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posted on 21 December 2017

Bitcoin: Gold Rush In The Wild, Wild Math Game

from EconMatters, EconMatters.com

Bitcoin has become a buzz word in the investing community, not as an alternate currency unit replacing the fiat money, but as an asset class with a spectacular 1,600%+ return this year, valuation almost doubled just in the December month alone. Bitcoin was heading towards $20,000 before pulling back to today’s $15,000 level. The entire cryptocurrency market capitalization rose above $600 billion for the first time on Dec. 18, 2017.

bitcoin


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Bitcoin Chart Dec. 21, 2017

Despite what you might have heard people raving about the "money of the future," the fact is that bitcoin and other cryptocurrencies are very expensive and experimental as well.

Existed Since 2009

Bitcoin is a form of digital or virtual currency and is not as “new" as you might think. It has existed since 2009. In January 2009, a programmer implemented the bitcoin software as open source code and released it under the alias of Satoshi Nakamoto. There have been many rumors regarding the true identity of Nakamoto, but nothing conclusive so far.

A Mining Math Game for All

With many companies adopting it as form of payment and many others getting ready to, bitcoins are an extremely fast-spreading “currency".

Unlike fiat currency controlled by world’s central bankers and partly backed by gold reserve, Bitcoin is based on mathematics and totally decentralized. That is, much like the precious metal, bitcoin can only be “mined", not “printed". All Bitcoin transactions, including Bitcoin creations, are recorded and verified on the blockchain, also originally developed by Satoshi Nakamoto. Today, around the world, people and companies are using software programs and computers following a mathematical formula to produce bitcoins around the world.

1,000+ Rival Crytocurrencies

It was not until 2011 when other rival crypocurrencies emerged partly due to bitcoin’s increasing popularity. Currently there are over 1,000 cryptocurrencies in circulation with new ones frequently appearing.

How Many Bitcoins Are There to “Mine"?

It seems anyone, with proper equipment, can “mine" bitcoins. The logical question would be is there a limit to how many bitcoins can be mined? According to Bitcoin.org, the bitcoin protocol - the rules that make bitcoin work - say that only 21 million bitcoins can ever be created by miners.

Silk Road Anonymous

Because Bitcoin was purposely designed with anonymity and lack of control in mind, it is quite attractive for criminals. Heard of Silk Road, the darknet black market, best known as a platform for selling illegal drugs? Though the U.S. government shut down Silk Road in 2013, Bitcoin benefited from Silk Road’s headlines and front pages of the mainstream media.

Gone in 60 Seconds at Mt. Gox

The lack-of-control nature of Bitcoin also comes with some security issues. In January 2014, the world’s largest Bitcoin exchange Mt. Gox went offline, and its total of 850,000 Bitcoins disappeared. Investigations are still trying to figure out exactly what happened. At today’s prices, those missing coins would be worth about $12 billion. Nevertheless, the bottom line is that those owners never saw their Mt. Gox Bitcoins again.

Bitcoin Futures Launched

Despite debacles at Silk Road and Mt. Gox, Bitcoin futures debuted on CME Group late on Sunday, Dec. 17, 2017, and on CBOE a week earlier. Many hailed this recognition by major exchanges as the pivotal moment of bitcoin to legitimacy. However, as Reuters reports:

“…. an almost twentyfold increase [of Bitcoin] since the start of January has also led to increasing warnings about the dangers of investing in an immature, opaque and largely unregulated market."

1,000+ Whales Control the Market

The Bitcoin market cap is about $300 billion today. 40% of that “immature, opaque and unregulated" market is held by about 1,000 users/whales. What is even more disturbing about this market structure as Bloomberg reports:

“….the whales can coordinate their moves or preview them to a select few. Many of the large owners have known one another for years and stuck by bitcoin through the early days when it was derided, and they can potentially band together to tank or prop up the market."

Late Does Not Mean Never

In other words, whales can easily make or break the market by colluding and manipulating the Bitcoin prices. This is akin to the Hunt Brothers cornering the silver market back in the ‘70s. It was illegal what the Hunt Brothers did, do you think regulatory agencies around the world would just sit idly by and watch the same thing happen in the new Bitcoin market?

Regulations are notorious for lagging way behind technology. Nevertheless, it is inevitable that sweeping regulations will catch on in the near future. France’s finance minister already said his country would propose that the G20 group of major economies discuss regulation of bitcoin next year.

"Gold Rush in the Wild Wild West"

To sum up,

  • Bitcoin is “created" or “mined" by a math program written by an unknown person.
  • The program protocol caps the creation at 21 million bitcoins.
  • 40% of the market is controlled by 1,000 whales who know and communicate with each other regarding buying and selling of Bitcoins.
  • There are over 1,000 cryptocurrencies in circulation rival to Bitcoin with new ones frequently appearing.

The current Bitcoin Market lacks the proper structure that a healthy asset market should have, that is,

  • Reasonable transparency,
  • Long and short players (Bitcoin right now is a long only market),
  • A diversified pool of producers (supply) and users (demand)
  • Appropriate regulations/portocols to prevent collusion and market manipulation.

Bitcoin Investment

Right now, much of the hype is about getting rich by trading Bitcoin. One thing to remember is that just like any other exotic asset class, Bitcoin is even more vulnerable to the boom-and-bust cycle. Bitcoin’s first crash took place in 2013 when the price of one Bitcoin reached $1,000 for the first time, but then the price quickly plummeted to around $300. It took more than two years before Bitcoin reached $1,000 again.

Many traders are on the sideline right now waiting for a significant pullback to get in on Bitcoin. The key is to buy low and not develop a sentimental/emotional attachment thus missing the proper selling point. Before jumping in, it is also important to understand risks and opportunities in the bitcoin market. Expect much higher than normal volatility and sweeping regulations that could drastically change the market landscape.

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