Why the recent crash in the price of bitcoin and other cryptocoins?
CCN reports that whales (large speculators) and institutional investors within traditional financial markets likely triggered a sell off of bitcoin that caused the sharp downturn. Some analysts argue that the massive amount of bitcoin was cashed out in order for short sellers of the futures in the Cboe and CME to be able to buy out their contracts.
CCN thinks that the theory that the whales selling off bitcoin triggered a domino effect that hit most major cryptocurrencies and led to the whole cryptocoin market crashing is far more plausible than what it calls the FUD theory emanating from problems in Chinese and South Korean markets. FUD can stand for “fear uncertainty and doubt” or alternatively ” fear uncertainty and disinformation”.
CCN says that Chinese trading volume is insignificant while “the South Korean government has officially refuted cryptocurrency trading claims.” This is not explained but perhaps it is referring to a statement by the Financial Services Commission (FSC) that they do not have the power to close down exchanges.
While at present, South Korea might not have the requisite laws to shut the exchanges down it could very well create legislation to do so. However, no doubt, the government worries about public reaction. The FSC, says: “The government is reviewing both options to shut down virtual currency exchanges or to close only those exchanges that have committed illegal acts.”
There were earlier reports near the end of the year and in early January that the Korean government was threatening to close exchanges and that new rules allowed them to do so.
It seems to me that both theories could be identifying factors that were at work in the decline. They are not mutually exclusive.
Why bitcoin may rise in the near term
Financial institutions and banks are considering building infrastructure around bitcoin according to CCN. A South Korean government official said that the government is considering allowing some financial institutions to operate bitcoin futures exchanges. This is not surprising since in the US the two large Chicago exchanges Cboe and CME already offer bitcoin future contracts.
The New York Stock Exchange (NYSE) has built a cryptocurrency tracker for institutions in the traditional finance industry. It is also waiting for the SEC to approve bitoin-linked ETFs. However, it may be some time before these are approved as several firms withdrew their applications on talking with the SEC as discussed in a recent Digital Journal article..
Even though many investors may have shifted money from bitcoin to alternative cryptocurrencies during the last six months, bitcoin still remains the number one dominant coin and acts as a sort of reserve cryptocurrency. Often bitcoins are bought to use to trade for other coins.
CCN says:” In the short-term, the network effect of bitcoin and the rapid increase in adoption of the cryptocurrency will likely lead the price of bitcoin to increase. As of current, bitcoin is showing better signs of recovery than it did over a week ago, and is preparing to initiate a new rally.” It is not clear what sort of adoption CCN is talking about. Some places such as Steam are no longer accepting bitcoin as it is too slow and exhibits too much volatility and has high fees as discussed in a recent Digital Journal article.
There are a number of technical problems that bitcoin faces that could cause a price decline
One important issue is the bitcoin system’s scalability its ability to handle large volumes of transactions efficiently and quickly. Bitcoin was intended to provide a fast secure and inexpensive way of making payments without use of the traditional financial system or any third party.
However, bitcoin does a minuscule number of financial transactions compared to Visa or Mastercard or banks. Much of the traffic involves speculators buying and selling shares rather than commercial transactions buying and selling goods.
The number of transactions is large enough to slow down their speed dramatically and also to increase the costs of using the system, the transaction fees. This no doubt is causing some investors to put their money into coins such as Bit Cash, or Libtecoin both of which operate quicker than bitcoin and have lower transaction fees. There are now coins such as Iota that have solved the scalability problem. Iota actually works faster with increased volume.
Bitcoin has not even been able to increase the size of its blocks as has Bit Cash which resulted from a hard fork in bitcoin.
Bitcoin’s liquidity
Although the number of bitcoins is increased by mining, there are not enough to keep up with the high demand, especially as many people keep their coins in the hope prices will go even higher. The high demand, while many do not want to sell, and the number of coins available are limited, creates huge price rises.
However, there is also an increasing volume of transactions causing congestion and slowing down transaction speed. A recent article notes: “… rising transaction volumes are causing network congestion. Bitcoin has no means of adjusting capacity other than rationing verification. Miners verify transactions with higher fees more quickly than those with lower fees. Those who want fast verification (which is nearly everyone, since bitcoin’s price is rising so fast) will pay higher fees. Those who don’t want to pay higher fees must wait longer for their transactions to settle.”
The Lightning Network
The Lightning Network would take most transactions off the blockchain network and process them through its own system so that they do not slow down the blockchain.
While the operation of the Lightning Network is somewhat technical, it is described simply in the appended video.
A recent article, describes the Lightning Network as follows: “Lightning is a decentralized network of pre-funded, bilateral bitcoin payment channels off the bitcoin blockchain. Lighting transactions are typically small, and most are not broadcast to the blockchain. So they should be much faster and cheaper than on-chain bitcoin transactions.”
If enough people open these pre-funded channels, there would be a considerable degree of liquidity within the system distributed across this network of payment channels. The Lightning developers are working to find out the shortest route through the nodes in the payment channel network. However, the network is still in the process of development and testing.
Pre-funded channels involve tying up coins that one could use for other purposes and people may decide to keep low balances in their channel. Also, channels will have varying funds from time to time, with a fair amount perhaps when first funded and then dwindling to almost zero before being replenished. Thus the liquidity in the system would be quite variable. There could be times when it could be difficult to make a large payment.
A possible solution to the problem is to have certain hub channels fully funded with large amounts of bitcoin at all times available for routing larger payments. This would mean the system was not fully centralized. It is not explained how these hub nodes would get established. With larger funding such hubs could be a “magnet for thieves”
The Lightning Network will work only if bitcoin is widely accepted as a means of payment for goods and services. That has not happened as yet.The Lightning Network needs to be established and tested to show that it works. Then perhaps, businesses will accept payment in bitcoin if there is a payment system that is safe, quick, and cheap. However, even if all of this is achieved unless bitcoin’s price stabilizes most businesses will not want to accept it. As it is now, bitcoin’s price volatility is much too great for it to be used very much as a medium of exchange.
Bitcoin’s scalability problem is far from solved. Even if it were, it would still have to solve its price volatility problem before it could become a generally used medium of exchange. It may very well be that as a medium of exchange other cryptocoins will gain more acceptance eventually.
UPDATE: As I post this, it is already January 21st 4:37 UTC. The price of bitcoin according to Coindesk is $!2,423 well off $13,000 but also thousands above its low of about $9,500 back on January 17.
