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The 2018 bitcoin crash

April 8, 2018

As things stand, Bitcoin is worth 67% less than its value (at its peak) in mid-December 2017. Speculators, some seasoned, some not so much, have attempted to establish a diagnosis for the sizeable market correction. Many put it down to the recurring FUD (Fear, Uncertainty and Doubt) from the media, some cynics put it down to BTCs inevitable downturn following the incessant hype. However, in this blog, I want to respond to @super_cryptos thought provoking theory regarding cartels suppressing the price of Bitcoin through the BTC futures market, whilst digging deep into the previous Bitcoin bubbles. 

 

@Super_Crypto is suggesting that the government/banks (aka the cartel) is suppressing the price of Bitcoin via the futures market. This is being done in order to preserve the power and value of the US dollar. He likens the BTC futures market to the Gold and Silver futures markets, where the US government have been able to manipulate the price of these two commodities as they please. 

 

What threat does the BTC futures market actually pose?

 

Futures markets are used to manipulate real world assets like gold... and now Bitcoin. It is a tool to short the market without actually owning the asset. The only thing they need is loads of money - @super_crypto

 

The CME bitcoin futures are 'cash-settled'. If you're unfamiliar with this term, what this simply means is that contracts will be settled by cash rather than the delivery of the actual commodity, in this case, Bitcoin. So, an actual bitcoin will NOT be needed. Gold/Silver futures still entail physical deliveries (even though 99% of the time a physical delivery is never required). This enables great leverage for bankers with 'free money'. Considering the fractional reserve banking mechanism, banks will have the power to inject a vast amount of money into the BTC futures market. The volume in these markets MAY trump the current cryptocurrency exchange markets that the majority of the speculators participate in. As the BTC futures market grows and attracts an influx of institutional money, the necessity of a reliable and a fully compliant cryptocurrency exchange will be desired and eventually introduced in a more-than-likely trivial manner. With hundreds of millions of institutional money at play, security and legal compliance will definitely be at the top of the agenda. My belief is that this exchange (or exchanges) will be highly regulated (by governments) in order to prevent 'criminal activities'. This narrative has been echoed by many leaders around the world, almost every cryptocurrency-related question posed to government officials is followed by a response along the lines of 'the biggest problem is money laundering'. Just yesterday, the Financial Conduct Authority released a statement for cryptocurrency derivatives to be authorised by the FCA. Another example of regulators tightening the lid on bitcoin. These exchanges will no doubt be swayed by government elected officials to prop up their agenda, as @super_crypto emphasises. 

 

BUT (and its a big but)


in order for the so-called cartel (banks/government) to take control of bitcoin, the BTC futures market will require liquidity/volume dominance over the actual BTC exchange market. Due to nature of 'leverage' trades that futures allow, the threat of BTC futures volume overtaking BTC exchange market is a real threat, traders can bet on £6k worth of BTC with £600 (for example). However, certain events have to take place in order for this to come to fruition:

 

1. Investor confidence in BTC plummets and the HODL'ers realise that they are not getting rich as quick as they first thought. - Market Cap of Bitcoin nosedives, and struggles to recover throughout 2018 and parts of 2019. 

 

2. Simultaneously, the volume of BTC futures contracts increase exponentially thus getting closer to overtaking the BTC market cap. 

 

BTC futures are not a real threat, for now...

 

BTC futures have been steadily increasing in volume. From February to March, there was a 30% increase in BTC futures contracts. This follows from a 15% increase from Jan > Feb, and it seems to be increasing. The futures market for BTC is extremely small when we compare it to the gold market for example, 500,000+ contracts for Gold, and 13,000+ for BTC.

 

My personal belief is that the BTC futures market has little to no impact on the current BTC price. @super_crypto laments the fact that we cannot sell our bitcoin to the 'cartel' and he is right. The lower the price of bitcoin drops, the higher the possibility of these people achieving 'bitcoin domination'. On the other hand, this cryptocurrency derivatives market is a small threat. The notion of not selling bitcoins is a preventative measure for the long-term preservation of the market. The small number of BTC futures contracts hold little weight in the overall bitcoin market. 

 

The 2017 digital gold rush

 

Many talk about the coincidental downfall of BTC immediately after the launch of CME BTC futures platform on December 17th, 2017. This seems like an attractive narrative for many libertarians, but attributing the 70% correction to a derivatives market with low volume is illusory. We should consider two other prominent factors before we judge the influence of the futures market. 

 

Regulatory uncertainty

 

The regulatory uncertainty surrounding bitcoin and the crypto-asset class has been at the forefront of the media coverage that has beleaguered the industry. Banks have been stemming the flow of money into the market. Recently, the Indian government announced that it would not be allowing banks to provide services to businesses and individuals who deal with virtual currencies. This follows the narrative set by banks closer to home that have impeded the flow of credit into the cryptocurrency market. 

 

Bubbles 

 

We can assign the blame of BTCs fall to 'FUD', regulatory uncertainty and the 'cartel' etc... but we shouldn't be so naive to the irrational investment behaviour towards the end of 2017. The period from Nov to Dec became an investment frenzy as BTC increased in value by over 200%. My whatsapp was bombarded with messages from people, young and old, wanting to know what the next best investment is and how quickly they can essentially become 'rich'. This sort of behaviour is typical of a 'bubble' brewing but bitcoin is not new to 'bubble' phases, neither are any other financial markets. 

 

If we look at the some of the past BTC crashes, the 'illogical' behaviour of the market in the run-up to a bear run is consistent with the one we are witnessing now. In 2011, bitcoin went up in value by 10,500% within the first 6 months, only for it lose more than 75% of its value within 1 month, followed by a 7 month bear market. Coincidentally, the first 6 months of 2011 saw bitcoin receive extensive coverage by the media, most notably Gawker's article on the value of bitcoin on the 'dark web' was read by tens of millions, giving bitcoin publicity it had never seen before. The parabolic surge of bitcoin in 2013 was very similar to the one in 2011. Bitcoin had been recovering from the 2011 crash and was hitting new highs. Cyprus was in trouble and its banks required a bailout of €10bn. Any wealthy individuals who had more than €100,000 in their accounts were about to incur a major levy. Many of these account holders turned to bitcoin to preserve their wealth. This time, CNN and other news outlets start to cover this new investment phenomena by the name of bitcoin. The value of bitcoin surged more than 900% by the end of 2013, only to be followed by a bear market, and the catastrophic MtGox hack which aided one the worst crashes in bitcoin history. 

 

The homogenous relationship between the 2011, 2013 and 2018 crash is undeniable. In all three scenarios we have heightened media attention which spurs a major FOMO (fear of missing out) amongst the masses. A recent research paper conducted by students at the University of Geneva touches upon the fragility of the bitcoin market after a major 'confidence interval... indicates a high hazard for correction in that neighbourhood... as any minor event could topple the unstable market'. This claim is consistent with the recent market downturn, the string of negative press that the cryptocurrency sphere has incurred has subjugated a market propped up by FOMO money (short-term, fickle investment). This is apparent in all 3 major crashes, and it will continue to happen for as long as human nature yearns for quick money, with minimal effort. Notably, this is the moment when the inexperienced erratic investors start to 'cut their losses' and the smart money starts to accumulate en masse. This statement is congruent with recent events that have come to light in regards to Rockefeller and George Soros' intentions to start investing in cryptocurrency. 

 

When attempting to unearth the investor sentiment surrounding bitcoin, we can look at the trading behaviour of the top bitcoin holders. Looking at the top 100 richest bitcoin addresses there seems to be a clear strategy, accumulate, accumulate, and accumulate. As stated earlier, the sell-off that we have been witnessing in the past 4 months is a result of impatient and inexperienced investors who were going through a major FOMO phase. The idea of becoming 'rich' within a few months was entertained by major newspapers around the world. This introduced the notion that 'cryptocurrency is the investment of a lifetime', but as we saw in 2011 and 2013, if these impulsive investors don't get their riches quick, they'll be the first to sell. These are most likely the same people that have prematurely planned their lambo purchase. 

 

Fundamental analysis will beat technical analysis

 

Fundstrat analyst, Tom Lee, earmarks the the fundamentals of bitcoin through metcalfe's law - "Metcalfe's law says the value of a network is proportional to the square of the number of users on the network". Tom Lee laments the parabolic growth of bitcoin from Nov>Dec 2017 as not being consistent with the fundamentals, thus showing signs of a potential bear market. This statement came to fruition, highlighting the disparity in the bitcoin fundamentals vs bitcoin price. 

 

What now?

 

The market cycles of bitcoin are starting to become a lot more predictable and apparent. This new asset class only has 9 years of market history to deduce from. As with gold, silver, stocks, it will have moments of bubble-like behaviour, its simply down to you as an investor to determine when the its price aligns with its fundamental value. As with any investment, if your belief is that the asset will only increase in price without any justifiable reason, then you will most likely sell at the first barrier. It's completely dependent on how you view it. 

 

"The question now, for investors, is to choose a narrative that explains bitcoin’s longterm place in the world: Should they take the view bitcoin is nothing more than niche—or, in Jamie Dimon’s view, a modern-day version of tulip bulbs? (If so, they can short it). Or should they take the view, espoused by Bloomberg View columnist Mohamed A. El-Erian, that bitcoin and other cryptoassets are now a permanent part of the invest landscape and will have a role alongside precious metals as longterm sources of value? Either outcome seems plausible" Jeff Roberts

 

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