Bitcoin (COIN) (NYSEARCA:GBTC) prices are fluctuating wildly again. Over the course of a single month, the currency is up more than 80%. For an asset class with a market capitalization of almost $88 billion, this is almost unheard of. Some media are already mentioning targets of $7500, which I do not find unrealistic given the past price fluctuations.
On the other side of the spectrum, many countries are tightening cryptocurrency regulations, or in the case of China and South Korea, the outright banning of initial coin offerings. China even went as far as shutting down its largest Bitcoin exchanges. Also, bankers and politicians are speaking up about cryptocurrency, sometimes calling it a "pyramid scheme."
A world leader joining the party
Even Russia's president Vladimir Putin joined the Bitcoin media party recently, calling on the Russian central bank to create a regulatory framework for the adoption and usage of cryptocurrencies with “legal guarantees for working with innovative financial instruments." At the same time though, he warned for the risk of cryptocurrencies:
The usage of cryptocurrencies carries serious risks. I know the central bank’s position on that, we have discussed it several times with the central bank’s governor.
In another source, he also elaborated on what he sees as 'serious risks':
Opportunities to launder criminally obtained money, evade taxes and even finance terrorism, as well as, of course, perpetuating fraudulent schemes that obviously may affect ordinary citizens.”
This does not sound too bad, were it not that the first deputy governor of the Central Bank of Russia, Sergei Shvetsov, revealed that the Russian government would block access to cryptocurrency exchange websites to protect citizens from the volatility of these currencies.
Volatility, how much of an issue is it?
To answer this question, let us first take a look at the yearly chart of Bitcoin.
While a single Bitcoin sold for about $640 exactly one year ago, the value increased more than eightfold. Though the chart looks like a steady uptrend, fluctuations have been huge. As I'm typing this, the currency is up more than 10% over the course of a single day.
Putin might have a point about the volatility of Bitcoin. But I am of the opinion that individuals are perfectly able to decide for themselves whether they want to engage in it. Warning people against volatility is wise, but the closing down of Bitcoin exchanges is simply wrong and not smart. People will find ways to trade Bitcoin if they want to and by limiting the options to obtain cryptocurrency, you are also limiting the government's options to play a supervisory role.
In my previous article about Bitcoin, where I tried to analyze the impact Amazon could have by accepting Bitcoin payments, I identified four challenges which are currently impeding Bitcoin's advance to adoption by the masses. These four challenges are:
- Bitcoin is complicated to use for regular people and dangerous if not stored well
- People are using Bitcoin as an investment, not as a way of payment
- Technology is not ready for widespread payment use
- Governments and institutions are cracking down on Bitcoin
These challenges appear to be more valid than ever. Especially challenge #4 is in the media all the time. On the one hand, these kinds of messages can make some people cautious of investing in cryptocurrency, but on the other hand, they are just as likely to encourage people to start investing in Bitcoin. I think the net result of such warnings might even be positive for cryptocurrency as a whole.
Bitcoin will become virtual gold, not the digital dollar
To elaborate a bit on challenge #2, Bitcoin isn't actually designed as a mass payment system. Currently, the blockchain can handle 1MB of transactions every 10 minutes. At the moment, about 300k Bitcoin transactions are done every day, which is nothing compared to the number of transactions big banks are carrying out. Also, payment fees for the miners are much too large to support a worldwide micropayment infrastructure.
The Bitcoin community acknowledges these shortcomings and is implementing some changes, like doubling the block size, which will decrease both transaction cost and transaction time. But even with this action, this will not nearly be enough to sufficiently support the increasing digital transactions which are done using the Bitcoin blockchain every day. Also, by implementing these changes, the Bitcoin community is risking throwing the baby out with the bathwater. Disagreements among the community have already led to a hard fork, where Bitcoin Cash was split off, and next November, when the doubling of the block size is on the agenda, Bitcoin is risking a split again.
There are multiple other cryptocurrencies which are much better designed to perform the function of a payment system. I will not go into details here, but Ripple and Litecoin come to mind. Also, Ethereum is a cryptocurrency which is focusing on the investment-infrastructure of the crypto world.
So, what does Bitcoin have that other cryptocurrencies do not have? Two things: a very active and big community, and the first mover advantage. Using this first mover advantage, I think that it is wise for Bitcoin to move towards the role of digital gold. A stable investment which can serve as a benchmark for other cryptocurrencies. In order for this to happen though, volatility will have to decrease.
Investors, be warned
To repeat the words of Putin: the use of cryptocurrencies carries serious risks. Only invest in it if you know what you're doing. It is very well possible that investors could lose almost their whole investment in cryptocurrency. At the end of 2013, I bought Bitcoin for a modest amount of money. I mentally wrote the investment off after the value of Bitcoin dropped more than 80%, but I could not have been more wrong. Until now, I did not sell my initial investment. But at the moment, with all the media attention, the closing of Bitcoin trading platforms in different countries and the continuous rally of cryptocurrency prices, I begin to become more and more cautious. Am I just being overreactive or is there a real risk here?
The hype cycle is a graphical presentation of representing the maturity, adoption and social application of specific technologies. It has been used explaining the stage of many technological innovations. Please pay special attention to the vertical axis: it does not represent price or market capacity but is a measure of the expectations the public has of a specific technology.
When we try to analyze Bitcoin and cryptocurrency using the hype cycle, we quickly discover that this is difficult. Second generation products are already 'on the market,' in the shape of innovative cryptocurrencies and blockchains being experimented on by entities like banks. Negative press has certainly already begun, and all the stages where venture capital is mentioned are likely irrelevant for Bitcoin. Bitcoin seems to be able to shake off negative media attention handily, but this might also have to do with the fact that negative media attention has been about the use of Bitcoin, not about the underlying blockchain technology itself.
When trying to analyze blockchain technology with the hype cycle though, the picture suddenly becomes much clearer. With regard to the blockchain, it is likely that the hype is still building. Though Bitcoin and other cryptocurrency have been criticized time and time again, blockchain always seems to escape from these critics unscathed. Also, early adopters are already investigating: multiple banks and other companies announced they are experimenting with blockchain technology. It is fair to say that cryptocurrency is just part of the first generation products which are forthcoming from blockchain.
With regard to the hype cycle of technology, it is fair to say that Bitcoin is riding the wave of blockchain, and it is likely that blockchain is currently entering the peak stage of expectations. Nobody knows exactly what will happen after the peak of the hype cycle, but in the case of Bitcoin, I can make an educated guess: volatility.
Your takeaway
Bitcoin volatility is likely to continue. If challenges are not solved, it might even increase. With governments continuing to crack down on cryptocurrency, the general public is not likely to invest in it for the long term. It is not hard to see why Bitcoin is attractive to traders and investors, but the currency needs long-term stability to truly become digital gold.
When looking at the hype cycle of innovations, it seems that blockchain technology is entering the peak of expectations. This is a beautiful phase, but also dangerous since it predicts more volatility in the future. I would recommend every cryptocurrency investor to continue to be very cautious. It is possible to make giant profits with this investment, but please realize that you can also lose almost your entire investment as well.
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Giesbers Investment Strategy
I am a private investor from the Netherlands in my mid thirties. I have a very long term view and with my own investments I focus on a combination of stable, dividend-paying investments, and growth stocks. My favorite holding period is forever, but I am looking for new and interesting opportunities. I am writing for Seeking Alpha because I like to share my insights and enjoy the interaction about investing ideas. My writing is mostly about stocks I own, and others I am interested in.I have a university degree in engineering and professional experience in many industries, including government, engineering, supply chain, mobility and IT. But please do not read investment articles because the writer has nice degrees or fancy references. Read my articles because I provide an authentic, humble and realistic voice with some good old common sense.In the picture you can see my cat, who sadly died a couple of years ago. He has been the logo of Giesbers Investment Strategy since its inception. I chose his picture since my investment strategy mimics his behavior: more than 90 percent of the time, investment means doing nothing, and my cat was a genius at this. Also, during brief periods of time he could become very agile and active, just like what I should do when I notice great investing opportunities. Also, my cat was very picky with his food, which a good investor should also be with his holdings. Only the very best is good enough.
Analyst’s Disclosure: I am/we are long BITCOIN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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