As Bitcoin prices slide below $ 40,000, should you buy down or sell?
As Bitcoin (CCC:BTC-USD) prices collapsed this week, crypto investors were left looking a lot like a deer in the headlights. ETF flows for most of the six popular blockchain ETFs have largely stagnant even though crypto prices have fallen.
Indecision highlights a disturbing truth: Bitcoin investors are moving from an aggressive crowd looking for profit to a crowd increasingly fearful of missing out. In March, the Bitcoin Trust in Grayscale (OTCMKTS:GBTC) – a proxy for the interest of institutional investors – saw its NAV premium go from positive to negative.
In their place, conservative investors intervened. Wednesday, Wells fargo (NYSE:WFC) joined other wealth management teams in announce plans to open crypto trading to high net worth clients. (Apparently, it’s better to let your customers lose money than to lose it yourself). Meanwhile, forward-looking investors have switched to more technologically advanced cryptocurrencies, such as Ethereum (CCC:ETH-USD), Cardano (CCC:ADA-USD) and Computer Internet (CCC:ICP-USD). Central banks have also announced their intention to launch their own digital currencies.
This makes a BTC recovery even more unlikely. As the age of Bitcoin begins to show it, its future has never been so shaky.
Bitcoin price: $ 60,000 price target error
Bitcoin’s 30% drop this week highlighted a fact experienced investors have long known: Bitcoin has no fundamental value. The price targets of $ 60,000, $ 600,000 or $ 6 million seem hollow because the cryptocurrency is only worth what your neighbor is willing to pay. (Fortunately, those who live next to a Goldman Sachs office).
The lack of a serious price target has long benefited Bitcoin holders. Influential investors like Cathie Wood of ARK Innovation have long proclaimed $ 500,000 price targets without providing any deep justification. Squint strong enough, and any value seems possible.
The benefits, however, go both ways. Since 2020, Bitcoin prices have become more of a leveraged bet on investor confidence than cryptocurrency adoption. According to data from Thompson Reuters, the cryptocurrency now has a 25% correlation with the S&P 500 and a correlation of 34% with You’re here (NASDAQ:TSLA). The 4% swing in the stock market last week caused crypto prices to drop by a third.
Usually, investors may want to buy the plunge. The stronger-than-expected post-Covid recovery led banks to revise the projection of stocks upwards. Bitcoin would probably win too.
But this time could be different. As experienced crypto investors have long known, the Bitcoin community is surprisingly status quo. As other competitors continue to rise, Bitcoin will find itself further and further behind.
The Bitcoin protocol: Miner League
Cryptocurrencies led by stakeholders like Ethereum have advanced. In November, the world’s No.2 crypto joined Cardano and other ‘third generation’ coins to launch an energy-efficient proof of stake protocol. Rather than letting miners waste energy on computations of unnecessary complexity, PoS systems run on a system of approved validators. Energy savings can be as high as 99.7% or more, and crypto watchers expect Ethereum to completely switch its blockchain to PoS by the end of the year.
These improvements are possible because cryptocurrencies like Ethereum are based on a stakeholder-based voting system rather than a system based on mining. With sufficient support from the Ethereum Foundation and the community, beneficial proposals can proceed without the support of minors. Centralized cryptocurrencies have found it even easier to push for change. Ripple controls 60% of all XRP, making changes virtually effortless to pass.
Bitcoin, on the other hand, remains relatively heavy due to a historical quirk in its development: BTC miners hold an outsized vote on protocol changes.
Although minors represent only 10% of the offer, the Bitcoin protocol does not work on a democratic voting system. Instead, all proposed changes follow a similar process – miners must reach consensus for any proposal to pass. While the system can prevent fraud and security issues, it also makes cryptocurrency difficult to change.
The Bitcoin community put this theory to the test in 2017 when it launched an offer to increase the block size limit of the cryptocurrency. It was not until 95% of the miners accepted the change that the software upgrade was successful. This makes it virtually impossible to switch to an energy efficient PoS system without a rigid fork. No miner will willingly vote for a more power efficient system as it renders their billion dollar investments in ASIC machines worthless overnight. It’s a prisoner’s dilemma where stakeholders acting in their own best interests poison the cryptocurrency for themselves and for everyone else.
Already former Bitcoin champions like Tesla CEO Elon Musk have reverse gear for energy-burning cryptocurrency. Other negative reactions could be underway.
Rearrange the lounge chairs on the USS Bitcoin
That hasn’t stopped Bitcoin fans from losing hope. In April, Niklas Nikolajsen, the founder of Swiss crypto broker Bitcoin Suisse, predicted that Bitcoin would eventually switch to energy efficient PoS.
“I’m sure that once the technology is proven, Bitcoin will adapt to it as well,” the entrepreneur noted in a German TV interview.
In truth, Bitcoin’s technology has fallen so behind that it might not matter. Today, cryptocurrency can still only act as a medium of exchange, not as a payment processor or commercial bank. These are the banknotes of the cryptocurrency ecosystem rather than the pipes or pumps.
Over time, this weakness could become the death knell for the price of Bitcoin. In its current state, crypto’s limited functionality makes it vulnerable to competition from central bank-sponsored digital currencies. China’s e-Yuan project has already threatened Bitcoin’s viability in the People’s Republic. A digital dollar could potentially do the same in the United States, threatening Bitcoin’s total $ 1 trillion market cap value.
To combat this, we need to use blockchain technologies for more than just transactions. Projects like Ethereum have already moved on to NFTs, creating electronic deeds for works of art and collectibles. Others like Celsius (CCC:CEL-USD) allow users to borrow and lend money like a commercial bank. The latest in the industry – Internet Computer – promises to use decentralized networks for cloud computing and website hosting.
Bitcoin, however, has failed. His current projects focus on minor wallet improvements and bug fixes rather than the drastic changes it needs to keep pace.
There is a good reason that early cryptocurrency investors ditched the heavy technology of Bitcoin. You should, too, while you still can.
As of the publication date, Tom Yeung does not hold (neither directly nor indirectly) any position in the securities mentioned in this article.
Tom Yeung, CFA, is a Registered Investment Advisor whose mission is to bring simplicity to the world of investing.