In February, I wrote an article to warn people against mindlessly buying the dip on Bitcoin (BTC-USD) and other cryptocurrency. The past has shown that bear markets in cryptocurrency – just like bear markets in other assets – can last multiple years. In this article, I will try to analyze if this drop of the Bitcoin price is merely a return to the mean or the start of further degradation of its value.
How bad is the damage?
When looking at a multi-year chart of the Bitcoin price, it looks terrible. There seems to be a lot of potential for it to drop even further.
Bitcoin price development since June 2013 (linear). Source: coinmarketcap.com
Readers of my previous article know that I love to look at logarithmic charts to analyze the price behavior of assets which have grown much in a very short time. In my opinion this is a fairer way to look at the price development of these assets, because it enables us to compare percentage changes in the price over time in a better way. Let’s take a peek at the logarithmic chart since the middle of 2013.
Bitcoin price development since June 2013 (logarithmic). Source: coinmarketcap.com
On this chart it can be seen that the recent price drop might have been large, but that the long-term trend has not been reversed yet. The direction is still up. This does mean that there seems to be a lot more potential for the price of Bitcoin to drop more.
Scenario 1: Return to the Mean
Now, I do not want to do an extensive technical analysis of the Bitcoin price, but if we extrapolate the trend which started at the beginning of 2015, which implies a rising price over time, we would end up at an expected price of around $3,000 today. This increase is exponential since the chart we are using for this analysis is logarithmic.
My interpretation of the trendline since the beginning of 2015
Because of the extraordinary price development during the previous year, this price was far surpassed – but could it be that the price will eventually return to this mean? Of course, Bitcoin is not a normal asset, its value seems to respond to market conditions and price developments in an extreme way compared with other assets such as stocks or currency exchange rates.
The big question is how useful such a trendline is for the Bitcoin price. In my opinion, the usefulness is that it is a sanity check in case of overshoot. In hindsight, it seems clear that Bitcoin prices of more than $10,000 were extreme when looking at the graph. But Bitcoin prices are more driven by sentiment and technological promise than by its fundamentals, and as such it is a bit questionable whether looking at a graph is useful in our discussion.
Scenario 2: Descent Into Oblivion
Many authors (including me) have been arguing that Bitcoin is one of the least technologically advanced cryptocurrency. In a way, this is not surprising since Bitcoin was the first cryptocurrency. Newer cryptos are using better technology and are using innovations which make them better, safer, quicker or leaner than Bitcoin.
This article describes this scenario very well: because of the technological limitations of Bitcoin, it is quickly getting replaced by better ones. According to the analysis described in the source, the design of Bitcoin simply prevents it from having a long-term future.
I partially agree with this, but we should not forget that there is possibility for change, both in the form of forks and in the form of behavior of people. For instance, Bitcoin was never designed to be a technology used for quick and easy payment. The lightning network partially solves this problem.
Return to the mean: the gold standard
Some people claim that there is a significant possibility that Bitcoin could become the gold standard of cryptocurrency. It could be argued that it has already behaved in such a way during the last couple of years.
But, as other authors have emphasized as well, when we look at the total market capitalization of all cryptocurrencies, we can see that since 2017, the dominance of Bitcoin has evaporated:
This seems to be a supporting argument for the “descent into oblivion” scenario. We should not be too quick in drawing conclusions though. The graph of percentage market capitalization might be influenced heavily by the development of new cryptocurrencies. If Bitcoin truly became the gold standard of cryptocurrency, it is not unthinkable that it would stabilize with a market percentage which is lower than in the past. This does imply that its market capitalization percentage needs to stabilize eventually and not evaporate any further. Also, Bitcoin urgently needs to solve its problems: for instance its gigantic electricity use, which could be mitigated by for instance using energy which would otherwise be wasted. If its problems are not solved, other cryptocurrencies seem more viable for a market position as gold standard than Bitcoin.
Analyzing the implications of both possibilities
In hindsight, everything seems explainable, even price developments of Bitcoin. 2017 was a very extraordinary year with regard to the Bitcoin price. In both scenarios, it seems normal for Bitcoin prices to cool off for a while.
If the return to the mean scenario would come true, Bitcoin price might return to the trendline, which is currently around $3,000. This could take a while, and of course the price can also experience some undershoot to even lower values before recovering. This scenario does imply that Bitcoin is here to stay and will take a position in the crypto market, most likely the one of Gold Standard. Price will return to the mean and continue to grow, albeit more slowly than in the crazy year of 2017.
In the case of the descent into oblivion, the recent drop is only the start. Bitcoin is getting slowly replaced by its competitors which are better, quicker, safer and leaner. The only benefit which Bitcoin has is its first-mover advantage, and this will not stay relevant long for a quickly developing technology like cryptocurrency. Bitcoin price will continue to drop during the next years, until it can only be found back in the history books as the first cryptocoin. Other cryptocurrency will take its place. Call it creative destruction or survival of the fittest.
At this moment, the scenario that Bitcoin will descend into oblivion seems most likely. Its future success will depend on the currency’s ability to solve its energy problem and the successful and safe use of the Lightning Network. As we speak, there exist multiple other crypto’s that do not suffer from these problems, which puts Bitcoin at a severe disadvantage.
A return to the mean would almost inevitably imply that Bitcoin needs to become or remain the gold standard of cryptocurrency. This is still a possibility. In both scenarios, I see the price of Bitcoin dropping to $3,000 or below. No matter if you believe in Bitcoin or not, I would stay away from it at the moment.
Thank you for reading! If you have any ideas about Bitcoin or other cryptocurrencies, please let me know in the comment section below!
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.