2017 was a wild ride for cryptocurrencies and for Bitcoin in particular, rising in price at one point above $19,000 only to drop back to a bit over half of that number now. But which number is correct? If only the market can tell for sure -- and these numbers are coming straight from the market, remember -- what the heck does it all mean? It means Bitcoin isn’t a currency at all but traders are pretending that it is. 2018 will see investors finally figure this out.
Confusion abounds, so let’s cut through the crap with an analogy. Cryptocurrencies like Bitcoin, Ethereum and a ton of others operate almost exactly like a market that uses only U.S. one dollar bills and doesn’t allow exchanging those bills… ever. If you need five dollars, that will be five one dollar bill, please. If you need less than a dollar then you and your counter-party have to agree how much of a one dollar bill you each own. And they aren’t just any one dollar bills: they are specific bills, each with its own unique serial number that can be checked against a U.S. Treasury database to make sure the money is real -- that it is actually worth a dollar.
Like those serialized one dollar bills, each Bitcoin (or part of a Bitcoin) is unique and can be held by only one party at a time. The Bitcoin carries its own computational proof of identity so no central database is needed, making cryptocurrencies part money and part accounting system. And just in case Scott Cook is reading this, I’ll suggest that a very logical addition to Intuit’s QuickBooks would be a proprietary cryptocurrency I’d call QuickBucks.
If KODAK… KODAK… can do it, why can’t intuit?
The problem with Cryptocurrencies, and the reason why their prices (and implied underlying value) are so volatile, is because the basis of that value isn’t the same as the basis for a real currency. It’s not backed by gold. It’s not backed by "the full faith and credit of the United States of America." It’s not backed by, well, anything. In that sense of innate value cryptocurrencies are worthless.
But this is not to say that Bitcoin has no value. It’s just that the value is misunderstood. And here’s probably the most important point I am trying to make here: as long as the value of Bitcoin is misunderstood there will be hucksters taking advantage of suckers, stealing their crypto lunch money.
EVERYTHING in the cryptocurrency world is about the exchange rate, which is to say nothing is about the actual cryptocurrency itself. You see there is nothing holding the price of any legitimate cryptocurrency up or down except supply and demand and both of those are constantly changing. So the smart trader knows never to hold Bitcoins -- or at least not to hold them for very long -- because what went up will inevitably go down.
This is what makes Bitcoin a horrible investment but a wonderful trade, because there is money to be made in that inevitable volatility. Not only will what goes up come down again: it will also go back up again if you wait long enough.
This is all because Bitcoin and similar currencies aren’t currencies at all but financial instruments. They are tools just like options or derivatives. And like good tools, they perform a specific function very well -- reliably transferring value between parties without those parties having to meet or even know each other. But once that transfer is complete, then the true value of the Bitcoin has effectively been used and is therefore subject to change, which again explains the volatility.
The value of Bitcoin goes up with demand on the part of those who would use it to transfer value. Some Russian oligarch, for example, has heard a rumor that Putin is after every Ruble in his piggybank, so the oligarch exchanges those Rubles for Bitcoins as he boards his private jet in Moscow, then exchanges Bitcoins for U.S. dollars before he lands in some safer country. He doesn’t care much about the exchange rate because the oligarch only intends to hold the Bitcoins for at most a few hours. But turning 10 billion Rubles into Bitcoins will inevitably drive up the Bitcoin spot price. This is key -- the spot price.
Now let’s say we have that day buying Bitcoins in addition to the Russian oligarch a Chinese industrialist, a Saudi prince, and a Nigerian con man, each with cops pounding on the door and $1 billion to move ASAP. With all that demand the Bitcoin price goes higher and higher and none of these parties actually gives a damn because over the course of their trades the price only goes up a bit. But to Bitcoin traders and (shudder) Bitcoin investors -- this rise in price looks like a rise in value so of course they jump-in driving the price higher still.
What happens, though, when the big trades are all finished and the Bitcoins reconverted to real currencies? The price of Bitcoin then drops because its utility as a financial instrument is not so urgently needed. There is nothing bad or good about this price change which is perhaps most analogous to breathing. In-out, up-down, that’s just how cryptocurrencies operate.
Well most cryptocurrencies. There’s one that is different. It’s called Ripple and right now it is the third most valuable cryptocurrency. Ripple is different because it doesn’t really even claim to be a currency. Ripple is a tool for transferring funds between banks. You don’t mine Ripple, either. Every Ripple that will ever exist already exists today, though not all are in circulation. All Ripple does is what I’ve described Bitcoin doing though in the case of Ripple it’s minus the drama and bullshit.
There are probably cryptocurrencies that are total hogwash and not even mathematically sound. After all, there are criminals in every industry. But the best known cryptocurrencies are probably okay. Bitcoin is worth more than the others only because it has been mined longer and there are more of them in circulation, meaning greater liquidity to support larger transactions. If you want to transfer a zillion bucks from there to here are you going to use Bitcoins or KODAKcoins? My point exactly.
Until everyone comes to understand these underlying truths there will be huge Bitcoin price volatility with fortunes made and lost every day. But once we all get onboard, Bitcoin promises to become the little trading engine that could. That’s because for every time we know Bitcoin will go down we know that it will inevitably go back up again.
If you notice Bitcoin is down, buy it. When you’ve made as much profit as you need, sell it, then wait for Bitcoin to inevitably go back down again. Those who have a very high risk tolerance or think they can time the market will hold on longer and be more likely to lose their shirts. It’s a much better Bitcoin trading strategy to not be greedy, living instead on the crumbs of oligarchs and con men.
This is an understanding that I predict will broadly emerge in 2018.