Bitcoin and cryptocurrency market: past, present and future

There’s been a clear hype around the cryptocurrency market. One can observe a lot of talks about its nature as well as its prospects. While there’s plenty of information on the internet, a comprehensive analysis is still lacking. This article is an attempt to analyse the history of Bitcoin price movements, describe the current state of the market and offer a short-term and a long-term view.

Since the cryptocurrency market has originated from Bitcoin, it’s reasonable to find out which factors contributed the most to its price fluсtuations in the past.

2013–2014: ups and downs

Bitcoin price was extremely volatile during this period. From its lows in the beginning of 2013 to its highs in December the price had grown more than 80 times. Among other factors, two major reasons were cited: the banking crisis in Cyprus in spring and massive inflows of money from Chinese investors at the end of the year [1], [2]. In the midst of the Cyprus banking crisis Bitcoin price was beyond 200 dollars, yet in January the price was only 13 dollars. It was natural to observe almost a vertical drop shortly afterwards. After several ‘calm’ moths Chinese factor came into play. Bitcoin began to be used by some merchants there. It also gained popularity as an alternative investment. Bitcoin price had reached 1100 dollars. Moreover, the Chinese market attracted speculators since Bitcoin price there was higher that in the rest of the world. During 2013 there was a shift from dollar to Chinese Yuan as a fiat currency to trade Bitcoin. In December People’s Bank of China (PBoC) restricted its banks from using Bitcoin as currency and warned its users [3]. Bitcoin price halved in a matter of days.

In 2014 Bitcoin price stagnated and stopped at the three hundred dollar level. Financial regulators around the world were mostly sceptical. Bitcoin was criticized for its use in money-laundering activities and in the black market. Confidence in Bitcoin had been further undermined due to Mt Gox bankruptcy which in those days was the largest Bitcoin exchange.

It’s worth noting that the distribution of wealth among Bitcoin holders was highly unequal — less than a thousand people owned half of all Bitcoins in circulation [4]. So this market wasn’t meant to be stable at that point.

Nevertheless, the concept of cryptocurrency gained popularity worldwide. The new industry had emerged: payments, mining farms and other cryptocurrencies.

Relative stability in 2015–2016

In those years Bitcoin demonstrated its viability, the market stabilized and the price started to grow again. Bitcoin price rose to 450 dollars in 2015. And during 2016 the price of Bitcoin had doubled. This was attributed to several factors [5], [6], [7], [8], [9], [10]:

  • the halving of the mining reward from 25 to 12.5 Bitcoin per block;
  • rising Chinese demand — avoiding capital control, reaction to Yuan devaluation and speculations;
  • growth in Bitcoin acceptance in the world;
  • additional publicity since venture capitalists started to invest in blockchain technology;
  • more serious and constructive attitude from regulation authorities in various countries;
  • increasing uncertainty due to Brexit, India’s demonetization and Venezuela’s currency problems.

Bitcoin market attracted HFT traders since there were some opportunities like no trading fees and price premiums on Chinese exchanges [11]. This can also be one of the sources of increase in Bitcoin price [12]. Interestingly, the price had risen more than 30% in December 2016 alone.

And again PBoC contributed to the burst of this bubble. In January PBoC spoke with cryptocurrency exchanges informing them that Bitcoin is still not a currency under Chinese laws. Rumors abounded that China would soon ban Bitcoin . Exchanges were forced to suspend withdrawal of funds, introduced fees and stop marginal trading. A sharp fall in prices from 1100 to 800 dollars in several days was justifiable.

Altcoins’ landscape before 2017

The tremendous interest in Bitcoin had led to the creation of other cryptocurrencies. They changed one or several features in the blockchain to differentiate themselves from Bitcoin: consensus algorithm, mining rules, type of encryption, emission scheme, nodes composition and so on. Among most popular altcoins were Litecoin, Ripple (XRP), Ethereum and Dash. But their capitalization was significantly lower than that of Bitcoin. Hundreds of other cryptocurrencies with no clear purpose had appeared and disappeared, some of which were very suspicious.

Ethereum demonstrated an interesting use case for positioning itself as a decentralized platform for implementing smart contracts and even running decentralized organisations. And even though the DAO hack had led to Ethereum split in Ethereum (ETH) and Ethereum Classic (ETC), ETH had grown several times in 2016. Still ETC demonstrated resilience and its price had risen two times by the end of 2016.

Explosive growth had been witnessed in Monero price due to its anonymity features and usage in the ‘dark’ web [13].

Asian fever — 2017

After the fall in the beginning of 2017 Bitcoin recovered, though its price remained volatile. One of the drivers of growth was expectations that Bitcoin-based ETF could have been approved by the SEC [14]. At the same time, another process started to gain momentum, which was Japanese and Korean money coming in.

Japanese exchanges had been legalized, they started to promote cryptocurrencies [15]. Moreover, Japan declared sale of Bitcoin exempt from consumption tax [16]. Merchants started more actively accepting Bitcoin. This led to a massive inflow of money in the cryptocurrency market. Japanese Yen got significant portion in Bitcoin trading volume. The similar process could be seen in South Korea [17]. Another source of growth was the fact that Korean markets were buying Bitcoin at a premium reaching 50% in some days [18].

Bitcoin was often used as a bridge currency to access altcoins. Ripple (XRP) and XEM (NEM) were among the most popular ones in Japan . During significant growth in April in May major cryptocurrencies were strongly correlated, while in the previous months this was not always the case.

Not the least, emotions and psychology played their part. As Koji Higashi mentioned, ‘Japan is known for its homogeneous culture and the key to adoption of anything is whether people perceive that ‘everyone else is doing it’ or not. So, obviously, it seems we have passed the tipping point in Japan and now it’s suddenly completely ‘OK’ to hop onto the crypto train and people started assuming it’s safe to invest in them because ‘everyone else is doing it’. Major Japanese cryptocurrency exchanges such as bitFlyer, coincheck and Zaif are onboarding thousands of users every day’. We could see it in the available traffic statistics for major websites of Asian cryptocurrency exchanges. So it’s not really surprising that Ripple and Litecoin grew tenfold in a couple of months.

Ethereum and ICO hype

Another phenomenon that also drew attention to the cryptocurrency market was so-called ICO (Initial coin offering). Blockchain startups sell tokens to raise money promising investors future profits or dividends. Since ICOs are mostly based on Ethereum smart-contracts, buying ETH is the way to participate in this process. Using the data from we can find out that ICO market attracted more than 1 billion dollars this year. According to cumulative market capitalization of top-40 tradable tokens worth today 3.4 billion dollars. It can be assumed that Ethereum was in huge demand as a result of the ICO boom. Moreover, some traders could have anticipated the price movement and bought ETH if there was a large ICO coming.

Fragile market

The lack of regulatory control makes it possible that prohibited trading techniques, insider trading and manipulation of information can be a part of the cryptocurrency market. For instance, big movements were observed in Litecoin before SegWit had been activated and Korean exchanges started to trade this cryptocurrency. Another example was false information that Ethereum founder had died, which led to a sharp decline in ETH.

Since cryptocurrency exchanges are new and sometimes inexperienced companies they may face problems when high volatility appears. Cyber attacks are also one of the reasons the exchanges sometimes suspend trading.

The exchanges are not immune from flash-crashes, when very rapid fall in price occurs within a short period of time. This was due to lack of liquidity in a market where trading algorithms and HFTs play an important role. The flash-crash in Ethereum on June 21 drove the price to as low as 10 cents. It was said that a single 12.5 million trade was the one to blame [19]. Afterwards there were suggestions to implement circuit breakers like in traditional stock markets and limit maximum order size.

Another aspect of this young market is its highly speculative nature. It can be illustrated by daily turnover ratio (value traded/capitalization). Bitcoin has the most stable figure of 1–5%. This ratio in Ethereum, Ripple and Dash can sometimes be higher that 10%. During very volatile days in Ethereum Classic this ratio is near 25%. But the most incredible cryptocurrency by this measure is Litecoin where the average figure tends to be 10–30% and during ‘hot days’ the ratio can approach 95%. In the US stock market this ratio is typically a lot lower than 1%. High ratio is common for small cap stocks when ‘pump and dump’ schemes are in place. It could be supposed that cryptocurrency market lack long-term money. This can be especially dangerous for altcoins with their relatively short history.

Ethereum may be additionally under pressure since it acts as a framework for ICO market. If ICOs are not able to drive sufficient demand for ETH, its price will go down. This might be true when one or several factors occur: the number of ICOs could decline, regulation of ICO comes into effect or ICO-companies won’t be able to prove their sustainability [20]. Moreover, ICO-companies will be gradually selling their ETH holdings to fund their operations.

Bitcoin scaling

Nowadays Bitcoin faces the scaling problem. One of the reasons Bitcoin had become so popular was because it had low transaction fees. Owing to its present blockchain nature the more userbase Bitcoin gets the more fees an average user has to pay. Transaction fees grew 10 times this year. To confirm a transaction one should wait longer these days as well. Bitcoin community offers various options to make Bitcoin more scalable. Two major proposals are based on Segregated Witness (SegWit) that changes the structure of Bitcoin transaction data. By implementing SegWit Bitcoin blockchain will be working faster and more efficiently. But the main problem is that there are two teams of developers who want to implement SegWit differently. Moreover, available solutions are conflicting. Only after July 21 and especially after August 1 the situation will become more clear. In the worst case scenario Bitcoin could be split in two or even several coins and it will be hard to predict which one is going to be more valuable. It is advised, however, not to conduct transactions on August 1 since there’s a potential risk of losing Bitcoins.

Therefore, in order to avoid the negative consequences of a hardfork, a number of market participants may stop making transactions or trading on exchanges at least for some time. This uncertainty could lead to higher volatility which may affect other cryptocurrencies as well.

Short-term scenarios

It’s hard to anticipate the impact of bitcoin scaling problem on the state of the market. Two major scenarios may be considered:

1. Bitcoin-positive. Either Bitcoin will remain as we know it or there will be a hardfork which removes the current uncertainty. Even ‘the second Bitcoin’ could attract users and investors. It should be recalled that after Ethereum split, ETH and ETC had become positively correlated after two months of trading. ‘The second Bitcoin’ may also be viewed like another ‘hot ICO’ and it’s not going to be a problem. When the Bitcoin situation becomes predictable this cryptocurrency/cryptocurrencies may further receive money from both users and traders/investors. In this case, altcoins could be under pressure. When and if the altcoin bubble bursts, we could witness some withdrawal of Asian money from the cryptocurrency market. Some money may return to Bitcoin to wait until the situation stabilises. This in turn could increase its price. Anyway, Bitcoin may be volatile with the price range of 1500–3000 dollars.

2. Bitcoin-negative. Both hardfork and uncertainty. Some confidence in cryptocurrencies will be impaired, volatility of the overall market will soar. Part of altcoins could surge for the moment, others may plummet. It must be reminded that Bitcoin price has grown two times this year whereas altcoin prices have risen significantly more (there’s a room for drop). If overall cryptocurrency market infrastructure encountered technical problems it could worsen the situation even more. Nonetheless, Bitcoin price will unlikely to fall below 800–1000 dollars.

Medium-term view (1-year period)

I believe we shouldn’t worry about Bitcoin’s future even in the worst case scenario. For several years Bitcoin validated sustainability and its price always recovered in the end. But most cryptocurrencies may face challenges. The overall market situation will depend on inflows and outflows of money. If, for example, Asian investors/speculators suffer from huge losses, financial regulators will intervene adopting more restricted rules. Such a development will lead to the downward pressure on many altcoins. In that environment Bitcoin could remain the leader (however several strong competitors may gain their share too).

With regard to ICO-companies, the following can be said. Most speculative money will probably leave the market in 1–2 years due to companies poor results (because this is clearly the venture market and only a small percentage of startups will be able to survive and grow). If regulation of ICO is introduced, it will be harder for new companies to count on present large valuations. Especially when they try to sell ‘breakthrough ideas’ and don’t even have the Alpha version of a product. But ICO as a method of raising money will likely to occupy its niche in the venture capital industry.

Long-term view

It seems to me that over time there will be just a few big universal cryptocurrencies. Others will become specialized. I would outline two groups of participants in the future cryptocurrency space:

1. ‘Technological’ — cryptocurrency as a medium of exchange, money transfer and a platform for smart-contracts and other functions.

2. ‘Financial’ — cryptocurrency as a store of value and an investment vehicle on a decentralized basis.

‘Technological’ cryptocurrencies may be responsible for day-to-day operations (cryptocurrency-as-a-Service). B2c, b2b and p2p segments will likely to be more distinguishable. In fact, cryptocurrencies may act as new technology companies. In my view Ethereum, Litecoin, Ripple, Dash and ‘second Bitcoin’ (if hardfork happens) could become such cryptocurrencies/services. Anyway, their success will be determined by two factors:

  • product quality and stability/efficiency of the underlying blockchain;
  • pace of adoption of the laws that allow people to use cryptocurrencies on a daily basis.

However ‘technological’ cryptocurrencies’ will be competing against big business from traditional areas like finance, IT, transport, manufacturing. Incumbent companies are already exploring opportunities in blockchain technologies. They are well aware of the problems they solve and they have significantly more resources and customers.

After all, some services are likely to stay in portfolios of traditional companies while others will be more efficiently delivered in a decentralized way.

The success of ‘financial’ cryptocurrencies will depend on whether they manage to attract retail investors, traders and/or institutional investors. This will also be largely determined by the regulatory environment in different countries. If cryptocurrencies will be commonly used as investment products, their prospects will be very positive.

In case Bitcoin (or other cryptocurrency) becomes a universal one combining both ‘technological’ and ‘financial’ aspects, its future will be even brighter. Sometimes we see potential estimates of Bitcoin price to be up to hundreds of thousands of dollars per coin.

Talking about the cryptocurrency market outlook, I would also define 3 possible future trends. The resulting balance between them will affect the market. They are all associated with the risk of global financial destabilization.

1. Significant obstacles to widespread adoption of cryptocurrencies may be imposed by different nations. They could start creating their own cryptocurrencies and integrate them in national financial systems. However, Bitcoin (or other leaders of the market) is likely to find its niche in any situation.

2. Central banks of one or several nations may start purchasing Bitcoin to diversify their official reserves. If Bitcoin is going to be globally accepted this situation cannot be excluded. In addition, several small countries with fragile national financial system can make Bitcoin (or other large cryptocurrency) their national currency.

3. People may massively move their personal savings to cryptocurrencies as a protective asset along with gold (we have seen it already during the banking crisis in Cyprus).

To sum up …

  • the cryptocurrency market is still very young and has all problems of any new market at this stage;
  • prices of cryptocurrencies are very volatile. They are driven by demand for: cheap, decentralized and often anonymized transactions, investment opportunities, save assets in times of uncertainty, trading and speculations. Technical aspects of a given blockchain also affect prices;
  • for the past several months all cryptocurrencies have experienced a massive rise due to new money inflows from Asia;
  • but the market is only in the process of establishing itself and, hence, could be vulnerable. The main risks are: blockchains’ technical issues, still undetermined positions of many financial authorities around the world, highly speculative market, cyber threats to market infrastructure, possible price and information manipulation, unclear outlook for technology itself;
  • Bitcoin scaling problem may be a turning point if uncertainty will lead to volatility and burst of altcoin bubbles;
  • regulation will likely define mid-term prospects of the cryptocurrency market;
  • further development of cryptocurrencies, their level of adoption by consumers and business as well as global financial situation will be the key determinants in the long run.

The original version of this article (in Russian) was published by the author in UTMagazine