The Rise and Fall of the Bitcoin Price
It has been just under a year since the bitcoin price peaked.
I remember the time clearly - I was in full panic. Not because I had so much stake in the game, but because collectively, lots of people did.
People were talking about bitcoin everywhere you went. Everyone was referencing the price. And that’s not to say that the crypto industry hasn’t progressed or that hope is lost. In fact, volatility detracted from its use as a way of exchanging value for products and services. It just means the price dropped, dramatically.
Question #4: What happened to bitcoin?
Speculative demand drove the price up as optimists bought bitcoin in the hopes the price would continue to increase. When bitcoin futures were introduced to the market last December, pessimists were able to signal to the market that bitcoin was overvalued and drive prices down.
Bitcoin as a Speculative Asset
Assets are something you own in the hopes of deriving future benefit. Shares of company stock are an asset that you own in the hopes of obtaining payouts. Bonds are an asset that represent debt you own in return for interest payments. Assets are lumped into classes based on their common features. The more diverse the bundle of assets you own, the better you can outweigh the risks associated with one for another. (If you put all your money into Facebook stock and they announce a data breach — on top of everything else — , you’re out of luck.)
Robert Greer identified 3 main super classes in his work “What is an Asset, Anyways?”:
- Capital Assets: Provide a consistent stream of income and are priced on the basis of their combined future returns ie. Apple Stock
- Consumable/Transformable Assets: Can be either consumed or transformed into another asset. ie. Oil
- Store of Value Assets: Cannot be consumed and cannot produce income yet society perceives them as having value. ie. Painting
Cryptocurrencies, like bitcoin, lie somewhere between a precious metal and a currency, but are arguably a distinct asset class in and of itself. Similar to a precious metal, the global bitcoin supply is fixed (there will only ever be ~21M BTC in circulation). As the price is essentially a function of supply and demand, the following takes place in a bull market:
The more people demand bitcoin, the higher the price grows. The price increase gets bitcoin more public attention and makes it appear as a more attractive buy.
But what happens when people stop believing the price will go up?
Bitcoin Futures
Mature assets offer more than one way to speculate on their price. Prior to December 2017, there weren’t that many options for bitcoin. You could go onto a crypto-exchange and buy bitcoin in the hopes the price would increase. If you were wealthy, you could go to an asset manager that you could pay to hold bitcoin for you and similarly hope the price would increase. Either way, you were betting the price would go up. Then in December, first CBOE and then CME came together to offer a marketplace for bitcoin futures.
Futures are contracts to buy a specific amount of an asset at some point in the future. Imagine, for example, your anxiety was peaking last December. You believed the price had reached an unsustainable level that was not reflective of the fundamental value of bitcoin, however it is that you personally determine it to be.
You decide to buy a futures contract on January 1. The price of bitcoin at the time is equivalent to ~19K USD. You, the pessimist, buy a contract that says you’ll sell 1 bitcoin for 17K USD on February 1. The optimist on the other side of the deal agrees to the terms because they think the price of bitcoin will assuredly be over 17K USD on February 1. They’re happy to sign now to receive a bitcoin at a discounted price in the future. You, however, believe that the price will really be 15K USD by February 1 so you’ll make 2K USD off the deal. By the time February rolls around, you’ll buy a bitcoin at market value for 15K USD and hand it right over to the optimist for the agreed upon 17K USD. Sucker.
In reality, CME and CBOE offer cash-settled contracts. You don’t even have to go through the hassle of delivering bitcoin. If you, the pessimist, are correct in your prediction, bitcoin will be priced at 15K USD on February 1, and the optimist will just hand over to you 2K USD. No transfer of bitcoin at all.
Data related to bitcoin futures is publicly available. Everyone can see that the futures market is signaling the price will go down. If people get the sense the prices are going down, they act accordingly, just as they took action when they thought it was going up. People believe the price will drop, so they sell. And then the price does drop.
Pricing Bitcoin
No one can actually pinpoint the worth of bitcoin. You can try and think of the cost economics and price from there. You could try and look at the valuation of private companies that offer analogous solutions. Or maybe you could look at the total addressable market. But how much does it truly cost to generate a bitcoin by verifying transactions? Which industries would be dismantled by the use of bitcoin? How much are they worth? And how much are people cumulatively paying to transfer money now? These are difficult questions to answer. It’s much easier to say that value of a bitcoin hovers below 4K USD, for now.
Also check out:
