After the 2008’s Great Recession the world
was avid for new solutions and alternatives to face the economic crisis. Since
then we have seen how Central Banks applied non-traditional policies and send
interest rates into historic lows.
At the same time, we have seen how
technology has evolved at an unstoppable pace. Terms such as social media,
investing algorithms, quantitative finance or even artificial intelligence are
more common every day.
While the world was worried about the
causes and consequences of the economic crisis, looking for answers and
solutions to it, few people saw that the economy was changing. In fact, in 2008
the first patent for a digital currency was registered by Satoshi Nakamoto,
under the name of Bitcoin.
Ten years later, Bitcoin has reached a
price above the $10,000, and leads the raging new world of cryptocurrencies.
Now we are getting used to terms like miners, Blockchain or forks. Yet most
developed countries still show certain reluctance to this kind of asset,
asserting that the lack of regulations could cause economic instability and
attract illicit activities to it.
In this paper we try to explain the
economic behavior that underlies, and boost, the digital currency industry,
adding some explanations on how they work. We study what could be the main causes
behind the rise of cryptocurrencies and how countries have been dealing with
them.
Also we studied the main differences
between fiat money and digital currency, focusing on the crypto’s supply and
the global demand for it. We don’t ignore the influence that countries like
China and Venezuela have in the crypto market.
Finally, we offer some views on how the
future of digital currencies should look.
Starting point
Before we start our analysis, we should
remark two concepts:
1- What is money?
Money is defined as a medium of exchange,
which must follow three attributes: store of value, unit
of account and widely accepted as a method of payment. In other words, you
might expect that the value will be hold tomorrow, and that can be used almost
everywhere.
2- What is a Reserve asset?
Basically are external
assets that are readily available. Investopedia (2017) define it as an external
physical asset that is, in some part, controlled by policymakers. The asset
should be easily transferable. For example: gold, dollars, SDRs.
Consequently, we must ask ourselves what is a
Cryptocurrency.
A cryptocurrency is a digital medium of exchange, that
works through a decentralized network around the world known as Blockchain.
Bitcoin represents approximately 65% of total crypto’s capitalization which is
almost 280 billions of dollars but, is not yet accepted around the world as a
payment method. Also, its extraordinary price increment established a new
paradigm as ‘digital gold’, which creates a dualism in order to define this new
kind of asset.
Regarding to its value, as every asset the interaction
between a limited supply and increasing demand is the friendliest explanation
of bitcoin’s value. Nevertheless, price dynamics indicates a perception that
the value in ‘t’ is the expectative of a higher value in t+1 which drives up
price considerably. Also, and we have to use the word ‘expectative’ again,
behind every crypto there is a technology which has an incredible potential to
change our lives.
When Bitcoin became mainstream?
The history begins in 2008, it is said that was created by
Satoshi Nakamoto. Its popularity started growing astronomically in the last 12
months. To illustrate this, let's make a comparison, ‘Kardashians’ searches in
Google have been overlapping Bitcoin in a 5 years’ framework, reaching a peak
in November 2014, when a magazine showed a peculiar picture of Kim. However,
Bitcoin popularity in 2017 showed that a digital asset could be in the mind of
millions around the world.
Source: Google trends, 2017.
On
the other hand, Bitcoin has been alone in the top, while others important
cryptocurrencies in terms of market capitalization as Ethereum and Litecoin
remain far from the big contender in google searches.
June
2017 was almost the exception through the whole year, Ethereum overtook 30% of
total market capitalization, which corresponded to the slight increment in
google searches (red line).
Source:
coinmarketcap, 2017
On
December 16, Bitcoin reached its peak of 19.666 USD/BTC which translates into
approximately 326 billion dollars on market capitalization. Just to draw a
picture it is more than the technological giant Intel or Norway nominal GDP in
2016.
Source:
bitcoinity, 2017
Bitcoin price major moves:
·
August 2008: Bitcoin creation $0
·
February 2011: $1
·
July 2011: reached first “bubble” top $30
·
December 2011: minimum after few months $2
·
April 2013: rally $266
·
June 2013: drop $100
·
November 2013: rally $1242
·
April 2014: Cypriot financial crisis $340
·
June 2015: beginning of
China stock market instability $222
·
January 2016: Chinese stock market experienced a sharp
sell-off of about 7% that quickly sent stocks tumbling globally. $464
·
November 2016: Chinese Renminbi depreciated against US
Dollar, Bitcoin trading volume surpassed 100 million BTC $780
·
January 2017: rally $1150
·
May 2017: rally $2000
·
August 2017: rally $4400
·
September 2017: China's bitcoin ICO and exchange crackdown
$2900
·
November 2017: CoinDesk said that the surge in BTC could
have been related to Zimbabwean coup d'état. $8100
·
December 17, 2017: CME Group launched futures contract. $19666
·
December 22, 2017: The media said that “It looks like it's
time to cash in the gains and spend the winnings on a bumper Christmas.” 50%
drop in one night. $10400
·
December 31, 2017: price surges and keep steady. End of a
year with a yield above 1000%. $14000
·
January 17, 2018: price declines after South Korea and
China rumors. $10733
Behavior analysis:
A
diffuse concept could become a powerful idea, because nobody can define in a
proper and universally accepted way, which means that we assume our
understanding regarding a specific phenomenon.
George
Soros a well-known investor, which in fact has a horrendous reputation on media,
proposed the idea of ‘Reflexivity’. It explains the moment when individuals try
to understand situations creating an image that correspond to reality, in more
‘sophisticated’ terms a cognitive function interacts with a participative
function, which models reality in relation to expectations. Consequently, through
the participative function individuals could influence the situation, which
they suppose is an independent variable from the cognitive function.
Just
to keep in mind through the paper, the understanding of individuals is not
objective. Thus, a gap between expectations and reality could be created. We
can be wrong and that is part of our nature and limits.
Herding effect.
John
Maynard Keynes once said that:
Is characteristic of human nature that
a large proportion of our positive activities depend on spontaneous optimism
rather than on a mathematical expectation, whether moral or hedonistic or
economic. Most, probably, of our decisions to do something positive, the full
consequences of which will be drawn out over may days to come, can only be
taken as a result of animal spirits, of a spontaneous urge to action rather
than inaction, and not as the outcome of a weighted average of quantitative
benefits multiplied by quantitative probabilities. (Keynes, 1936, p. 161)
In
fact, Behavioral economists such as Richard Thaler, who won the Nobel prize in
2017, have brought to the table how important it is to understand human
interactions not based in classical assumptions like rationality.
In
speculative markets, herding or crowd effect has been documented as a result of
investors interactions, based on the idea that we can emulate behaviors
commonly seen in animals. This irrational behavior explains that an individual
takes a decision based on the observations of others, which subsequently have
based their decision in other’s. Thus, this effect implies
a massive bias on public media regarding a subject, because there is less
information about it that gives a strong incentive to follow the consensus.
Sornette
(2017) expresses that research on herding behavior can be subdivided in the
following non-mutually exclusive manner:
1-
Informational cascades: occurs when individuals ignore information and start
mimicking the actions of individuals who acted previously. The total amount of
information is so overwhelming that an individual's piece of private
information is not strong or relevant to reverse the decision of the crowd.
2-
Reputational herding: individuals ignores
private information and instead mimic the market leader, which has a reputation
and strives to protect his current status and level of income.
3-
Investigative herding: occurs when an analyst chooses to investigate a piece of
information that they believe other also will examine (perhaps just as our
essay!). Also, they can profit from an investment if other investors follow
suit and push the price of the asset in the direction anticipated by the first
analyst.
4-
Empirical herding: it occurs when investors buy or sell following the same
pattern that they did in the past.
Ivo
Welch in 2000 provided empirical results to prove herd behavior in
recommendations of security analysts. He used the Zacks database, which is a
commercially compiled database of analysts’ recommendations from 1989 to 1994
with 226 brokers and 302,458 recommendations. Also, delimited analysts’
decision as: strong buy, buy, hold, sell, strong sell.
His
study found that:
1-
An analyst recommendation revision has positive influence on the next two analysts’
revisions.
2- Also, the influence of these most recent
revisions can be traced to short-lived information, that means influence is
stronger when stock returns are accurately predicted by the revision and when
the most recent version has occurred more recently.
3-
The prevailing consensus has a positive influence on the recommendation
revisions of the analyst.
4-
The influence of the prevailing consensus is not stronger when it is a good
predictor of subsequent stock returns. Analysts’ consensus herding is not the
result of rational and efficient information aggregation.
5-
The influence of the prevailing consensus is stronger when recent market
conditions have been bullish. Welch found that the total number of
recommendations (of any direction) starting from a previous “strong buy” is
14,682, compared to only 1,584 recommendations starting from a previous “strong
sell”.
Thaler & Sunstein (2008) studied many examples of this behavior, just to take few of them from others fields:
·
Teenage girls who see that other teenagers are pregnant
are more likely to become pregnant themselves.
·
If your best friend is fat your risk gaining weight goes
up.
·
The academic effort of college students is influenced by
their peers.
·
In the American judicial system, federal judges on
three-judge panels are affected by the votes of their colleagues.
Herding effect is just one kind of behavior that individuals may follow during a determined period of time. Bitcoin and cryptocurrencies have been showing a conduct that can emulate this principle, but, it is not a complete answer for the value and popularity of these new assets. However, recognizing a pattern is an important step in order to understand a phenomenon.
Back
to Keynes, he remarked that in a beauty contest:
It is not a case of choosing those that to the best of one's judgment,
are really the prettiest, nor even those that average opinion genuinely thinks
the prettiest. We have reached the third degree where we devote our
intelligences to anticipating what average opinion expects the average opinion
to be. (Keynes, 1936, p. 156)
Thus,
the ability to recognize objective beauty is not important at all, but is vital
to recognize how other try to understand it.
Is Bitcoin a Bubble? Can you feel
a great disturbance in the Force?
Nowadays,
“bubble” is one of the most commons things that you can see and hear
everywhere. Let’s introduce ‘The Boom-Bust Model’ that George Soros elaborated
to understand bubbles process:
He
describes an initial stage when the trend is not recognized, then comes the
period of acceleration. Second, the trend is recognized and reinforced by the
prevailing bias, in that moment the process approaches far-from-equilibrium
territory. A period of testing may intervene when prices suffer a setback. If
the bias and trend fail to survive the testing, no bubble ensues. Eventually
there comes a moment of truth, when reality can no longer sustain the
exaggerated expectations, followed by a twilight period when people continue to
play the game although they no longer believe in it. Eventually a crossover or
tipping point is reached, the trend turns down and the bias is reversed, which
leads to a catastrophic downward acceleration, commonly known as the crash.
Bitcoin
has suffered many drawbacks, so it makes really difficult to recognize in which
stage we are. First, we can feel the bias, short term investment, big money,
the herding effect aforementioned has taken place which means that yes, we are
just in front of a speculative bubble, which isn't bad. Second, some people
would consider the abrupt fall of Bitcoin from $19,666 peak on 17th (Dec) to
$10,775 a crash, but it appears that we are in a testing zone, price rebound above
$16,000, then slipping to $14,000. The best part of the movie is coming, and as
Star Wars fans we might wait until 2019.
Risk, uncertainty, a lifetime
opportunity, is this time different?
It
is not a secret that Bitcoin is the prettiest of the beauty contest of all
cryptos. Just this year price increased approximately 2036%. However, we should
remember that reward and risk have a positive correlation, if we expect a
higher reward, higher risk must be taken.
In
words of Frank Knight:
It
is a world of change in which we live, and a world of uncertainty. We live only
by knowing something about the future; while the problems of life, or of
conduct at least, arise from the fact that we know so little… If we are to
understand the workings of the economic system, we must examine the meaning and
significance of uncertainty; and to this end some inquiry into the nature and
function of knowledge itself is necessary. (Knight, 1921, p. 199)
We
should keep in mind two concepts:
-
Risk: it’s a measure, the possibility that a particular event could yield a
known outcome.
-Uncertainty:
implies a situation where the future events are not known. Thus, cannot be
measured.
“There
is a fundamental distinction between the reward for taking a known risk and
that for assuming a risk whose value itself is not known,” Knight wrote. A
known risk is “easily converted into an effective certainty,” while “true
uncertainty,” as Knight called it, is “not susceptible to measurement”.
(Knight, 1921, p.44)
Also,
we do not perceive the present as it is and in its totality, nor do we infer
the future from the present with any high degree of dependability, nor yet do
we accurately know the consequences of our actions.
Cryptocurrencies
have shown to us as a lifetime opportunity, something completely new that we
must follow, we must take a part of this new world, a new era. Thus, many
investors could have a bias that blind their horizons in relation to risk and
understanding uncertainty.
Just
to create a picture, Thaler (2008) created a short experiment in order to
understand how we face risk. Initially,
Note:
Supposing you are a fifty-year-old resident of the United States you will face
a roughly 4-in-1000.
1-
You will be exposed to a fatal disease, the chance to get it is 1 in 1000,
there is only one antidote, what is the most you would be willing to pay for this
antidote?
2-
Researches needs volunteers, you will be exposed to a fatal disease, the chance
get it is 1 in 1000. What is the least amount of money you would demand to
participate in the research?
In
the first version a typical answer was 2000. On the contrary, in the second
case people ask for no less than 500,000. Just to remember, the chance to die
in the first case is 4 in 1000 and in the second case is 5 in 1000.
How
much are we willing to lose to earn an annual yield of 2000% rather than a ETF
with annual year of 12% approximately? Selling your house and buying a ETF or
government bonds does not sound attractive as buying the “new gold”.
But,
according to Vishnu Varathan, the head of Economics & Strategy at Mizuho
bank, Bitcoin is so volatile that an average bitcoin investor will have done
less well than someone who put the same money into stocks in the post-Trump
period. Using the Sharp Ratio concept, he calculated the returns adjusted for
volatility described in the following graphic.
Source:
Vishnu Varathan. Head, Economics & Strategy
In
words of Varathan:
Admittedly, “bigger picture” investors argue (rather eloquently) that
the value of Bitcoin is in its potential as the ubiquitous global currency set
to supplant fiat currencies. And current volatility is merely “noise”; a minor
speed bump for the Bitcoins locomotive. (Varathan, 2017)
While
Bitcoin may be superior medium of exchange and unit of account (if volatility
is reined in), it is not free of the deficiency of fiat currencies in terms of
having no intrinsic value other than being “money”; unlike Gold or other
commodities. Hence, like all other fiat currencies, its
store of value must be derived from guarantee of exchange for Gold (or some
other asset) from a central authority; which it now lacks.
Ironically
then, the selling point of Bitcoin - being run by algorithms not subordinated
to, or manipulated by, potentially corrupt authorities – is a double-edged
sword that denies Bitcoin an identifiable guarantor that could substitute for
intrinsic value.
Would you like to pay more for the
antidote?
We
have tried to construct many concepts in order to understand how difficult is
to analyze something unique as Bitcoin. We must clarify that without no doubt
cryptocurrencies will have an impact in our society and that many of them will
become more valuable over the time and market selection mechanism will destroy
those useless an obsoletes and reward the most efficient and useful one.
A
lifetime opportunity implies risk, and it is impossible to go further with
complete certainty about the future outcome. If our understanding as investor
is biased, our results will influence future decision driving us into a false spectrum of
understanding. It is possible that you, our reader could have made a lot of
money buying cryptos, if is that the case, you should invest your new wealth in
knowledge.
Creator nature and his creation:
Bitcoin
has a creator and many people around it that made it possible. Every creation serves
to his own master, as many people do in the pursuit of God whatever religions
it is. Even if we suppose that Bitcoin’s creators have wonderful ideals and
good intentions regarding to the future of our economy, perhaps that in fact
could influence in a certain way the underlying asset.
If
you were the mastermind behind this, you would try to maximize the profit due
the fact that you would have spent time and money to bring to life your
creation. At least, it works as a supposition, but how dangerous to us could that
be if we do not know exactly who those invisible guys are?
The
market capitalization has been growing faster, which could reject the
hypothesis of deliberate manipulation that has spread on the media.
Nevertheless, as a creator maintaining a considerable share of your creations
it is not unreasonable, in fact, selling small fractions and using that money
to finance huge campaigns that could increase popularity and thus it demands.
Bitcoin
and so many cryptocurrencies have a limited offer, which means that its own
nature is influenced by the scarcity principle. Less offer over the time, more
valuable it would be.
Supply analysis:
The
supply for most of cryptocurrencies does not behave the same way as for
“standard” currencies, of course is if one can consider virtual currencies as
such.
It
is possible to illustrate considerable differences between money supply for
usual currencies and crypto coins.
For
example, fiat currencies are physical objects, at least a considerable part of
it. Even though, money has a fiduciary behavior since the seventies, which
implies that isn’t backed on any other asset except trust. On the other hand,
crypto coins are virtual, one cannot have a wallet full of Ethereum or write a
check on Bitcoins. That may seem as an obvious difference with no relevance.
However, it has a strong impact on individuals’ economic decisions. It’s easier
to trust in something physical, backed and regulated by formal institutions
than in a virtual world, at least for modern society.
Also,
there is a more relevant difference between both kinds of currencies, money
supply. Standard money has an unlimited money supply; in a theoretical way any
Central Bank can issue an infinite amount of money. In fact, most currencies
have a positive growth rate on long horizons. However, relevant
cryptocurrencies have a limited “money” supply. Virtual currencies such as
Bitcoin, Litecoin and Dash hold the mentioned condition. Moreover, Bitcoin will
reach its limit on the next century, nevertheless most of its supply will be
available before the first half of the current century. This is a point that
should not be ignored, especially because it provides Bitcoin –or any other
e-coin with limited supply– the attribute of a precious metal. Applying the
principle of scarcity, Bitcoin behaves as gold or silver will behave on the
long term.
There
is another considerable difference among virtual and standard money, which is
the acceptance as a valid, and massive, method of payment. Although most
currencies aren’t accepted worldwide, there is a handful that can be considered
global currencies (US dollar, Yen, Euro and Sterling pound among few
others), but almost every country in the world has its own currency, perceived
as a valid method of payment by their own society. This is a crucial point that
virtual currencies fail to achieve, at least for the moment. This is not an
insignificant barrier for e-coins, fundamentally because one of the main
conditions that any asset must fulfill to be considered money, is that it can
be used as a method of payment and exchange.
At
last, e-coins, but more precisely Bitcoin, aren’t regulated. While any standard
currency its publicly issued by a formal institution, with known government or
monetary officials, virtual coins are backed on a complicated element such as
the Blockchain.
These
aspects make the e-coins an asset that could be considered similar to money,
but not quite as such. At least not yet. However, this has not proven to be a
problem for many people around the world who are looking for an attractive
asset to invest. Especially in socialist countries like China or Venezuela.
Now,
the cases of China and Venezuela are both contradictory and curious. It is well
known that both countries are main catalyzers of the Bitcoin boom. While China
abandoned traditional communism in the mid-seventies, Venezuela has been
embracing the idea of a planned economy since the beginning of the twenty first
century. But, even considering the progress of the Chinese economy since they
welcomed a pseudo free market policy, there are still some barriers imposed by
the government. On the other side is Venezuela, who has been imposing
innumerable government regulations on the economy, such as price controls or
foreign exchange controls. Both countries share the last characteristic on
their economies, however they have a complete different performance.
While
China abandoned a fixed rate pledged to the American dollar on 2005, Venezuela
has tightened their exchange policy in the last decade. Since 2005, Chinese
Yuan (CNY) has been reducing its gap with the dollar, reduction based on a
managed float rate controlled by The People’s Bank of China. This dynamic found
a hiatus, between 2014 and 2016, when the CNY depreciated 15% and helped the
current account balance surpass a 2% of China’s GDP. A GDP that has shown an
average of around 9% increase per year since 2000.
However, not everything in the Chinese economy is ideal. The GDP has been
slowing its pace for the last seven years, the Shanghai Stock Exchange (SSE)
lost around 2,500 points in 2015 –50% of its value– and remained in a stagnant growth
since then and on top of that the SSE still shows some reluctance to welcome
free market while keeping strong barriers to foreign investors.
In
the middle of the conditions just explained the Bitcoin makes its appearance,
offering an alternative for Chinese citizens to avoid government regulations.
Chinese Bitcoin –among other cryptocurrencies– exchanges reached an 90% of the
worldwide trading volume of Bitcoin, raising concerns on public authorities.
The
answer from the Chinese government came in September, in a form of tighter
regulations, shutting down public exchanges. Government officials explain this
measure as a way to isolate CNY from the volatility of the cryptocurrencies
market and protect the economy from a potential capital flight.
Nevertheless,
Chinese government is struggling to eradicate initial coin offerings (ICO) and
Bitcoin trading, while people use private over-the-counter market methods to
avoid regulations. Even though market volume of Chinese exchanges has been
dropping the past year, to stabilize around a 9% of the world trading volume,
the feared fall on the Bitcoin price due to the government actions is still on hold.
Also the proximity with countries like Mongolia offers an attractive
opportunity to Chinese miners, who face a relative low cost of electricity on
these countries.
The
relative low cost of electricity is a quality that Chinese miners share with
Venezuela. By the end of 2016, the cost of a Kwh (that is a kilowatt per hour)
was roughly $0,2 cents. On the same period, according to official data recently
published by the SEC (Securities and Exchange Commission), inflation rose up to
274%, with a contraction of 16.5% in the GDP. These factors added to the
political, and social, turmoil, the scarcity of food and basic services and the
continue depreciation of the Bolívar Fuerte (VEF) –VEF has lost more than 90%
of its value in 2017– have drawn the attention of thousands of Venezuelans, who
are looking for alternatives to protect their wealth from the economic crisis
Alternatives that includes turning into cryptos, especially Bitcoin.
The
volume of Bitcoin trading has been rising abruptly in the last year. According
to Coin Dance, the average trading volume showed an increase of 140% since
2016.
Source: Coin Dance
The
“cryptomania” has become so popular, that even the socialist government
announced the creation of an asset like-crypto called Petro. This asset,
allegedly, will be backed in oil reserves and it will be similar to a sovereign
bond. Although this was announced as an ICO, it has slowly become just a
government strategy to avoid sanctions and find funds. It is important to
remember that Venezuela hasn’t paid their obligations issued in bonds, due to
the last quarter of the 2017, and currently has a ban to renegotiate the terms
of the debt or issue new debt.
The
limited options have encouraged the Venezuelan government to look for
alternative ways to find liquidity.
Chinese
attempts to elude government regulations and Venezuelan efforts to avoid the
terrible effects of hyperinflation have become two main boosters of Bitcoin
growth in the past year.
Another
factor to consider in the cryptos revolution is confidence. Since the Great
Recession in 2008, economic confidence, in the main top markets in the world,
have been in doubt.
We
have been witnesses of the so called non-traditional monetary tools, such as
Quantitative Easing (QE) and Forward Guidance. The first one, used for the
first time in Japan in 2001, its focused on long term debt assets purchases and
its main objective is to lower the long term interest rates. The second one, is a tool
that central banks used to influence expectations on monetary variables. With
Japan, United Kingdom, The United States, The European Union and Sweden have
embraced this non-traditional tools, lowering in most cases theirs interest
rates to historical lows.
The
Federal Reserve (FED) ended in 2014 a $4.5 trillion in purchases of Treasuries
and mortgage backed securities. This massive stimulus sends the federal funds
rate from around 5% to nearly 0% -an average of 0.13% through the duration of
the program- while the 10-Year maturity rate went from around 4% in 2008 to
2.17% at the end of 2014.
In
the UK, the Bank of England (BoE) continues under a monetary stimulus, since
2009 the total amount of government and corporate bonds purchases has reached
£450 billion. The British short term interest rates went down to around 0.50%
in 2017, although this hasn’t been a steady downtrend on the UK’s interest
rates, mostly because the BoE has been struggling with the inflation targeting
policy, specifically on 2010 and after the depreciation of the sterling pound
caused by the “Brexit”. The 10-Year government bond rate showed a similar path.
Thanks
to the quantitative easing world macroeconomics have witnessed an interesting
phenomenon, presented in the way of nominal interest rates below zero. This
extreme version of the liquidity trap made its appearance on countries under a
QE program, such as Japan, Sweden or the EU. In fact, only the US have
officially ended their QE program.
Source:
Eurostat
The
effects of the monetary stimulus are still in discussion. In most cases prices
still show strong resistance to the increase in the money supply. Since 2012
inflation have been rarely above 2% in any of the countries under the monetary
stimulus, even showing some periods with negative inflation, although prices
are on an ascending trend since 2015. In Japan’s case inflation struggles to
stay above the zero line.
Source: Eurostat
Source: IMF
Growth
under quantitative easing moves around 2% in most countries, except for Japan.
While unemployment, with the exception of the United States and Japan, behaves
like an inelastic process showing values still distant to those showed before
the crisis.
Factors
such as the discrete economic growth, historic low interest rates and the
sensibility of the exchange rates to the QE announcements could have a deep
influence under people’s economic choices.
It
is not casual that after the global financial, and economic, crisis and after
the application of QE programs many stock indexes showed an upward trend while
real economy was on a slow recovery track.
Assets
like gold have showed an increase in 100% since the crisis. Dow Jones index has
gained more than 10,000 points since the great recession. A similar path has
been followed by the Euro Stoxx 50, FTSE and Nikkei.
Under
this circumstances, and the Chinese stock bubble popping, the Bitcoin –and the
Cryptos– made their appearance. The Bitcoin started it unstoppable upward trend
after mid-2015, behaving as a reserve asset for those looking an attractive
option to keep their money safe.
ICO’s world
Crypto
investors have set their attention to an unregulated market which could be
incredible profitable.
Investopedia
defines an ICO as:
An unregulated means by which funds are raised for a new cryptocurrency
venture. An Initial Coin Offering (ICO) is used by startups to bypass the
rigorous and regulated capital-raising process required by venture capitalists
or banks. In an ICO campaign, a percentage of the cryptocurrency is sold to
early backers of the project in exchange for legal tender or other
cryptocurrencies, but usually for Bitcoin[2].
ICO’s
allows to almost everyone to invest money in projects that looks promising.
However, one must emphasize that most of those projects only exists on paper
-and that is why they are called white papers-. Thus, this implies that people invest
for two main reasons, speculation and future development and outcome.
On
the other hand, Putincoin, Evilcoin, Mao Zedong
and thousands more “Shitcoins” were nonsense ICO’s that somehow gained
popularity and raised a considerable amount of money. This just creates a
picture of how strange and dark ICO’s could be, in fact behind a whitepaper any
criminal organization can be involved, corruption, money laundry, drugs and
friendly guys just as Kim Jong Un.
However,
many projects look so promising and many investors have put their money to see
them growing in the long term. This market has become popular moving millions
of dollars from Bitcoin to these new tokens and new cryptos.
Future of Cryptos:
The
future of Bitcoin, or at least of cryptocurrencies, shows great potential.
While 2017 was the year where Bitcoin push the limits of rational economics, it
appears to be that e-coins are here to stay.
However,
many doubts have aroused around the actual utility, and future, of digital
currencies. The gold rush that Bitcoin caused also brought with it high
volatility in its price, becoming an extremely risky asset. Another factor
against Bitcoin was the lack of instruments available, or legally accepted in
developed markets, that allowed to take short positions on the asset. Most
brokers only offer a contract for difference (CFD) that allows investors to
take short positions in some cryptos.
The
first step into accepting cryptos as a new reality have been taken in the last
few months. By the end of 2017, futures of Bitcoin started to trade. The main
objective behind this action was to provide investors an instrument that increased
the options of taking short positions. Another objective of the creation of
Bitcoin futures was to reduce the volatility of the asset. In fact, in the past
month Bitcoin price apparently found some sort of stability around $10,000 per
BTC.
By
contrast, Bitcoin options –and binary options– are still considered an non
attractive instrument to investors due to the expensive prices of options. It
is important to know that the price of an option is reflected on the premium
that investors pays for the right to buy or sell the asset. The value of the
premium is taken from the volatility of the asset associated to the option.
Considering that Bitcoin, and most cryptos, have an important volatility, the
price of its options will be high.
However,
the application of new instruments and alternatives to trade Bitcoin, and
cryptos, would probable lower the volatility and the cost of investing in
options. The approval from the Commodity Futures Trading Commission (CFTC)
of Bitcoin’s options trading in the U.S. is another step forward for the
stability of cryptos.
Nevertheless,
even considering the new variety of instruments for cryptos trading, there is
still road ahead for any virtual coin in order to be considered a currency. The
case of Bitcoin could be used as an example of this idea. We’ve been seeing
progress in the financial instruments available to trade the e-coin, however it
cannot be considered an actual currency for its not accepted as a universal
method of payment in any country in the world. In the present, Bitcoin is more
similar to a precious metal than a currency.
In
order for e-coins to be considered as money they, or at least one of them, must
be used not only by investors but by monetary and governmental institutions as
a store of value and even as an international reserve. Commercial banks must
start implementing methods of payments, that includes any given e-coin, and
bank accounts denominated in cryptos. It is probable that some governments in
the world could start imposing taxes on virtual currencies.
In
the present, cryptos are used as a speculative asset, people often buy a crypto
looking for a future profit in dollars, euros, sterling pounds, etc. Another
use for cryptos is to avoid some governmental regulations, as mentioned before.
However, the potential value of the Blockchain could change this reality.
These
elements could help burst the bubble of Bitcoin, in detriment of other e-coins
such as Litecoin, Dash, Ethereum or Ripple. But also could bring stability
around cryptos. Also, the fact that China played an important role on the rise
of Bitcoin, it’s reasonable to think that they could have an influential amount
of stock that could affect volatility.
Another
factor that must be brought in the discussion, about the future of cryptos, is
the ICOs. As the BTC transforms into a more complex financial instruments, with
future contracts, options and even ETF’s, other cryptocurrencies could imitate
the recent growth of BTC.
The
use of an open Blockchain is a common element among every attractive crypto,
however not all cryptos share the supply rules that apply to the BTC. Some are
available for miners to extract and sell the coin, but others have a limited
and controlled supply. Some e-coins offer extreme privacy around transactions
(like Monero), which is a desirable asset specially for illicit businesses.
Nevertheless,
ICOs are often been used as a way for Startups to look for crowdfunding.
Countries like Japan allow entrepreneurs to finance their enterprises with
e-coins offerings. However, China or South Korea recently banned this
alternative, arguing that ICOs are an extremely speculative asset that could
have negative effects on their domestic markets.
Even
though, many governments and institutions still are reluctant about BTC and cryptos,
every day they become more important in our society. The elevated value that
BTC has achieved shows that either for speculative reasons or the real value
the token could have people are becoming more familiar around e-coins. And the
fact that BTC reached an elevated price, makes other cryptos an attractive
investment due to their relatively low prices against the BTC.
The
future of cryptos will be shaped by the interaction between the feasibility and
legality with the development of a technology that could improve the relations
among economic agents.
The
use of e-coins as a way to attract investors –using ICOs– would help startups,
and the economic incentives behind innovation. Crypto currencies endow
entrepreneurs with a non-traditional tool that could help democratize the
conditions new enterprises face in order to find funds.
Finally,
the application of the Blockchain simplifies economic interactions, and works
as an online blueprint for economic transactions.
There
is a long way down the road for cryptos and Bitcoin, as for society. Digital
currency will shape under the people’s preferences. What is certain is that a
new way to find profit, and the opportunity to be cautious, has arrived.
Conclusions
The world has changed, we have changed, and
there are so many things changing. New inventions come with many questions and
just few answers. Bitcoin has awakened a strong force into the financial and
economic system, decentralised operations, cost reductions and market freedom.
Bitcoin and cryptocurrencies have showed
how profitable, risky and trendy they have become. Public opinion is completely
divided between economists, businessman and politicians, some of them claim
that is the biggest fraud and bubble in history and others seen it as an
one-lifetime opportunity and a total breakthrough in our time.
In this paper we introduced concepts from
behavioral economics and finance that could help to explain many
characteristics of bitcoin and cryptocurrencies. However, it is necessary
extend the analysis with an empirical model.
We have studied factors that could have
influenced the exceptional growth of Bitcoin and the cryptocurrencies industry.
Countries like China and Venezuela have been strong influencers on Bitcoin’s
boom. In the Chinese case, the existence of strong economic regulations and a
bearish stock market have put some pressure on the digital currencies market.
In Venezuela’s case, the combination of a deep economic crisis and the
relatively low cost of electricity and internet makes the Bitcoin mining and
trading an extremely profitable business.
We also considered the influence of QE and
recent monetary policies over the rise of cryptocurrencies. Historic low
interest rates –negative in some countries– and the strong volatility showed in
the principal currencies due to announcements in changes in the monetary
policies could have work in favor of digital currencies. It appears that many
people lost their faith in the banking system and governments, consequently
this have raised Bitcoin and cryptocurrencies popularity, representing a new
hope.
In relation to the future of
cryptocurrencies, ICOs, regulated markets and instruments and massive use put
themselves in the main objectives for the industry and regulators.
It is time to be prudent, wise and open
mind. We cannot deny change, it is part of life, but also we cannot just assume
things in order to understand complex things or situations.
Fidel Álvarez
Luis Ojeda
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