As of writing this article, Bitcoin is experiencing a price bloodbath. The virtual currency has been the victim of a relentless market sell-off that has no near end in sight. While a daily 30% drop in value is not uncommon in Bitcoin, well known for its extreme price volatility, something might be different this time.
The average investor or speculator in BTC may not fully understand the reasons for this recent sell-off. At the peak of the mania in December 2017, many uneducated investors entered the market, driven by the potential of realizing considerable gains in their capital. Credit cards were maxed out, second mortgages arranged, and loans drawn to provide these investors with the fiat currency needed to purchase their precious Bitcoin. Unfortunately for them, the biggest financial bubble ever began to deflate shortly after that, leaving many investors “HODLing” the bag as the price tanked.
“HODLers” (the name given to long-term Bitcoin investors) may still have a lot of pain left to endure in 2018 as the price drops further into oblivion. If the pace of the current bloodbath continues and joined by further sell-offs, could 2018 be the year for the death of Bitcoin? Here are four existential risks to the cryptocurrency in 2018, any of them could be a catalyst for the pending destruction of BTC, ignore them at your peril.
The Four Horsemen of the Bitcoin Apocalypse
#1 Government Crackdowns
Bitcoin is a decentralized currency. This means that it cannot be controlled by any government authority or central bank in the same manner as national fiat currencies. In early 2016, Japan made international cryptocurrency headlines when they announced the acceptance of Bitcoin as legal tender in Japan. Other East-Asian countries such as Vietnam followed suit, legalizing the exchange of BTC for fiat currency as well as purchases of goods and services with the virtual currency.
Despite these nations' progressive steps, other countries did not view Bitcoin in the same light. The Chinese government announced a total ban on crypto trading and advertising in early February 2018. The Chinese cited the reason for the ban as Bitcoin facilitating “illegal fund-raising and other types of illegal financial activities,” pointing to fraud and pyramid schemes in exchanges and the ICO market.
In reality, the Chinese government is most concerned with the capital flight from the country. Chinese citizens use BTC to circumvent capital exchange controls, giving them the opportunity to move their wealth out of China to avoid depreciation in the Yuan. All the major exchanges and mining operations have relocated out of China to neighboring Japan and South Korea to continue their business activities.
Bitcoin is currently being scrutinized by the United States as well, with the IRS and SEC launching probes into cryptocurrency exchanges, investors, and speculators for possible fraud and or tax evasion. The lack of regulation in the crypto marketplace, particularly in the ICO market, is a grave concern for western governments and we can expect to see further crackdowns in the future.
#2 Unplanned Obsolescence
Bitcoin transfers occur between peers with no need for a third party, such as a bank. Before the Bitcoin bubble grew to its astronomical heights, transaction fees were low and completed within a few hours. As miners released new blocks in the algorithm, issues of scalability began to arise. Transaction fees started to increase and transaction times slowed.
The industry solution to this problem was the implementation of a network upgrade known as SegWit2X. The software upgrade consisted of changing the block size from 1MB to 2MB to facilitate faster payments and cheaper fees. However, the mining community resisted SegWit2X with less than 30% of miners supporting it.
The lack of consensus around the SegWit2X fork shows that the Bitcoin community, particularly the miners, are resistant to change. Without an upgrade to the blockchain via a “hard fork,” Bitcoin is set to fade away into the distance as costs around mining and transacting Bitcoin increase. The result will be a flight from BTC to a cryptocurrency that is not affected by these BTC blockchain restrictions.
#3 Bitcoin Futures
The violent, sudden rise of Bitcoin captivated the attention of sophisticated investors, starved for yield in today's modern markets. As the price skyrocketed, it was only a matter of time before an institution launched a financial product based on BTC. The Cboe and CME Group were the first to answer the call, launching Bitcoin futures in December 2017.
The first expiries of these futures contracts saw them mature out of the money, with the price of the contracts dropping over 40% from their launch. Bitcoin whale's short futures contracts into selling pressure, making money as the price drops toward the expiry date. For every dollar lost on the open market price, the whales make a dollar on futures contracts they hold.
Futures contracts have been identified by the precious metals community, as a tool for manipulation of the commodity markets, particularly gold. It would seem from the data that a few large players are using the same manipulation tactics in the Bitcoin futures markets. The next expiry of futures contracts is due mid-March for Cboe futures, and at the end of March for CME futures. It will be interesting to keep an eye on the price action in the next contract period.
#4 Fraudulent Exchanges
The fourth horseman of the Bitcoin apocalypse has the potential to damage not only BTC but the entire cryptocurrency ecosystem. There have been allegations of price manipulation made against the major cryptocurrency exchanges. Wash trading and spoofing are tactics used by crypto traders to move the market in a given direction. While these tactics are illegal, many crypto exchanges allow this practice on their platforms, with some even encouraging it.
Traders trading to their own orders (wash trading), and placing large orders before withdrawing them (spoofing) create an artificial impression of trading volume to retail investors. These investors commit their capital to the market, only to have the price move against them and their position stopped out.
While these tactics are despicable, there is another “conspiracy” attached to the exchanges, particularly Bitfinex, that dwarfs the damage done by illegal trading. Tether Limited launched in late 2015 as the first “Stablecoin” issued in the cryptocurrency sector. Tether is used by traders to avoid periods of high price volatility in the crypto markets. Traders can cash out their crypto for Tethers and then return to the market when a new trading opportunity presents itself, cashing in Tethers for the crypto of their choice at the exchanges. Tether Limited states in its terms of service that it backs all USDT 1:1 with U.S. Dollar reserves held in a nominated bank account.
However, Tether Limited has refused to complete the accounting on their reserves, with their auditor; Friedman LLP, withdrawing from the audit in mid-January 2018 while removing any mention of Bitfinex from their website. This withdrawal by Friedman LLP is incredibly concerning as Tether Limited has not made any attempt at using a monetary authority to prove their USD reserves. Instead, they choose to use large Bitcoin whales and traders as proof, stating that they have seen their bank accounts with the full amount present and available.
Should it be proven that Tether Limited does not have the reserves they claim, the resulting fallout from a fraud of this size and nature could be enough to cripple Bitcoin. Tether has printed more than $850,000,000 in new USDT in 2018 alone, during a market crash. This behavior is very suspicious but still unproven as a fraud.
The underlying technology of Bitcoin, the blockchain, may have multiple technological benefits for many different applications. The blockchain is here to stay but should any of these four existential risks occur in 2018, it may be the death blow for Bitcoin. Hedge and trade accordingly.