A Simple Analysis of Bitcoins
Most Bitcoin traders, miners, and
merchant alike are still feeling the effects of the Bitcoin bubble crash of
April 10, 2013. From a price of $13.30 per unit at the beginning of 2013,
Bitcoins rose to an astounding high of $266 per unit. Such a movement caught
global attention as the virtual currency surpassed both the price of a one ounce bar of silver
and one share of a gold ETF (NYSE:GLD). In addition, the Bitcoin market
capitalization rose from $500 million USD to over 2 billion USD.
Suddenly, as quickly as it rose,
Bitcoins crashed in value from what many economists called - a “bubble’. Like
most economists, I would tend to believe that the Bitcoin bubble was created by
panic buying that was sparked by the financial crisis in the nation of Cyprus.
What caused the
bubble?
The Cypriot crisis created a global
fear that our governments could at any time step in and seize our hard-earn
cash and allowance it out to us as if we were little irresponsible children. In
addition, there were calls from Russia demanding its citizen to repatriate
their offshore capital (1) . The response was
panic buying of Bitcoins from all across the Eurozone.
There was also speculation that the
merger of US based, CoinLab (1) and Japan’s MT.Gox (2) would ease
investment fears from American and Canadian investors. Such a merger would have
created better liquidity as the North American investors try to move their cash
to and from the Mt.Gox exchange.
What caused the
crash?
I believe the crash was brought on
by rumors that the Cypriot government was in talks on April 10 to sell its excess
gold reserve in order to raise euros that would finance its bailout deal with
the European Union and the International Monetary Fund (4) . Nevertheless, it is
just my opinion that this monetary action created a bearish sentiment in the
Bitcoin markets as investors felt that the Cypriot banking system would recover
from the deal.
Macroeconomics.
Macroeconomics teaches us that the
price of a product or service is determined by its available supply and level
of demand. Bitcoins by all means, fall under this rule. When predicting the
price movement of Bitcoins, I find the macroeconomic method easier because of
its simple fundamentals.
According to macroeconomics, a product like Bitcoins has a supply (S) that is in circulation and a level of demand (D) placed on it by investors, merchants, and consumers. The supply and demand chart is used by economists to predict price movements. In the above chart, the point where the supply curve intersects with the demand curve is called the Equilibrium. It is the equilibrium where the market price (P) and market quantity (Q) of a product is set.
Nevertheless, the price of Bitcoins
will increase only if the global demand for it increases or if the global
supply of it decreases. And the price of Bitcoins will fall only if the global
demand for it decreases or if the global supply of it increases.
Economic Analysis of
Bitcoins
I have mentioned earlier that in
the beginning of 2013, the price of a Bitcoin was $13.30 per unit and by April
10, 2013, it reached a high of $266 per unit and then crashed. The chart below
shows an economic picture of this event.
Figure 1: The Bitcoin Bubble
The Bitcoin Bubble
According to the chart see Figure1, the move from P1 to P2 was caused
by a rightward (increase) shift in the demand curve. It is understood that this
shift was created by a fear coming from Cypriots, other Eurozone members, and
Russians that feared their private savings and personal capital were under the
threat of being seized by their governments. Since Bitcoins are decentralized-
meaning no government has jurisdiction over them; fearful investors and
depositors flocked to the virtual currency for safety.
Figure 2: The Bitcoin Crash
The Bitcoin Crash
According to the chart see Figure2, the move from P1 to P2 was caused
by a leftward (decrease) shift in the demand curve. It is understood that this
shift was created by a restored confidence in government and banking from the
Cypriots and other Eurozone members. It may also be assumed that the crash
could have been brought on by the DDOS attacks and excessive trading on the
Mt.Gox exchange servers which cause serious delays in trade transaction;
causing the exchange to temporarily shut down and spooking traders into selling
their Bitcoins (5) .
Determinates of
Bitcoin Demand
I believe these five economic
factors can affect the global demand for Bitcoins.
1.
Government seizure of private assets – This
is perhaps the main reason why Bitcoins exist and will continue to exist.
Nobody wants their life savings or hard earn cash taken from them. It’s bad
when a thief does this, but it is devastating when your government does it.
Cyprus showed the world what happens when a government and banking system can’t
manage their debt (it takes it out on its people). Nevertheless, I believe this
is a key sign to watch out for. If governments start taking people’s money
by force; expect Bitcoin prices to soar!!!
2.
Price speculation and manipulation –
I see this as the second determinate of Bitcoin demand. I also see this as a threat
to Bitcoins. Just my opinion, I believe Bitcoins were meant to protect its user’s
privacy from abusive government and banking regulations. Personally, I believe
the current market price is overvalued. However, this new trending currency has
a global potential to rival the current fiat system. Naturally, a few investors
see the Bitcoin popularity as a multi-million dollar opportunity and of course;
buy, mine, and hoard as many Bitcoins as possible.
These actions artificially drive up the price of Bitcoins as these
‘speculators’ try to manipulate the market. Without any major geo-political
event or financial regulations affecting Bitcoins, speculators have free reign
to abuse the Bitcoin market. Nevertheless, I believe this is a key sign to
watch out for. If there is no other global situation like Cyprus; expect Bitcoins
prices to drop!!!
3.
Competition from alternative digital
currencies – I see this as the third determinate of Bitcoin demand. I
also see this as a threat to Bitcoins. As an open source technology,
alternative forms of digital currencies can be created by any skilled
developer. Because of Bitcoins popularity, many copycat developers are seeking
to develop their own versions of the crypto-currency in order to capitalize on
the trend. The results are variants with names like Litecoin, NameCoin, NovaCoin, FeatherCoin, and ChinaCoin (5) . Fortunately for Bitcoins, these variants
are not accepted in the same market places where Bitcoins are exchanged for
goods and services. If they were, then they could create an aggregate effect on
global supply of crypto-currencies and crash Bitcoin prices down. In other
words, too many alternative currencies can decrease demand by drawing money
away from Bitcoins. Nevertheless, I believe this is a key sign to watch out
for. If
alternative crypto-currencies are accepted in the same places where Bitcoins
are accepted; expect Bitcoins prices to drop!!!
4.
Acceptance of Bitcoins by consumers
worldwide – I see this as the fourth determinate of Bitcoin demand. I
also see it as crucial to Bitcoin survival. So far Bitcoins are used to
purchase items like electronics, clothing, and food. Bitcoin are also used to
purchase services like web hosting and guitar lessons. However, acceptance can
only grow once more people get over their fear and ignorance of this
revolutionary technology. Nevertheless, I believe this is a key sign to watch
out for.
5.
Trading of illicit products and services – I
see this as the fifth determinate of Bitcoin demand. I also see this as the
lifeline of Bitcoins. There are many pundits of Bitcoins that claim Bitcoins
are a scam and eventually will fail. However, I dispute their claims because
Bitcoins do have practical uses. The Tor Network was created so that its users
could sell products and services anonymously. In fact, the Tor Network is what
gives Bitcoins their famous hallmark; anonymity. The network was also created as a last outpost
for people wishing to challenge their oppressive governments. Obviously, they
needed an anonymous medium of exchange. This why Bitcoins and the Tor Network
have become a perfect pair.
Even if the government tries to ban Bitcoins, the price will never go to
zero. Governments must learn that banning an item will only create a
black-market for it. In fact such actions by the government will be viewed as a
threat to civil liberties. As long as the internet and the Tor Network exist,
Bitcoins will always hold a value. Nevertheless, I believe this is a key sign
to watch out for. Remove the internet and the Tor Network; expect Bitcoin prices to crash to zero!!!
My Analysis
In order for the price of Bitcoins
to return to the $266 price of April 10, 2013, we must see an event similar to
the Cyprus crisis; which would shift the demand curve greatly to the right. In
addition, this event could spark a fury of buying activity from speculators
seeking to profit from the crisis.
In my opinion, I don’t see the
price for Bitcoins returning to its previous high unless some government
decides to seize its citizens’ bank accounts. My educated guess for Bitcoins
would be to expect a sudden pull back to $60, then a steady increase to $200
price levels as other Eurozone nations and the North American nation of Canada
a face similar crisis like that of Cyprus (7) .
References:
1. Durden, Tyler. Rethinking Money With Bitcoin
Quadrupling Since Cyprus. Zero Hedge. [Online] 4 7, 2013.
http://www.zerohedge.com/news/2013-04-07/rethinking-money-bitcoin-quadrupling-cyprus.
2. CoinLab. Bitcoin
Price Reaches All-Time High after Mt. Gox Announces CoinLab Partnership. CoinLab.
[Online] 2013. http://coinlab.com/.
3. Mt.GOX. Trade
with confidence on the world's largest Bitcoin exchange! Mt.GOX. [Online]
2013. https://mtgox.com/.
4. Reuters. Cyprus
to sell around 400 million euros worth of gold. Reuters. [Online] 4 10,
2013.
http://uk.reuters.com/article/2013/04/10/uk-cyprus-bailout-gold-idUKBRE9390NW20130410.
5. Burn-Callander,
Rebecca. Yesterday's bitcoin billionaires are today's virtual vagabonds. Management
Today. [Online] 4 11, 2013. http://www.managementtoday.co.uk/go/howto.
6. BTC-e. News. BTC-e.
[Online] 2013. https://btc-e.com/news.
7. Thomas, Jeff.
If Cyprus Is the Bellwether, then Canada Is the Red Flag. GoldSeek. [Online]
5 9, 2013. http://news.goldseek.com/GoldSeek/1368125054.php.
8. The Tor Project.
Anonymity Online. Tor. [Online] 2013. Anonymity Online.
9. Bitpay, Inc.
The world leader in Bitcoin Business Solutions. BitPay. [Online] 2013.
https://bitpay.com/.
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