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What Is Causing The Crypto Recession?

         4/17/2018

Cryptocurrency Market Representation

                                                                                                                                                                                                                                                 

Cryptocurrencies have dropped in price dramatically since bitcoin peaked at over $19k per coin on December 17th, 2017. There are a number of factors that contributed to this, from technology to politics, and ultimately market pressures. Let's look into the factors that have lead to the overall crypto recession.

Bitcoin had 95% of the overall market share of cryptocurrencies in early 2017. But due to an issue with technology, transaction fees began to skyrocket, and bitcoin became unreliable, with some users unable to get their transactions confirmed, even after days of waiting. Bitcoin code had a maximum limit of 1MB of data per block, or about 3 transactions per second. Although technically simple to raise this limit, the community could not reach a consensus, even after years of debate. So as the network grew, block size became a bottleneck and caused these problems. Bitcoin stopped growing. Many users, merchants, businesses, and investors abandoned Bitcoin. Its market share among other cryptocurrencies quickly plummeted from 95% to 40%.

You also need to consider the fear being driven by government regulation, particularly in the East. In September of 2017, the first crackdown started in China. On September 19th, 2017, it was reported that China had ordered bitcoin exchanges in Beijing and Shanghai to shut down. The move followed China's central bank's decision to ban initial coin offerings earlier that month. Top exchanges like BTCC exited the market entirely. And then later, on 12/28/2017 it was reported South Korea, which is one of the most substantial markets in the world for Bitcoin, accounting for 20% of the world's volume, said it was preparing a ban on opening anonymous cryptocurrency accounts and new legislation to enable regulators to close coin exchanges if they felt there was a need to do so. The move came less than two weeks after the high-profile insolvency of one of the country’s digital currency exchanges, after the Seoul-based platform was hit by hackers for a second time. Bitcoin's price fell $1,000 that day.

Another major factor is the launch of futures contracts. CME Group officially launched their Bitcoin Futures offering on 12/18/2017, despite many critics of the move suggesting that it would result in a drop in price for the digital currency. With futures available, investors have an easier time betting against bitcoin, and since the contracts settle in cash, investors are able to stay more liquid than with traditional bitcoin, meaning the new derivatives market is more valuable, resulting in less overall investment into the spots market, and in extreme cases, like what we've seen, can even force sell-offs and depress real prices. Remember, the gold market, for example, there is 10x the market around futures on gold than the physical gold itself. And since it's a cash market, it needs an index to compare against, and these indices are prone to manipulation.

And we have indeed seen massive sell-offs. It has been reported that Nobuaki Kobayashi, a bankruptcy trustee for Mt Gox, sold over 35,841 Bitcoin (BTC) and 34,008 Bitcoin Cash (BCC) on the open market immediately after the futures market launched. More than half of the bitcoin they sold (18k BTC) was transferred to an exchange on Feb 5th. This was the day before bitcoin hit its 3 month low of ~$6000. The sales appear to have been a large contributing factor to the overall drop in price over the last several months.

The First Sale Date? 12/18/17

What's more, these sales were done in one lump sum through an individual exchange as opposed to through an OTC, which would have helped mitigate the effects of that large of a sale on the daily volatility of the price. Instead, the prices were influenced more directly and caused a more wild swing in price than necessary. It would be very easy to leverage the ability to cause that sort of volatility and profit off of arbitrage through futures.

But despite all of this volatility, prices are starting to even out, and even beginning to rally again. Some of this is to do with the futures market settling now that this speculation period is winding down. Last week bitcoin's price surged $1000 in less than one hour. Analysts largely attributed the precipitous surge to a “bear trap,” which occurs when futures and margin traders attempt to short an asset but have their positions liquidated due to a price increase, forcing them to buy at market prices to cover their position. Matthew Newton, an analyst at crypto brokerage eToro said in a report: “Whilst there has been some stability in the cryptocurrency markets over recent weeks, we’ve seen a record number of short positions building on major exchanges. When the price began to rise this afternoon, a large number of shorts with big positions were squeezed. The resulting interest from buyers increased momentum, causing the price to jump $1000 in 30 minutes.” Additionally, the technology has been advancing rapidly, with many alt coins available. Bitcoin Cash (BCH) solved the block size issue and has shown to have much lower fees and a faster overall network. And Bitcoin core itself is looking to launch their Lightning Network, a sort of middle layer to bitcoin transactions that will help keep transactions low at the expense of having to rely on more centralized, private servers. And the blockchain technology itself is ultimately what is important here. It has proven effective, with everyone from Goldman Sachs to world governments working to implement their own versions of the technology. Bitcoin really needs to be seen for what it is; what Napster was for peer to peer technology, bitcoin is for blockchain technology and cryptocurrency.

Overall, cryptocurrency may have hit a wall, but the technology is strong, proven, and the market cap looks to be moving further and further up. It would be wise to diversify your portfolio with a cryptocurrency fund, if not in bitcoin itself.

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