via Forbes: When I wrote my first article on the Bitcoin bubble entitled The Great Bitcoin Scam on December 28, 2017, Bitcoin was trading at $15,433.73. As of today, February 9, 2018, about 40 days later, Bitcoin has fallen by more than half and the price is oscillating somewhere between $6,000 and $9,000 depending on the time of day or night. Swings of 10% or greater are sometimes occurring every few hours.
So why has Bitcoin suddenly become more volatile? There is no singular answer, but several. Let’s examine the most important ones in turn.
The Cryptocurrency Bubble Has Only Started To Deflate
Although some of us called it at the time, in only a month’s retrospect it is crystal clear that investments in crypocurrency had formed a huge bubble. Economist Nouriel Roubini in fact declared it to be the “Mother of all Bubbles”, and the largest recorded bubble in history.
Contrary to popular perception, economic bubbles do not collapse completely in a single day as with a balloon popping, but usually take some months to fully deflate. For instance, the 1929 stock market bubble began to deflate as early as September of that year, had massive selloffs in October, but didn’t fully bottom until February, 1930. Ditto for the 2008 crash, which started in June of that year, but the market didn’t bottom until February, 2009. Very similarly, the dot-com (or, more accurately dot-con) crash which began in the spring of 2000 didn’t bottom until almost a full year later. For that matter, even the infamous Tulip Bulb Bubble in 1637 took some months to fully deflate.
All of these bubbles had plenty of “false bottoms”, where it looked for a while like the price would creep back up.
If history is to be followed, the cryptocurrency bubble had just started to deflate, and there is still plenty of falling left to do. It is the old joke about the man who jumps from the Empire State Building, and on passing the 80th floor on the way down says, “Well, so far, so good.”
Bitcoin Has No Fundamental Price To Fall Back Upon
Stock market crashes never bottom at zero, for the reason that at some point market fundamentals take back over and folks can see a return for their investments. Take Microsoft stock, which got hammered in the dot-com bust of 2000 from a high of 39.264 in December of 1999 to a low of 14.589 in December of 2000. Why didn’t Microsoft stock go to zero as did so many other tech stocks around that time, or as Lehman Brothers did in 2008?
The reason is that Microsoft’s stock had a fundamental price to fall back on, as Microsoft continued to turn out and sell its operating system and lucrative Office products. At some point, investors could see that both Microsoft was going to survive, and that Microsoft would continue paying dividends to investors by which, eventually, they would not only get their investment back but also get a decent return. Contrast Microsoft in 2000 with Lehman Brothers in 2008, where the latter was so leveraged by its mortgage-backed securities products that it became insolvent and offered no chance for new investors to have hope of even getting their principal back, much less any return.
The problem with buying a Bitcoin is that it doesn’t generate a return, but is simply an internet token that is used as an alternative to transfer money between its users (and for which they have to pay fees with each transaction). In other words, Bitcoin has no fundamentals, and will never have fundamentals. The only thing that Bitcoin investors have is a hope, or maybe closer to a prayer, that the value of Bitcoin will increase in the future based on demand. Even the latter seems bizarre, since there are over 1,300 cryptocurrencies which do about the same thing that Bitcoin does, and it doesn’t take much more than a sharp mathematician with an algorithm to create a new cryptocurrency, i.e., crytocurrencies are a widget of potentially cheap and infinite supply, which should make any investor betting on future appreciation, well, cringe.
That cryptocurrencies, including Bitcoin, lack a fundamental price has another ramification, which is that it seems impossible to price individual units of crypocurrency at much above zero. Some economists, for example, say that at best Bitcoin should have a nominal price of $20 per unit.
The point is: If you don’t know what the price of Bitcoin or any other crypocurrency should be, then you have utterly no idea whether you are overpaying or underpaying for it. At the very least, this circumstance will contribute to high volatility.
There Is Rampant Market Manipulation In Cryptocurrency
In recent days, there has been no shortage of articles discussing price manipulation in Bitcoin, with clear evidence of significant price manipulation occurring in 2013, and in the 2017 run-up.
Price manipulation is simply the flip-side of the so-called benefit of cryptocurrencies that they are not subject to government regulation. Without regulation, bad actors can manipulate the price of cryptocurrencies and then cash out rich long before the rest of the investors catch on.
Even as the Bubble deflates, there seems to be quite a bit of bull trapping going on, by key low-volume trades being made which seem to indicate a price-reversal upwards, and then selling to these fooled investors at the higher price. This sort of market manipulation significantly contributes to volatility.
There Is Rampant Fraud In Cryptocurrency
Any asset that doesn’t have a fundamental price is a target for scam artists, who can spin a big fish tale as to what the asset should be worth. “Buy my cryptocurrency today, and I’ll promise you’ll have a Lamborghini in your garage by tomorrow night.” Such are the allegations flying around Bitconnect, among others, whose discussion board now contains a reference to a suicide hotline.
News like this causes investors to wonder: “Which cryptocurrencies are real, and which are fake? Are any of them real?” Ergo, volatility.
Institutional Investors Are Staying Away
Because cryptocurrency has neither an intrinsic value nor is capable of being valued according to fundamental analysis, the institutional investors are largely staying away. Thus, cryptocurrencies are denied access to that largest ocean of wealth, and instead must rely on individual investors worldwide. The downside is that individual investors are rarely buy-and-hold investors or have an investment horizon much past the next official holiday, whereas institutional investors take the long view of their assets and may be content to hold particular assets for years before they pan out.
The lack of institutional investors, with their buy-and-hold views, is one of the biggest reasons for the extreme volatility of cryptocurrencies.
Financial Planners Are No Longer Recommending Cryptocurrency Investments
When the cryptocurrency bubble was building in 2017, not just a few financial advisers told their clients to make bets in Bitcoin and other alt-currencies. By the end of that year though, most of the larger brokerage firms began banning trading in crytpocurrency as being too speculative (which is a gross understatement). This likewise took potential buy-and-hold investors out of the cryptocurrency marketplace, and has contributed to volatility.
As an aside, not just a few of the financial advisors who told their clients to buy Bitcoin and its brethren when it was near the high, are now expressing a newly found interest in asset protection planning.
The “Store Of Value” Theory Has Been Exploded
One of the biggest selling points for cryptocurrency has been that it has the potential to store value against inflation involving the governmental currencies. Here, Venezuela is an oft-used example.
The problem is, for all the foregoing reasons, that cryptocurrencies are inherently very volatile, and nobody wants to “store value” in something that may go up and down in value by 10% or more nearly every day. Stated otherwise, it is small comfort that a cryptocurrency might or might not provide protection ten years from now if there is increased inflation, if you are risk of losing a substantial part of the value today.
The bursting of the “store of value” argument for buying cryptocurrency is also leading to its increased volatility — sort of a self-fulfilling prophecy in the negative.
The “Buying The Technology” Theory Has Been Exploded
This is the biggest farce of them all is the idea that if somebody is buying Bitcoin, or any cryptocurrency, they are “buying the technology”. This is a reason for buying and holding Bitcoin that many of the true-believers frequently express, quite wrongly.
A person that owns Bitcoin is not an owner of the technology, but rather just a user of the technology, which is quite different. No Bitcoin owner will receive a royalty if anybody else buys or uses Bitcoin. To the contrary, to use Bitcoin the owner must pay transaction fees.
This argument is similar to somebody buying a hair dryer because they “believe in the technology”. Well, that’s great, but it doesn’t mean that the purchase of the hair dryer will profit from the technology, other than by their own enjoyment of it.
True-Believers And The Desperate Are Still Buying — But Running Out Of Money
To a significant degree, Bitcoin’s price is being propped up by true-believers, being folks who seriously believe that Bitcoin will someday become the world’s currency and they will thereby get rich because of it. The true-believers refer to themselves by the intentionally mis-spelled term “hodlers”, and have more than their fair share of sovereign citizen and other anarchist types.
The hodlers are bolstered in their efforts to defend Bitcoins’ price by the desperate, being folks who bought into Bitcoin when it hovered north of 15,000 and then promptly lost half or more of their money. These poor (literally) folks are doubling-down on Bitcoin, much like a gambler who has lost a bunch of money, and then gambles the balance to try to make it back up. Many of these folks have been buying Bitcoin on credit, and in fact at least one study suggests that as much as 20% of Bitcoin purchases have been on credit.
However, the latter group of credit purchasers of Bitcoin are either running out of credit or their banks no longer permit the purchases of Bitcoin with credit cards. Another way to look at this is that double-down makes one run out of money twice as fast.
Both hodlers and the desperate have the same thing in common, which is they have a bullish tunnel-vision that Bitcoin will return to its prior heights. This is not fundamental price analysis, but simply prayer.
For nothing is more dangerous
Than desire when it’s wrong
~ Lyrics to “I Desire” by Devo
Folks continuing to buy Bitcoin regardless of the (lack of) fundamentals, also contributes to Bitcoin’s high volatility.
Bitcoin Is The Purest Speculation
Let’s assume that we have a bunch of players around a table with one of those cheapie poker chip sets, which has white, blue and red chips. Let’s say that Bitcoin is the red chip, and the blue and white chips are some other cryptocurrencies.
The value of the chips is simply what the players say it should be. The initial players pay just $1 dollar to the house for each chip. Thereafter, there is no poker game, but the players simply sit around and trade chips based on what they think the chips might be worth at the end of the game. Some players take additional wallets out of their pockets, and buy more chips from other players, who take that opportunity to cash out. Some players leave, and new players come in, but the trading continues. The values of all chips, including the red Bitcoin chips, are worth at only given moment what two players agree they are worth when they make a deal. The prevailing price for chips becomes simply a function of whether there are more players who believe they will go up in price, or they will go down in price.
This is what trading in cryptocurrencies is really all about. It is simply the purest speculation, since Bitcoin itself doesn’t do anything to generate additional income (unlike stocks which pay dividends or bonds that pay interest). In other words, Bitcoin is a speculator’s dream, since there is no outside event that will impact its price, other than what other investors believe the price is going to go up or down. This is also why selling futures contracts and other derivatives in Bitcoin is at the same time both ludicrous and makes perfect sense.
Cryptocurrencies, including Bitcoin, will always be volatile (except maybe when the price is very low) because at the end of the day they are all about speculation — this has become their primary use, for bulls and bears to have something to fight over.
Enjoy the adrenaline, and the nausea.