A friend of mine casually remarked the other day in the midst of the highly destructive Bitcoin Cash hash war — “but surely Bitcoin is now trading below the cost of mining? Isn’t there a minimum floor price?” Unfortunately, there is no floor when it comes to cryptocurrencies — the same way that there is no ceiling. To try to postulate what drives cryptocurrency prices one way or the other is akin to telling the future in tea leaves — whatever you’re looking for is there. The cost of mining Bitcoin differs from country to country and the figures that we do have for the cost of Bitcoin mining is an estimation at best.
There is no centralized reporting authority or auditor measuring electricity rates, equipment costs and coming up with a figure which accurately represents the cost of mining Bitcoin — or any other cryptocurrency for that matter. But based on those estimations, pundits have suggested that Bitcoin’s minimum price is anywhere from US$4,500 to US$6,500. What those estimates fail to take into account is that the marginal cost of simply switching off Bitcoin mining machines is zero. There’s only the upfront capital costs of the mining equipment. Add to that the possibility that cryptocurrency miners may already have depreciated their mining equipment in previous pricing cycles and so in essence there really is no floor — Bitcoin miners can simply switch off their mining rigs and consume no additional electricity.
Compound that with the observation that there is also no buyer of last resort for Bitcoin. Being decentralized, there is no one entity to prop up the value of Bitcoin relative to the dollar. If we consider Bitcoin as a sovereign currency, countries will typically (depending on their ultimate goal), soak up excess amounts of their currencies to prevent a devaluation, which would make imports prohibitively expensive. Similarly, when a country’s currency keeps rising, it makes their exports more expensive, so central banks start to print money (one way is by making loans through banks through the discount window), in the hopes that the increasing supply of dollars will temp down the rising currency. The balance is a delicate one, with some of the brightest economists and central bankers working to achieve it. But Bitcoin does not enjoy that same privilege.
Plus, there are lots of reason for investors to go for dollars right now. From the fallout of Brexit to Italy’s potential fiscal implosion, Europe is looking pretty unstable right now. Yet the continent is home to two of the world’s most important currencies — the euro and the pound, both of which have taken a beating against the dollar in recent weeks. The Japanese yen, which rounds off the basket of the world’s most sought-after currencies has fared little better. Despite a peak against the dollar in March, as Japan’s economy showed the first fruits of a tepid turnaround, the yen has come back down to more or less the same level where it started the year from. And while demand for gold has risen in recent weeks, it’s price is still well down from where is started the year from. Gold, typically seen as a safe haven during times of economic turmoil, lost its sheen as investors went into stocks and other more risky investments in search of better yields, but now that volatility has returned, investors are heading back into the dollar.
But each crisis is slightly different and the impending crisis, which seems to be the general sentiment that is now unavoidable will be similar in that difference. Already there are several signs which point to greater volatility (a typical precursor to a crises).
Under our current global economic system, whether we like it or not, the dollar is dominant. Whether you’re looking to buy frozen orange juice or Freon, global commodity prices are denominated typically in dollars. Even cryptocurrencies are measured against their dollar values. And because dollars are the lubricant that oils this global system, spikes in the greenback can be one sign of impending economic turmoil. One way of measuring that turmoil is through determining the additional cost which banks charge for swapping one currency for another in the derivatives market. During times of peak crisis, financial institutions and investors scramble to raise dollars to finance dollar-denominated liabilities, such as commercial paper or trade finance. These premiums tend to skew upwards in particular towards the end of the financial year, when banks look to cut the amount of dollar-based derivatives they on on their balance sheets, ahead of reporting season. But outside of reporting season, when these numbers start to get skewed — it can be an indication of banks looking to tighten their liabilities and cash out for dollars — which may be precisely where we’re at now.
Tech stocks, the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) have also come down from their lofty heights as traders pared down holdings of the stock market darlings and valuations start to be questioned.
Amidst the volatility, cryptocurrencies, including Bitcoin can’t reasonably be expected to be spared either. Closely associated with technology, if even FAANG stocks can’t avoid the brutal sell downs, who’s to say that cryptocurrencies would be spared as well?
But to draw parallels from one to the other would be premature.
Cryptocurrency markets are still relatively juvenile and manipulation is allegedly rife. So what’s to make of all the chaos? Is this an opportunity for a savvy investor to latch on to some cryptocurrency and ride the bull upwards?
There are several reasons to exercise caution during these periods of uncertainty. For cryptocurrency prices to recover, dollars need to be poured into it and these dollars need to come from somewhere. As stock and property prices were rising steadily, there was little reason for investors to pour into the new and highly speculative asset class. And with interest rate rises from the Fed tightening now a reality and no longer a postulation, the costs of funding are increasing. Against this backdrop, investors may consider that holding on to cash may be the prudent move and not just any old cash, but the good ol’ greenback. Despite the machinations on the stock market, the U.S. economy continues to hum along. Unemployment is at record low levels and there are green shoots of the first sign of rising wages — typically a sign of inflationary pressure. And with investors now (more than ever before) starting to question profit and revenue targets as well as valuations, it should come as no surprise that dollars are fleeing from cryptocurrencies — an as yet speculative investment.
Given these macroeconomic considerations, an SEC-approved cryptocurrency ETF or greater adoption is not like to see greater fund flows into cryptocurrencies just yet.
So is it time for the scores of crypto-faithful to throw in the towel and go back to their day jobs? Hardly.
Nary a day goes by without some major financial publication, including The Wall Street Jouranl, CNBC, Forbes, Fortune, Bloomberg and Financial Times mentioning cryptocurrencies. On the sidelines of a the recently concluded Singapore Fintech Festival, no less than IMF Managing Director Christine Lagarde argued for central banks to issue their own digital currencies. Stock exchanges from Singapore to Sao Paolo are all considering tokenizing stocks to facilitate more rapid trade reconciliation. Logistics companies have been trialing blockchain-powered tracking systems and insurers such as MetLife have even experimented with their own blockchain-based smart contracts. Quietly and behind the scenes, scores of fintech companies are working out custody solutions to prop up cryptocurrency trading and some more publicly like Fidelity Investments, one of the world’s largest asset managers are working on cryptocurrency trading solutions. The Chicago Board of Exchange and the Chicago Mercantile Exchange were one of the first mainstream exchanges to offer the trading in Bitcoin derivatives. Prices aside, the amount of human and financial muscle being put into the space is astounding — especially if you consider that it looks like cryptocurrencies may tank worthless (at least if you look in the short term).
The other problem is confirmation bias. Bitcoin and its brethren only really first came to public consciousness when its price hit US$20,000 late last year. And it makes absolute sense that people would be drawn to it — people love you when you’re winning. But what about the fact that not so long ago (and it really wasn’t so long ago) when Bitcoin was trading at US$200. With any asset, digital or otherwise, how you view this asset is closely associated with the returns you’ve received from it. It’s natural to want to shun or avoid the very vehicle which may have caused you substantial pain and media is quick to lap up sob stories of financial ruin from the speculation on cryptocurrencies. But that only paints half the picture, because like two sides of a coin (no pun intended) there have been countless winners as well in the cryptosphere. Unfortunately, given the relatively juvenile cryptocurrency markets, charts, charting and price discovery is a bit like divination. It would be comforting to have a reassuring hand on one’s shoulder to tell you to “stay calm because we’ve seen this before,” but like it or not, we haven’t. There just simply isn’t enough empirical data, historical prices or correlation matrices to call a bottom or a top just yet. To quote Sir Winston Churchill,
Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
Words more relevant now for the cryptocurrency markets than ever before.
Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company.