Death bells toll for the Bitcoin!

Mehdi Chowdhury
Published : 22 Dec 2017, 10:17 PM
Updated : 22 Dec 2017, 10:17 PM

Bitcoin and other crypto-currencies experienced massive appreciation in prices in recent times. In the last one month, the price of Bitcoin has almost doubled. The same is true for other crypto-currencies. Many are comparing this phenomenon to the Tulip Mania of the 16th Century.

However, Tulip Mania happened in a far distant past and this comparison does not seem to have any effect on the enthusiasm of investors.

In order to understand Bitcoin Bubble and how it will burst, we need to ask one of the fundamental questions of Economics, i.e. the value creation of a commodity.

To understand the value creation of Bitcoin, we need to understand its origin from Blockchain technology.

Understanding Blockchain Technology

The Blockchain technology used in Bitcoin first appeared in a white paper by someone using the pseudonym, Satoshi Nakamoto.

The true identity of the author is still unknown. Using the technology, massive calculations need to be done by a large number of people to verify transactions. The process is known as mining and the individuals who conduct the mining are known as the miners.

Bitcoins are rewards of successful completion of the calculations. Therefore, the minimum price of a Bitcoin is the cost of conducting the calculation for obtaining a Bitcoin.

Initially, the cost of these calculations were very low; now it is very high.

The mining today needs to be done using something like supercomputers while the electricity consumption of these calculations are tremendous. The high price of a Bitcoin reflects the cost of the current mining of a Bitcoin.

The value of a commodity also reflects our willingness to pay for that particular item. For example, there is a cost of gold mining, however, the price of gold also reflects our willingness to pay for gold.

Value is determined by our perception

Similarly, the price of a Bitcoin should reflect our willingness to pay for a Bitcoin. The obvious question is, what is the use of a Bitcoin? For example, gold is used for transactions. In addition, gold is used in jewellery because of our perception of it as a unique and a beautiful metal.

The Blockchain technology states that the Bitcoins can be used for transactions and the transactions made using the Blockchains are cheaper than the usual mechanism of transfer through banks or third parties.

This cost effectiveness gives Blockchain the edge over banks or third party based transactions.

However, Bitcoin has no other unique characteristics. Gold is a unique metal and that uniqueness is valued by us. There is no close substitute for gold. The use of Bitcoin is easily substituted by another crypto-currency.

For example, a company wants to use a crypto-currency for remitting money from the UK to Japan. In order to obtain it, the company decides to opt for mining.

Question is, which crypto-currency will the company mine?

Bitcoin has become expensive to mine

Bitcoin now involves a very costly procedure. To be honest, this currently has no cost advantage over other crypto-currencies in facilitating transactions.

We should also note that the acceptability of currency is an important factor here. At the moment, there are many crypto-currencies in the market. Most are not directly convertible to regular currency like Dollar, Pound, EURO and the Yen.

These crypto-currencies first need to be exchanged to Bitcoins, and then to regular currency.

Though Bitcoin presently has monopoly, this will possibly change in the near future

One may argue that there is no need to mine new Bitcoin; instead, a company can just buy Bitcoins from the market and use that to remit money.

For example, someone wants to send 500 pounds to Japan. There is no need to buy a whole Bitcoin as crypto-currencies are infinitely divisible.

The company can exchange £500 to buy Bitcoin equal to 0.0417 (approx.) or another crypto-currency Litecoin equal to 1.557(approx.).

Both Bitcoin and Litecoin have the same purchasing power, however Litecoin needs to be exchanged to Bitcoin in most of the exchanges.

Therefore, there is an additional cost of using the Litecoin. This should give Bitcoin a cost advantage.

I feel this advantage will not last long.

Cypto-currencies are gaining widespread acceptance, along with their direct exchangeability.

A maximum number of 21 million Bitcoins can be mined due to the initial protocol set up by Satoshi Nakamoto.

The fallacy of value

It is hence argued that Bitcoin is a precious asset. This is a just an illusion. Crypto-currencies are infinitely divisible.  A single gold dust has no use and .05 gold makes no sense. On the contrary, this is not a problem in the cryptocurrency world.

These 21 million can be in the hand of 1 million, 21 million or, 1 billion.

On the other hand, the limit of mining is a disadvantage. This implies a limit of the coverage of information containment of a Blockchain in both spatial and time dimensions. That will eventually make Bitcoin and other early Crypto-currencies obsolete in the future.

The biggest challenge comes from the free entry into the market. The crypto-currencies can be substituted in actual transactions.

Meanwhile, new entrants will come with improved technologies to deliver cost advantages, thereby having market dominance.

Phenomenal profit signals fast falls!

As long as there is abnormal profit, this free entry will continue.  Any unusual profit from a crypto-currency therefore is a short term phenomena.

Bitcoin enjoyed this appealing image for a long period though this may not be the case for other such currency.

Predictions state that by 2040, the limit of 21 Million for Bitcoin mining will be reached. As the mining cost is already very high, the future miners may not mine Bitcoin anymore and the limit may never be reached.

Hence, The Bitcoin mining is likely to experience a shutdown before 2040.

Will Bitcoin still be transacted in the future? This also seems unlikely. The entrants will come with new effective solutions to transaction problems.

Current Blockchain platforms will be driven out of market. There is a possibility that the new technologies will incorporate the existing Blockchain, obviously, subject to the technological feasibility of that incorporation.

However, this incorporation does not ensure existence of a strong future market for the current Blockchains.

The current Blockchains will be like ancient underground cities smothered and obscured by modern megacities.

Therefore, my prediction is that the Bitcoin and other crypto-currency bubbles will bust hard and be out of the market.

There can be only short term trading gains, lasting for the next 1, 2 or 5 years.

The advice: nobody should treat crypto-currencies as long term investment.