an achievable alternative for the existing financial system

10. Bitcoin’s blockchain is not a bad strategy to emulate
While Bitcoins bear many risks, the technology behind Bitcoin, blockchain however has a great future. Adopting blockchain or other Distributed Ledger Technologies is not a bad strategy for the financial world, but also for other applications such as trade finance, supply chain etc. …... . Blockchain may even rely on enthusiasm by the most conservative watchdogs. In my previous blogs I already set out and explained the many benefits to grape if implemented well. But stay away from Bitcoins and other crypto currencies. As these may do more harm than good. They are only for …..!!