Bitcoin in 2018 and related topics

What’s the future of Bitcoin?

I was recently asked what the cryptocurrency market will do. To be more specific, where I see Bitcoin - with a date and price tag please. According to one article, Bitcoin could fall as low as USD 1’000 this year and according to another article, Bitcoin could rise up to USD 100’000 by the end of 2018. Believe it or not, I think both are right at one point in 2018, albeit with less extremes.

The number of factors impacting Bitcoin is immense and it’s hard to track, particularly because it’s global. The total number of economic, regulatory and social factors multiplied by the amount of involved countries exceeds the capabilities of every crystal ball. However, it seems that Asia is one of the main drivers of the market. It was the legal acceptance of Bitcoin as a currency in Japan that drove the bull market in May 2016 and it was the Chinese ban on ICO’s that caused a correction in September 2017. Last Monday, it was the South Korean 24.2% tax policy that initiated the next correction.

On a separate note, technical events are not to be dismissed. On August 1st 2017, the first Bitcoin fork to Bitcoin Cash happened. Bitcoin owners were happily surprised because they received an equal amount of Bitcoin cash for every original Bitcoin in their control. Shortly thereafter, Bitcoin prices increased in anticipation of the next Bitcoin fork to Bitcoin Gold in October. As forking is a profitable business model, other forks were immediately announced, including Bitcoin diamond, Super Bitcoin and Bitcoin Segwit 2X. These forks exposed the controversial topic of scaling, have split the community and cause confusion.

As the popularity of Bitcoin rose through 2017, the transaction pool increased to 184’680 unconfirmed transactions on December 8, 2017. Alternative cryptocurrencies claim to offer better scaling possibilities, but as the game of crypto kitties got popular, also the Ethereum network was clogged with 30’000 transactions in the same month. This is the beautiful thing of public blockchains, everything is visible, they can’t cheat! So scaling is (currently) a weakness, but visibility is a strength.

Related to the pending transactions was the increase of transaction fees. Transaction fees spiked at USD 55 in December 2017 as Bitcoin rallied to USD 20’000. After year-end, transaction fees came down to a more reasonable range around USD 10 today. The damage was done, because it was proven that Bitcoin cannot scale like Visa. That was already clear to the developers, but speculators might have missed that point earlier on. I’ll state it for future reference: Cryptocurrencies are a work in progress. All of them are experiments and Bitcoin was the first one.

I once read an article that cryptocurrencies aren’t winning, but traditional currencies are losing. This brings us back to the starting point of Bitcoin. It’s no surprise that Bitcoin started in 2009, it’s the result of dissatisfaction with government practices during the financial crisis in 2008. The success of Bitcoin is therefore dependent on the management of the existing monetary system and that might be one of the biggest values. Cryptocurrencies are competition for centrally issued currencies. Up to now currency issuance was a monopoly of central banks and governments. Governments can’t shut down cryptocurrencies, so central banks must be careful with their monetary policies. Otherwise people have a working alternative, one that is beyond government control.

In addition to all these factors, hedge funds, trade desks and individual traders are taking part in crypto trading. Some of them with substantial amounts of funds and leverage. These traders are well trained with professional chart reading that become true if enough traders apply the same technical analysis – aka a self-fulfilling prophecy. They benefit from the volatility of the cryptomarket, market inefficiencies and uncertainty of amateur traders.

So back to the original question, I think we need to keep an eye on Asian developments, large technical events, macroeconomic changes and apply limits that are set with technical analysis, because many market players will apply them. As long as the scaling issue isn’t resolved, Bitcoin probably won’t pick up. The Bitcoin futures on the CME will expire on January 26th and this might be another bearish event . The Chinese New Year is on February 16, 2018 and previous years have shown that the cryptomarket is bearish the few weeks before Chinese New Year. As a result, I’m bearish for the next three weeks. Technical analysis shows support at USD 8’000 and I think that limit will be tested.

At some point in 2018, I expect one of the big countries to take out the big guns trying to shutdown large exchanges. If history repeats, then this could cause a correction of 70% like we experienced in 2014 with Mt Gox and Bitcoin could fall around USD 3’000.

If exchanges would be closed, it’s not the end of cryptocurrencies - In contrary, what doesn’t kill them, makes them stronger! Both Bitcoin and Ethereum are working on scaling solutions, with updates called the Lightning Network and Casper respectively. I anticipate that successful implementation of these will give the green light for the next bull wave. Furthermore, Bitcoin is likely to benefit from its first mover advantage and its dominant position in exchanges to get access to the rest of the crypto market. As for the limit, I let the technical analysts give the answer, but I think USD 50’000 is not unlikely.

Is it better to use Bitcoin Cash to buy altcoins?

Transaction fees of Bitcoin Cash are lower, but the use of Bitcoin is dominant as we can see from the trading volume. Despite cheaper transaction fees, Bitcoin currently makes up for 33.7% or daily trading volume, versus 1.9% for Bitcoin cash . The monthly volume is 53% in BTC and 6% in BCH. This indicates how much more dominant Bitcoin is and can be explained by the fact that people already own Bitcoin and trust it.

What about the amount of energy used?

The energy usage of the Bitcoin Network is a problem, it’s related to the price of Bitcoin. If you consider the mining cost part of the transaction fee, then each transaction currently costs around USD 125 . As the price of Bitcoin soars, it encourages adding more mining farms and as prices fall, some farms will (temporarily) close. If the block reward reduces, then it discourages adding more hashing power, but the next block reward reduction is not before January [2021[(https://medium.com/krown/will-Bitcoin-rise-to-50-000-in-the-next-few-years-b9e5cae4ffb6). The lightning network might make a difference by confirming transactions off-blockchain, but any price increase of Bitcoin will continue to incentivise more energy usage.

Do intermediaries make sense?

Investing in Bitcoin is easy, download a Coinbase app, make an account and start trading.
However, this doesn’t correspond to reality. For proper cryptocurrency investments, risk diversification is recommended over different currencies and different exchanges. Along with that comes wallet management, password management and security management on several devices – and that complicates the situation. Below a visualisation, for illustrative purposes only.

The last column represents Bitcoin Cash. This was not a trade, but was the result of a fork. To claim a forked cryptocurrency, users have to go through a technical process. In other words, trading is only part of cryptocurrency asset management. The resulting problem is threefold: knowledge, time and operational risk. Therefore, investing in cryptocurrencies depends on the available time and the expertise of the investor. If cryptocurrency trading is not done with careful reading and testing, then it’s likely to go wrong. I made my mistakes, and I learned from them.

This is my message to people that compare the cryptomarket to the dotcom bubble. They claim that risks are similar, but I argue that the risks of crypto investments are much higher! Because in the dotcom period you could only win or lose because of price changes. In crypto assets, prices can soar, but investors can still lose their investment because of crashed computers, shutdown of exchanges, lost private keys, phishing and malware. Taking security and backups serious is imperative!

Using intermediaries makes sense to mitigate the operational risk. Depending on the expectations, investors can choose different strategies. Investment Strategies range from investing in cryptocurrency funds, buy and hold (hodl), active trading and joining ICO’s. These options each have their benefits and drawbacks.

Is there correlation between cryptocurrencies?
This link shows the correlation coefficient between many of the main cryptocurrencies: https://bitinfocharts.com/de/correlation.html
The result is sobering; there is no clear indication of correlation.

What will be other good performing cryptocurrencies?

This depends on the definition of good. Despite great returns for Bitcoin in 2017, there were numerous altcoins and ICO’s that outperformed Bitcoin, like Ripple, Cardano and Tron. Identifying a shooting star requires close observation of the market. There are multiple ICO’s per day and screening them is a full time job. A bit less time consuming, in return for a bit less performance will be offered by the established cryptocurrencies with good perspectives. To help us assess the perspectives, Martin Weiss has released cryptocurrency ratings on January 24, but their reliability is controversial.

From a rational perspective, I see potential for improvement in scaling, energy usage and general acceptance. IOTA is interesting because their token is completely premined and claims to scale well without any transaction fees. If their network works, then it has very good chance to be used for micropayments in the internet of things.

NEO is interesting because it has similar possibilities like Ethereum and is widely supported by developers in China. NEO has a maximum supply of 100 million tokens, whereas Ethereum doesn’t have a maximum supply. Therefore, from a pure economic perspective NEO is more interesting than Ethereum, because it has scarcity, just like Bitcoin.

Finally, Dash is also on the watchlist, because it is a Bitcoin clone with much experience and advanced features to Bitcoin including “instantsend” and “privatesend”. Their solution of a 2-tier network with masternodes is suggested to be the solution for the scaling problem. It really sounds like the better Bitcoin, but will the public put it to the test in 2018?

Comparing cryptocurrencies to Private Equity investments

If people ask if it’s too early to add cryptocurrency to their portfolio, I ask if they invest in private equity. I like to compare the two investment types because it reveals some real advantages of cryptocurrencies. Private equity investments are non-marketable and added to portfolios with 2 main objectives, high potential returns and little correlation with other asset classes. In return, investors accept high entry barriers, very limited liquidity and high fees.
Private equity funds are specialized in screening investment opportunities several markets with several strategies and it requires a minimum team-size to be successful. Private equity investments are great, but they’re considered to be very risky and only for well-informed professional investors. Retail investors are protected from making investments in private equity because it’s considered too risky and despite high potential performance, total loss of investment is not unlikely.

cryptocurrency investments are also non-marketable investments with probably even less correlation to traditional asset classes than private equity. They protect from traditional currency risk, don’t require high minimum tickets and offer immediate liquidity. The risk of total loss is not unlikely, but the performance quite likely bypasses the performance of Private Equity investments with an average IRR between 9-17% per annum on a 5-10 year investment horizon. Finally, they don’t charge the fees that apply to private equity investments.

From my perspective, the risk-reward ratio of cryptocurrency investments are well balanced. The only hard thing is management of a cryptocurrency portfolio and that’s why intermediaries for a small allocation to cryptocurrencies make sense for those who don’t have time to manage a portfolio of cryptocurrencies themselves.
Finally, I recommend watching the latest video from Andreas Antonopoulos about consensus without rulers.

Thank you for reading and thank you for upvotes, comments or suggestions.

Image source: glitter-graphics.com