Happy 10th Anniversary for Bitcoin! – The Year of the Crash

The last year has seen a lot of bloodshed in the Bitcoin market. After the bubble burst, many predicted the death, or at least the depreciation, of Bitcoin. Their view is that the most significant cryptocurrency is in fact the tulip bulb of the modern age.

It seems worthwhile, however, to examine recent events from a different perspective and review the history of the Bitcoin market at its tenth anniversary. It appears to me that – despite the huge price drop – everything is as it should be when it comes to Bitcoin – at least for now. As opposed to the price of the tulip bulb, that of Bitcoin might stabilize at a much higher level after the mania has settled. Interestingly, the market tendencies of the past three years and the period before that demonstrate a striking resemblance. In fact, all of this has happened before. If the upcoming events will follow the usual pattern, we have every reason to be optimistic.

The Beginnings

Before elaborating on the similarities, let us revisit the beginning of the story. Following the birth of the “genesis block” on 3 January 2009, only a few experts were aware of the existence of Bitcoin. This was for the best, since the mining program’s code still included a large number of serious defects, thus the cryptocurrency was fragile and easy to attack in this period. Nobody intended to attack it though, as there was no potential income to be gained – for example by shorting – after its crash. Bitcoin was worthless.

The next months were all about discovering and correcting the defects of the program. This was performed by a handful of enthusiastic cryptographers on a voluntary basis, who were led by Satoshi at the time. Nevertheless, even those who worked with him had no idea who he was. The community communicated online, all the work was done in the virtual space.

Their efforts soon brought tangible success, and the first ever known transaction where a certain product was bought with Bitcoin took place on 22 May 2010. An American man of Hungarian origin bought two pizzas, and the value of one Bitcoin was set at 0.25 cents. The day is still celebrated by the cryptocurrency community under the name “Pizza Day”.

The first Bitcoin stock markets emerged that same year. Although they operated with few participants and minimal liquidity, they provided a steady flow of exchange. At the end of the year, Satoshi ceased his involvement completely, and hasn’t been heard of ever since. He must have felt that his work was complete – or at least that it was operating in a normal manner – and it was no longer his task to further refine and tune it. The chances of losing his anonymity were increasing in parallel with the popularity of Bitcoin. More and more people became interested in his real identity, and it would have been revealed eventually if he’d stayed involved. He did everything in his power to avoid this. Besides, it was easy to find someone to pass the baton to among the talented programmers working on Bitcoin.

In the next year, 2011, the Bitcoin market had already seen a mini-mania, but was still characterised by a small number of participants, little liquidity, small market capitalization, and an easy-to-manipulate exchange rate, thus this mania arguably was not of large significance.

In what follows, we are presenting the post-2012 history of Bitcoin, alongside illustrative diagrams. These demonstrate that there appear to be four easily distinguishable phases in terms of market development, with each lasting approximately a year. The phases will be described in detail one by one. To support our claim that the phases recur regularly and recent events astonishingly resemble earlier ones, we will present the rest of the story on two parallel timelines, separated by four years.

The Years of Strong Vital Signs (2012 and 2016)

The turnover in the exchange market started to become considerable in 2012, and in this climate, Bitcoin doubled its initial 6-dollar value with a relatively gradual, steady increase by the end of the year. The resemblance between 2012 and 2016 is uncanny, with one difference: in 2016, the initial price later doubled was 450 dollars. Bitcoin showed healthy vital signs in these years.

 

The Years of the Mania (2013 and 2017)

The changes witnessed in terms of price in 2013 and 2017 are also strikingly similar. With a few ups and downs, the market demonstrated a tendency for increase. By the ending months of the year all hell broke loose, and the craze was in full effect. The price of the currency reached its culmination in December: in 2013, it peaked at around 1200 dollars, and in 2017, around 20 thousand dollars.

The Years of the Crash (2014 and 2018)

After sobering up from the craze, the crash of the exchange rates also went down according to the same script in the years 2014 and 2018. After the year-long drop spattered with significant fluctuations, the price decreased to its fraction: in 2014, it hovered around 300 dollars, whereas in 2018, around 3500 dollars. On this diagram, we have indicated the December of the previous year too, as this was the peak of the mania in both cases. This enables us to identify the rate that marks the starting point of the crash.

The Years of Agony (2015, potentially 2019)

Post-crash 2015 was characterized by disinterested commercial activities, and Bitcoin was agonized in the 200-300 dollar price range. The deadlock was actually broken in November, when the graph indicates a definite rise, and Bitcoin started exhibiting strong vital sings again. Thus, the year ends only to mark the beginning of the repeated cycle. The question is whether 2019 will also be a year of agony.

What lies ahead?

If we take the above analogy seriously and apply it to the future, the price of Bitcoin may be agonized between 3-4 thousand dollars in 2019, in 2020 it could approach 10,000 dollars, and in 2021 a new mania might start. However, it is better not to bet on this actually happening. The present prediction is merely a blind projection of past tendencies, without any serious basis.

Towards an explanation

It might provide us with comfort to find a believable explanation to these events, or at least get a sense of the logic behind them. This would help us understand why – and why exactly in this order – the steps followed each other the way they did. It may also potentially enable us to identify the factors that led to the repetition of the old pattern from 2016, while shedding light on the odds of this pattern to continue. Based on these observations, we might find those critical factors that have the potential to disrupt the usual order of events. I believe that the inherent operational rules of Bitcoin in combination with the nature of humans may provide us with the explanation we seek. Let’s examine why.

While trying to come up with a possible solution, we might find that the four-year period examined in connection with price tendencies is familiar from somewhere else too. That’s right, the pace at which Bitcoins are created is also halved every four years. In the beginning, every miner who found a block received 50 newly created Bitcoins. Later, however, the reward for miners was halved twice according to the prerequisites of the programme: first in 2012 (to 25 Bitcoins), then in 2016 (to 12.5 Bitcoins). What’s more, in the Years of Strong Vital Signs. Coincidence? I don’t think so.

Halving drastically decreases the availability of new Bitcoins, which in turn results in the increase of prices. Indeed, we witnessed a nice and relatively steady rise in terms of price in the Years of Strong Vital Signs. Although the decrease of supply is a sudden, drastic event, it did not arrive unexpected by market players. They can precisely foretell what will happen and when, they anticipate it, and they have time to prepare. And that’s exactly the reason why the halving results in a gradual, lengthy increase of price. In terms of extent, if we suppose that money enters the Bitcoin market at a steady pace, i.e. the net cash flow is regular time-wise (which we have no substantial reason to do), the price should double (and, alas, in the Years of Strong Vital Signs, the price level is doubled).

According to our explanation, humans are inherently prone to creating bubbles, and this instinct is activated at this point. The fast and steady rise of the price attracts more and more people. The increased attention generates new demand and additional price growth. And the subsequent price increase attracts an even bigger crowd. Positive reinforcement comes into effect, and the outlines of the upward spiral become clearer and clearer. The story starts appearing on the cover of magazines, and even housewives rush to buy Bitcoins. Thus we reach the Mania Years.

What follows is an essential, indispensable part of all manias. There is no way to move the already abnormal hype forward. Everybody has bought their Bitcoin, there isn’t any more demand generated. The downward spiral has been formed, and nothing can stop it. In the Years of the Crash, the price falls to its fraction. Newspapers announce the death of Bitcoin. They claim that it was just another tulip bulb. There is one significant difference between Bitcoin and the tulip bulb, however: once the mania is over, the price is stabilized at a much higher level in the Years of Agony than where it was in the Years of Strong Vital Signs in the case of the former.

The function of the Year of Agony is to cleanse the market completely. Bitcoin is no longer discussed in the newspapers, it’s not even pronounced dead, it is simply a subject of utter disinterest. The time of panicky sales is over, the price fall has reached a halt. The sales made by the desperate, hopeless investors who have lost a lot of money remain a heavy burden on the market for a long time. It takes a long time to take even the last Bitcoins out of weak hands. And by the time this process is over, we slowly reach the next halving point of the mining rewards. The Year of Strong Vital Signs comes once again on the cleansed market.

Could a new mania start?

Will the cyclic nature of events persist in the future? Will we see a new craze on the Bitcoin market? I believe it is possible, but there are a number of things that can interrupt the process. The good news is that the reward of blocks will be halved according to the pattern next year (to 6.25 Bitcoins). Thus, 2020 can potentially become another Year of Strong Vital Signs, creating a foundation for the next mania.

There is one necessary prerequisite for this to happen, however: global regulations must not become hostile. Currently, the situation is satisfactory in this regard. Nevertheless, there is a sad probability that once the regulatory bodies realize the rich potential in programmable decentralized platforms (such as Ethereum) the current friendly attitude toward the cryptocurrency might quickly turn hostile. Potential wonders are, indeed, things the operation of which regulatory bodies have no actual control over, and thus they prefer to avoid the existence of these.

Another essential prerequisite of a mania is the emergence of significant technological innovations. The mass spreading and usability of Bitcoin is also hindered by the issue of scalability. The network is currently unable to handle the number of transactions required for a globally used financial instrument. Fortunately, it’s not impossible that there will be progress in this area. The issue of uneconomical energy usage in the Bitcoin network should also be mentioned. I doubt that this would interfere with a starting mania on its own, but if we aim to promote the long-term success of Bitcoin, the community has to address this question as well.

If all the conditions are met and the next cryptocurrency mania starts according to the pattern, it might not take place in the Bitcoin market. Perhaps, a Bitcoin rival will claim the throne and will become the focus of the new craze.

It is also possible, even highly probable, that something that we could have not anticipated whatsoever will happen.

 

 

Original date of Hungarian publication: 03 January 2018