At time of writing, the total value of all outstanding cryptocurrencies is nearly $2.4 trillion US dollars, according to coinmarketcap (CMC), which makes it larger than the CDOs of the housing bubble and the infamous South Seas Company bubble. Trading in the coins in also at record high with daily trading volume surpassing $200 billion USD, according to CMC.
What has been driving up price?
Firstly to blame is most certainly the excessive amounts of money printing by central banks around the world coupled with unprecedented amounts of fiscal stimulus to fight the “pandemic”, which have propped up all assets classes. In the recent past, similar fiscal and monetary policies to fight “crises” have been the trigger for the previous bubbles: the Dotcom bubble was triggered by money printing to save the world from “Y2K” and equally the housing bubble was triggered by money printing to pay for the wars following the terrorist attacks.
What’s more, crypto’s own “central bank” Tether has been printing huge amounts of fractionally backed tether-dollars as well.
Now, couple rising prices with everyone being at home, following “finance gurus” (e.g. the Technoking of Tesla) on social media and having easy access to the markets via apps like Robinhood and the perfect conditions are created for a bubble of epic proportions.
Why will it crash?
Proponents of Bitcoin will claim that it is the ‘new money’, a hedge against inflation or that DApps and DeFi will take over the financial systems. Let’s break down these arguments.
First of all, Bitcoin is not money. This is easily observed by the fact that it is not a unit of account (the thing you use to measure value); everyone is looking at dollar prices. Similar to gold, Bitcoin is a value transfer system, but can never be money. Money, since the dawn of humanity, is a meta-physical concept representing value and is therefore not necessarily tied to anything physical. IOUs denominated in a certain value system (e.g. the USD) are valuable because they are contractually enforced by courts, police or military. In other words, money is established as such by government regulation. In practice this is seen in times of crisis, where people flock to the credit of the government with the strongest military.
Secondly, Bitcoin is not a hedge against inflation. Inflation can be caused by many different events (one being money printing). However, prices can also go up because of higher energy costs following tensions in the Middle-East. Higher prices caused by an energy crisis will lead to lower disposable income for almost everyone, which means people will also have less to spend on “investments” or will even be forced to sell their assets to pay for higher cost of living.
Thirdly, Dapps will never provide an efficiency over current state of the art systems. This is easily observed by the fact that dapps have so far failed to gain traction within high performance firms, where performance really counts such as market makers, manufacturing firms or global logistics services. The reason is that dapps are many orders of magnitudes more expensive and slow (fees for ETH have gone up above $50/tx) and the decentralization provides no benefit. As pointed earlier in the money discussion, contracts are no good unless they can be enforced (by the use of force if necessary). For example, you can’t use a ‘smart-contract’ to track home ownership, since people can just violate the entries in the blockchain.
This is not to say that dapps haven’t been heavily used, though mostly to speculate and gamble, however these use cases have no attachment to reality, it is no different than buying assets in a video game.
Finally and most importantly, Bitcoin right now is a pyramid scheme. The only way to make money on Bitcoin is by selling it to someone else at a price higher than you bought it, but then that person will have the problem. This is unlike income producing stocks and real estate which have capital returns in the form of rents, have dividends or buy-backs, which means the person holding the asset can make money without having to sell it. Eventually you will run out of greater fools and it will be at a time when it will be most inconvenient.
Triggers for the crash
The exact trigger for the crash will come unexpected and will be hard to predict. High amounts of leverage in the system however makes it that the decline is abrupt and it is especially speculative assets that get killed. The most recent panic in 2020 was caused by a virus scare (Bitcoin dropped nearly 50% in one day in March of 2020), the housing bubble deflated because of skyrocketing energy prices, the terrorist attacks were the nail in the coffin on the dotcom bubble and an agricultural recession combined with higher interest rates caused the 1929 decline.
Looking forward, there are many known risks: e.g. large-scale cyber attacks, religious uprisings, peak oil but of course there also many unknown risks (e.g. that could come from emergent technologies).
Hope for cryptocurrency
Now while this has been a quite negative article on crypto, I do think crypto will have an important role to play in the future. As governments have increasingly started limiting freedoms in light of the pandemic, demand for a private and uncensorable means of value exchange will continue to go up (it was the stringent drug laws in the USA that pushed Bitcoin into mainstream in 2011 with the Silk Road). Bitcoin (BTC), however no longer fits this use case as transactions have become prohibitively expensive and slow and each Bitcoin is tracked by specialist data analysis firms, for example people have had their Coinbase account shut down because they sent coins to a darknet market. Given this, it seems likely coins like Monero or Zcash will take over the top spot, but probably only after a massive crash in the crypto market.
How to trade this
While the price of Bitcoin could definitely go higher, if you still hold some, taking profit is a prudent move; certainly you will want to at least get your initial amount back.
As for shorting, with $MSTR and $TSLA buying large amounts of bitcoin, there are now safe (limited and defined risk) ways to short Bitcoin indirectly by buying puts in these companies. To reduce risk a put position can be hedged with a $QQQ long.