What could cause crypto-currencies to fall?

It is not the first time that an article is about crypto-currencies being bubble. There are lots of rumors about the same. Although we are concerned about a future bubble, it is not as if crashes never happened before with crypto-currencies. Let’s take the example of bitcoin; since its inception in 2009 bitcoin has witnessed many crashes, following which there emerged speculations about the death of bitcoin. However, each time bitcoin has re-emerged and disproved every accusation that labeled it a fraud or a Ponzi-scheme. This re-emergence itself proves the fact that the idea of crypto-currency is itself very relevant in the Digital Era. Bitcoin was started with a real price of almost $0 in 2009, and to everyone’s amazement it achieved parity with US dollar in February 2011. This was a landmark event that signified that there could be the existence of currencies other than fiat currencies and that is because of blockchain innovation and technological advancements.

Bitcoins, thus have managed to exceed expectations regarding the bubble, that speculators perceive around it. However, despite what they have achieved so far, crypto-currencies are very poised to go down. The primary incentive that people will use crypto-currencies is the idea that it should be more beneficial to use crypto-currencies than the conventional fiat currencies or credit cards (for digital transactions), but no crypto-currency has yet crossed the critical value after which investing in these crypto-currencies would be beneficial.

Let’s break it down as to why crypto-currencies are not a feasible option for firstly, the consumers, and secondly, the investors.

The consumers

The primary purpose of crypto-currencies is to act as a token of transaction on digital platforms, and these transactions incur some transactional cost. The transactional cost for crypto-currencies (say, bitcoin) is, at present, much lesser than the transactional cost for credit cards. This incentive has lured many to choose bitcoin over credit cards.

However, there is another side to this story. The bitcoin miners get 99% of their revenue from the selling of new bitcoins and rest from the transactional charges, a phenomenon which would be in the interest of consumers except there is a gold rush in bitcoin mining which decreases the income from the sale of new bitcoin. This would raise the transactional cost for consumers to maintain the revenue for the miners. Over time this would lead to equivalence in the transactional cost of bitcoin and the credit cards.

Moreover, unlike fiat currencies crypto-currencies does not offer credits option. Not having credit option in crypto-currencies makes purchasing using credit cards more practical choice. These constraints would lead to loss of incentive to use crypto-currencies over credit cards.

The investors

The sudden surge in the price of some crypto-currencies has lured many investors to invest in them blindly. Crypto-currencies, known for their volatility, is soaring its value surprisingly and is making us think: ‘Isn’t the value of crypto-currencies (like Ethereum, Bitcoin, and Zcash) exaggerated.’ And if so, which is most probably true, it would result in correction of the values of many crypto-currencies. This correction would not be like any usual downfall in their price but would bring down many crypto-currencies to 10%-30% of their original price. It is unclear whether investors would instantly lose faith in crypto-currencies, but there would still be a significant blow to virtual-currency-economy.

Let us now analyze the structural problems that could lead to bubble burst:

The unique feature of crypto-currencies that differentiate it from fiat currency is that there is no central authority involved in crypto-currencies. Although it is vital for its sustenance, it raises some issues. If some mishappening occurs, there is no place to complain. The incidences, like Mt. Gox, showed us how vulnerable could crypto-currency market be to hackings and security breaches. Any significant compromise in security in future could develop a mistrust in users of crypto-currencies and could spark a crypto-currency bubble burst.

Recently, there was an announcement of a major update in Bitcoin codes which will enable the Bitcoin transaction to be almost entirely anonymous. This was done to address the concern of Wall-Streeters who needed anonymity so that their competitors do not guess the volume of transaction they perform. After this update, Bitcoin transactions will become even more private and it would be tough to know who completed how much transactions.

Although this will ensure complete privacy, it raises many concerns too. This situation makes me think of Mayor Amschel Rothschild who once said, “permit me to issue and control the money of a nation, and I care not who makes its laws.” And if no one knows who owns the significant shares in crypto-currency-market, it would become a nightmare for the Governments around the world. As they cannot impose tax properly, curb black money or track illicit activities.

What could be even worse is that, if the criminals or trafficker start using crypto-currencies for illegal activities then that would urge governments to take actions. They may make regulations and that would undermine the existence of crypto-currencies and may result in a sudden drop in their value. This is not a mere speculation. Recently, IRS tried to curb the irregularities in crypto-currency-market and commented that profit in crypto-currency trading is a taxable affair. If such regulation becomes a reality, it could substantially increase the reporting and compliance cost. This will result in a higher transactional cost.

There is another possibility that government realizes that crypto-currency is the future of the financial system and launches its own crypto-currency that would be a competitor for crypto-currencies owned by people and may lead to the collapse of many crypto-currencies.

The crypto-currencies are not generating any real value, and only demand shift is making real price of crypto-currencies rise. So if suddenly people be reluctant to hold crypto-currencies, then its value will go down, and it can happen suddenly just like the speculations mentioned above show.

Even-if crypto-currencies succeed against all the odds that are mentioned above, there is a huge uncertainty that lies with crypto-currencies in future as technology is advancing day-by-day and anything is possible. Moreover, if we see what crypto-currencies have achieved since its inception, for example, Bitcoin started with almost no value, and today it cost $13040 per bitcoin, all that can be said with certainty one should expect the unexpected.

Written by: Siddharth Kumar

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