Bitcoin, Gold, and Necessary Market Cycles
They say the best things in life are free but who came up with the prices for everything else? The market did. A market is composed of producers and consumers which include people, businesses, and governments. Consumption drives production. The more demand there is for an item, the more it will be produced. Less popular products are discontinued. Think of the fate of iPhones compared to Blackberry phones. Therefore, market participants decide the value of goods with purchases.
Governments have learned this the hard way. In the 20th Century, the former Soviet Union opted for a government-led economy to determine prices instead of a free market. The Soviet politicians took it upon themselves to increase the price of moleskin pelts. Afterward, pelts overflowed in warehouses and industries were unable to sell them all. The Goskomtsen (State Committee of Prices) were repeatedly told about it but didnât have time to decide on lower pelt prices due to the 24 million other prices they tracked. Governments rarely dictate prices nowadays so they can direct effort to other economic decisions and leave prices up to the market to decide. The economist, Thomas Sowell, states âprices only become an economic reality when people are willing to pay themâ.
The Irish government copped onto this in February 2000 when they liberalised the energy market from the monopoly of Bord GĂĄis and Electricity Supply Board (ESB). By 2005, all Irish customers were able to choose energy suppliers beyond the two offered by the state. Competition between private companies kept pricing tight and empowered consumers with options. You vote for the world you want with the things you buy. Producers of unwanted services will go out of business due to the lack of consumers unless they alter or improve their standards.
The phrase âcustomers are always rightâ comes from their position in the market as consumers. However, this is often misconstrued because it only relates to what they buy not what they say.
Youâll come to find that, indeed the market is always right and this is the reason why a drop in the value of any asset is called a price correction. Iâll explain how the correct prices of Bitcoin and gold are resolved by fluctuating market sentiment. Then Iâll elaborate on why these market cycles are necessary.
Bitcoin vs. Gold
Whenever I think of the comparisons between Bitcoin and gold, the legendary debate between Erik Voorhees and Peter Schiff comes to mind. The discourse happened in July 2018 and is accessible on Youtube. Erik is the founder and CEO of Shapeshift, a digital asset exchange. Peter is the CEO of Euro Pacific Capital Incorporated and pioneer of Schiff Gold (a precious metals dealer). Erik argues that Bitcoin or a similar form of cryptocurrency will replace government fiat currency as the preferred medium of exchange. Peter Schiff opposes that view.
Erik expresses how Bitcoin is a digital asset that is provably scarce and has a predictable supply. These traits are made possible through Bitcoinâs immutable blockchain source code. Bitcoin is a public ledger (database) distributed on thousands of computers around the world operating as nodes. A âblockâ is comprised of a list of data and a âchainâ is a stack of the blocks of data which consistently grows over time. It makes changing earlier data almost impossible and blockchains excellent at storing valuable data. Itâs like Tetris but with data. Each block constitutes a financial transaction verified by miners and cryptographic (encrypted) proofs that the transactions took place. That is a consensus mechanism where all the nodes need to agree. This is what happens with Bitcoin, every 10 minutes a new block is created. When a new block is generated, miners get a reward in Bitcoin.
The block reward for Bitcoin (BTC) miners is regularly cut in half in a process known as Halving. It occurs roughly every 4 years due to how long it takes to mine 210,000 blocks. The genesis block provided rewards of 50 BTC in 2009. In 2012, the reward was reduced to 25 BTC per block in the first halving. Then block rewards lowered to 12.5 BTC in 2016. The third halving occurred in 2020, reducing the compensation for miners to 6.25 BTC. Bitcoin is programmable money operating on a public blockchain so we can predict the supply daily and all the way to up the date of halvings. The fourth halving will deplete rewards to 3.125 BTC and is expected to be in 2024.
Once the halvings are put into context, the periodic Bitcoin rallies (sharp rises after a fall in price) start to make sense. The market responds to the scarcity of Bitcoin following diminishing block rewards. Post the 2020 halving, Bitcoin gained 294%, while gold rose 23% in the same year. In 2021, Bitcoin continued growing in value by 58%. On the other hand, gold dropped 5% in price. As mining technology improves, gold becomes easier to extract from gold mines. This inflates the gold supply by 2% every year. You guessed it, gold is becoming less scarce. Conversely, despite advancements in technology, Bitcoin is more challenging to acquire because of its Halving Cycle.
Peter Schiff advocates for gold on the same basis we explored in my first article. Thus, Iâve focused on how gold compares to Bitcoin. Gold can be debased, i.e., melted and reconstructed with tungsten to manufacture more gold and make it appear heavier. The precious metal has too many denominations; coin, bar, rod, nugget, ounce, etc. Fiat currencies typically have 2 denominations, e.g., euros and cents. Bitcoin only has 1 denomination. 1 BTC is made up of 100 million satoshis (sats), an homage to the pseudonymous creator of Bitcoin â Satoshi Nakamoto. There are unpredictable fluctuations in the gold supply, e.g., the California Gold Rush in 1848. Transporting gold is a tedious exercise that multiplies in difficulty if you possess a large supply of it. For these reasons, I think Bitcoin will surpass gold as a better medium of exchange, store of value, and unit of value.
Bull Market
In January 2021, Rapper, Meek Mill, and Co-Founder of Coinbase, Fred Ehrsam spoke about Bitcoin (BTC) on the social audio app, Clubhouse. Their chat is available on Youtube. Fred discussed the growing inequality in the current global financial system which he witnessed while he worked at Goldman Sachs after he graduated college. During that conversation, Fred said that he bought his first Bitcoin 10 or 11 years prior for $6. At the time of writing this article, Bitcoin is $41,978. That is an increase of 699,633%. No other asset in a global market has yielded that return on investment (ROI). Bitcoin went from being worth nothing when it was invented in 2009 to a $793 million market capitalisation in 2022. Market cap is the total value of Bitcoinâs circulating supply.
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A bull market is a phase in a market cycle where there are more buyers than sellers. Confidence in assets soars and market actors who already own desirable assets hold their positions (amount invested). They front-ran the trade via buying before anyone else. This leads to a supply shock of assets for new buyers who would have to pay a premium price to get them. The demand for scarce assets sets the value and causes prices to rise. The growth in value is said to be bullish because bulls swipe up with their horns when attacking. In a state of euphoria, market participants pay expensive prices in order to get exposure to gains that highly sought assets reflect. Thereâs a saying, âeveryoneâs a genius in a bull marketâ. The level of greed in this stage is so excessive that everything looks like a good idea.
The rose-tinted glasses get cracked when reality sets in. Weâve confirmed that prices only matter when someone is willing to pay. Eventually, the value of an asset rises to a point where no one considers it to be a fair price. Bigger players (institutions) game the market by selling off a large supply for a short period to squeeze (scare) retail (public investors) out of the market. Retail sale of scarce assets enables corporations to purchase more assets at a cheaper price. Once thereâs a mass shift to a prolonged sale of assets to realise gains or reduce loss, then the bull run is over.
Despite the series of market crashes in the last decade, Bitcoin hasnât returned to the $6 that Fred Ehrsam first bought it. The overall sentiment depends on your scale. If youâre measuring from 13 years ago, the market sentiment on Bitcoin is bullish. If your reference point is from November 2021, then the market sentiment on Bitcoin is bearish.
Bear Market
The last all-time high (ATH) of Bitcoin was over $68,000 back in November 2021. Since then, BTC has dropped 38%. This indicates a bearish decline relative to that period. Here, the market sings a new song to the tune of âbear necessitiesâ because a bear swipes down when attacking akin to the downward spiral in prices. A bear market is a step in the market cycle where there are more sellers than buyers. Market actors are pessimistic about assets holding their value so they sell their positions. This results in a dip in price as greed is replaced by fear. Renowned investor, Warren Buffett, suggests âbeing greedy when others are fearful and being fearful when others are greedyâ. Yet, the panic and losses can be so pervasive that prices continue to fall for extensive periods of time.
A seasoned market observer knows the severity of bear markets depends on the timeframe used to gauge them. Meaning, they can range from mild to extreme, contingent on whether you zoom in or out on a graph. Itâs harder to succeed in a bear run but, the prior bull market gives an indication of what is likely to rise when bullish sentiment returns. Hence, rational actors consider bearish conditions to be a sale where desirable assets are cheaper than usual. Warren Buffett popularised âvalue investingâ which is a technique assessing the value proposition of an asset through fundamental analysis. I employ the same method.
The last all-time low (ATL) for Bitcoin was $67 in July 2013. Bitcoin is a significant improvement on gold as a store of value. Goldâs market cap is $11.4 trillion. If Bitcoin reaches or exceeds that marketcap, it would put Bitcoin at over $600,000 per BTC. I canât guarantee this will happen but graphs show progression towards it. Bitcoin went from $67 to $67,000 in 8 years. Regardless of whether the current Bitcoin price rises or falls, I intend to keep buying based on my analysis that BTC is still undervalued.
When a fair price is attained and buying resumes, market participants have a shorter time preference (less patience) during a bear run. They cash in on gains sooner than they would in a bull market. Consequently, recoveries are fleeting during this phase. Market actors who inaccurately suspect a bull run can end up in a loss and aim to sell at the next price increase. This continues until peaks (tops) are sustained and troughs (bottoms) are temporary â signifying a transition to more buyers and the end of a bear cycle.
The Necessity of Market Cycles â Conclusion
Market cycles are needed to keep opportunities recurring. Baloo from âThe Jungle Bookâ said it best, âforget about your worries and your strifeâ. Without volatility (price fluctuations), there are no optimal moments to enter or exit a trade. Volatile prices allowed early adopters of Bitcoin to obtain a profit in a bull market. Changes in value facilitated late adopters of Bitcoin buying BTC cheaper throughout a bear market. Itâs in these key occurrences that market participants have chances to gain returns or assets at a discount.
A robust and tenable investment approach, like âvalue investingâ explored earlier, can make an outstanding difference in how you manage your portfolio of assets. It automates your functions because youâve done the bulk of your thinking already by doing your own research (DYOR). Then act accordingly. Ultimately, the market is always right so donât be reluctant to adapt and revise your asset valuation. Trading that is dependent on hype or emotions (apeing) can misguide you. Understanding the nature of markets is imperative to effective decisions and cultivating healthy investor psychology.
- ** If you made it this far itâs been a pleasure writing for you. I hope you enjoyed it and picked up something along the way (hidden code in article enabling you to win free crypto rewards đ). I want to simplify complex things including the environment, economics, and crypto. Please follow, like, and share as it helps me a lot. Subscribe to get exclusive access to the audio version of this article. Tune in weekly for more insights.
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