Bitcoin has been massacred, suffering an almighty crash over the weekend that saw the digital currency lose a third of its value at one point. However, it managed to pare back some of those losses to open Monday trade 19% below its Thursday all-time high of $2,779.
I might have been a bit premature when I called out the Bitcoin bubble once the electronic currency crossed $1,700 on May 9. But with the currency taking out new highs almost everyday, a correction was an almost inevitable outcome.
The Winklevoss brothers once claimed that Bitcoin will one day become better at being gold than gold itself. Is this based on fact or mere hyperbole?
Short Bitcoin Overview
Bitcoin has quickly established itself as one of the most exciting monetary experiments and the leading cryptocurrency of modern times.
Created in 2008 by a group of Japanese programmers under the name Satoshi Nakamoto and released to the public in 2009, the digital currency flew under the radar for the most part, with the price of single bitcoin remaining under $20 till late 2013. The first Bitcoin breakthrough came during the holiday season of 2013 when prices spiked to $1,242 per coin to briefly overtake gold which was trading at $1,240 per ounce.
But 2017 has proved to be the true turning point.
Prices still are up an impressive 127% year-to-date even after the severe correction, well ahead of gold, which is currently at $1,266 per ounce. Bitcoin has been rapidly gaining acceptance by major world economies including Japan and Russia. It also has become the darling for mainland punters in China amid growing expectations of the yuan’s devaluation, a slumbering stock market and hopes that the currency will dodge Beijing’s anti-corruption drive.
Famous investor Jeff Gundlach recently tweeted that it was probably not a coincidence that Bitcoin had more than doubled in 2017 at a time when the Shanghai Composite was down 10%. But is it really that powerful?
More importantly, what are the chances that investors will begin to view bitcoin as the new safe haven asset and a viable alternative to gold? After all, the SPDR Gold Trust (ETF) (NYSEARCA:GLD) is up just 10% YTD, not a whole lot better than the 7.9% gain by the S&P 500.
In all fairness, it’s hardly likely that the cryptocurrency is to blame for the sad state of affairs in the country’s equity markets.
Unlike the case in Japan where the cabinet recently recognized Bitcoin as a legal method of payment, demand in China has diminished greatly ever since the People’s Bank of China started cracking down hard on local exchanges. China has consequently ceased being the most important Bitcoin market, and its 85%-90% market share has dropped to something like 10% currently.
But prying eyes by the establishment is only part of Bitcoin’s troubles. The other one is far more pernicious — extreme volatility.
Bitcoin’s Extreme Volatility
Sure, Bitcoin sports certain features that make it ideal as money including scarcity (the absolute total amount of Bitcoins that can be mined is only 21 million, and mining takes an enormous amount of energy) and the fact that it’s virtually impossible to print — something that fiat currencies such as the American dollar cannot lay claim to.
You can even say that total anonymity of transactions is a plus, though that of course depends on who you ask. (Hint: Governments might not share that sentiment.)
But all that cannot negate the fact that Bitcoin’s volatility might be beyond what most people can stomach.
Its volatilty greatly exceeds that by gold and other leading currencies, as we were so aptly reminded during the weekend. Downside deviation is a more meaningful metric than standard deviation when it comes to measuring the risk of a currency. The bad news is that Bitcoin’s downward deviation is several orders of magnitude greater than that by gold and other currencies. Bitcoin has a downward deviation of 45% when measured as annualized daily returns. That compares poorly with gold’s 8% reading for the same metric.
This huge downside risk makes it a lot more difficult for the average trader to accept Bitcoin as money. Holding the currency for years could hold a big upside, but nobody wants money that can easily lose a third of its value at the drop of a dime.
Sure, traders can quickly change their Bitcoins to everyday currencies. But few will be willing to spend their time and energy changing it into currency bearing in mind that a single transaction takes about two hours.
No Way to Grow the Bitcoin Pie
Although a major requirement for anything to be accepted as money is that it should have limited supply, Bitcoin takes that concept a bit too far.The total market is currently worth just $36 billion. Compare that to the $7 trillion value of the total above-ground gold stocks — considerably more than all the world currencies combined.
About 80% of all available Bitcoins have already been mined. It’s not yet clear how the market will progress once nearly everything is gone, and there’s no way to grow the pie. Suddenly the idea that Bitcoin cannot be printed will not look so appealing anymore.
Bitcoin might one day overtake gold as the leading safe-haven asset, but that day appears to be a long way off.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
