In Coinland's Wild West, bitcoin still holds all the cards
But while the cryptocurrency rules for the time being, the effects of the rise of punchy alternatives have yet to be played out
Bitcoin and bubble have become virtually synonymous in the minds of many sceptics during this year’s breathtaking rally.
While the digital currency has defied doomsday prophesies, there’s a number of ways this party could end badly for the swelling ranks of bulls.
But be warned: many of the potential causes of death have surfaced during the past few years, and have proven unable to bludgeon bitcoin into oblivion thus far.
The multiple offshoots of bitcoin could cause the world’s largest digital currency by market value to cede its crown.
Divides among developers as to how to proceed with upgrades to bitcoin’s network have led to "forks" in which different versions of the currency are spun off from the original. Excessive fragmentation could prove a bug for bitcoin, just as it did for the US financial system during the free banking era. When it comes to cryptocurrencies, hedge fund manager Mike Novogratz warns: "Not everything can win," although that’s not enough to stop him from launching a US$500 million fund to invest in the asset class.
Given bitcoin’s chequered history as the means to purchase illicit materials, a vehicle for capital flight and a victim of theft, it’s no surprise that regulators around the world have cast a watchful eye over the asset class. As such, the spectre of a complete crackdown on cryptocurrencies remains an ever-present tail risk. The SEC has been keeping an eye on crypto and has given guidance saying some tokens may be securities, making them subject to their oversight.
The UBS chief investment officer Mark Haefele says the wealth manager will not dedicate funds to bitcoin because "all it would take would be one terrorist incident in the US funded by bitcoin for the US regulator to much more seriously step in and take action".
The Federal Reserve chairman nominee Jerome Powell said bitcoin is not big enough to matter right now but alluded to the possibility that it could impede the central bank’s transmission mechanism "in the long, long run".
That raises the prospect of bitcoin becoming a casualty of its own success should cryptocurrencies gain sufficient mainstream adoption and pose a threat to the government’s ability to collect taxes or the efficacy of monetary policy. Even so, the recent history on restrictions is not encouraging for bitcoin bears: the digital currency was able to shake off what was tantamount to an attempted ban by Chinese authorities in September.
Ever since the 2011 breach of the Mt Gox exchange, bitcoin owners have had to face the possibility that this intangible asset may fall into the hands of hackers. The Tokyo-based exchange filed for bankruptcy February 2014, alleging there was a high possibility that what was then nearly half a trillion in bitcoin had been stolen.
The 2011 breach and 2014 collapse of Mt Gox were accompanied by steep declines in bitcoin, as was the $65m theft of the digital currency from Hong Kong exchange Bitfinex in 2016.
But a $31m hack of alternative currency tether earlier this month was only a speed bump for bitcoin. After falling more than 5 per cent, the cryptocurrency recovered to post a fresh record high the same session.
CME Group, Cboe Global Markets, and Nasdaq are planning to offer bitcoin derivatives - a move which seems poised to introduce more two-way traffic to the asset class.
At present, most options investors have for shorting cryptocurrencies are fairly expensive and risky. With futures from reputable, established exchanges in play, more investors may be incentivised to enter into positions that put downwards pressure on prices.
The introduction of bitcoin futures could also ultimately prove detrimental to its valuation should clearing organisations come under stress amid the digital currency’s wild swings.
Thomas Peterffy, the chairman of the Interactive Brokers Group, argues that allowing bitcoin futures on platforms that clear other derivatives would raise the risk of price gyrations that could "destabilise the clearing organisation itself".
Any institutional credibility recently gained by bitcoin could evaporate should the cryptocurrency’s fluctuations serve to disrupt and undermine the operations of financial markets.
The failure of major cryptocurrency exchanges such as Coinbase to handle traffic on the day bitcoin breached $10,000 throws into sharp focus the scalability problems that cryptocurrencies face as speculative vehicles.
Indeed, bitcoin touched a nadir of $9,009.15, according to prices compiled by Bloomberg on Wednesday triggered in part by intermittent outages at cryptocurrency exchanges. Still, it again showed its resilience by then rallysing as much as 20 per cent and climbed as high as $10,787.99 in Asian trading hours on Thursday.
"A bitcoin correction is now likely and human psychology suggests it will finish the day lower," wrote the Bloomberg macro strategist Mark Cudmore. "If this was a normal market, it would almost definitely retrace in the short-term because large barrier magnets had been taken out."
Profit-taking opportunities when the cryptocurrency passes significant milestones could foster steep declines and waves of selling pressure due to poor liquidity.
It’s been a puzzle to explain why bitcoin’s gone parabolic. Why would we expect the way down to be any different?
The practical applications for cryptocurrencies to facilitate legal commerce appear hampered by relatively expensive transaction fees and the high energy costs associated with mining at this juncture. On this note, the Nobel Prize-winning economist Joseph Stiglitz says bitcoin"ought to be outlawed" because "it doesn’t serve any socially useful function".
The former Fed chairman Alan Greenspan has said that "you have to really stretch your imagination to infer what the intrinsic value of bitcoin is," calling the cryptocurrency a "bubble".
Perhaps it could end like the dot-com bubble - with investors who have no clue how to value high-flying assets fleeing for the exit en masse - but so far the chances of that look remote. Investors seem to be having a golden affair with the invisible currency.
But with all this love for bitcoin, one should maybe spare a thought for the little guy.
Despite a plethora of new coins coming online in the past year, and the emergence of ethereum's ether as another alternative cryptocurrency, bitcoin is still sucking up most of the oxygen.
Without a doubt, the new coins' sponsors owe a debt of gratitude to bitcoin for blazing a trail. But you'd think some of them might enjoy more of the spotlight.
Take ethereum. Despite a widespread belief that it's more versatile than bitcoin because of a technical ability to support other uses such as smart contracts, its coin - ether, the second-largest digital currency, which has posted huge gains since the bitcoin forks began - has been slower to take off. Sure, growth has been phenomenal, including a 55-fold increase over the past 12 months but not quite at the long-term rate enjoyed by bitcoin.
By tracking the number of days it took for both currencies to double - from $1 to $2, $2 to $4, and so on - ethereum has been a consistent laggard. It's been at least 190 days since that cryptocurrency reached $256, yet it still has not sustained itself above the next benchmark of $512. Bitcoin's growth would suggest it should have hit that point around six months ago.
There are many reasons why this may be the case, including a rash of new coins, many based on ethereum, that diverted funds elsewhere. Detractors also point to a previous incident that led to the cryptocurrency being forked.
Yet people who looked beyond bitcoin would have been rewarded by returns of many multiples of that offered by the leader over the past year.
And while many punters have tried to ride the wave of smaller coins, sticking to the top 10 would have been a solid strategy, returning around 64 times the initial investment from a year ago. Admittedly there's a certain amount of selection bias here, but most of the top 10 coins today were also leading players in December 2016. The point is that selecting a broad basket of smaller coins would not have been a better guarantee of bigger returns than simply choosing a selection of top 10 names - as long as bitcoin wasn't among them.
Despite this, bitcoin's early-mover advantage, continued fame and single-purpose use (as a store of value) still make it an oversized influence on the global crypto market, in a way that suggests it is already playing the role of reserve currency among peers. This may also be because most exchanges offer some kind of bitcoin pairing, and many only allow trades into and out of fiat currencies via bitcoin. The same cannot be said for other coins.
It is still the Wild West in Coinlandia, and there is no sense that bitcoin is going to go away anytime soon.
But we are yet to see what role all those alternative currencies will play in a broader market.
Updated: November 30, 2017 01:02 PM