Daniel Mark Harrison is a financial journalist and entrepreneur who writes a daily column for The Motley Fool UK and whose work has appeared regularly in other mainstream publications, including the Wall Street Journal. Since discovering bitcoin in early 2013, he has had a fascination for the digital currency.
In this article, Harrison examines the many reason touted for the decline in the bitcoin price, debunking a few myths along the way, and takes a look at where the price might be headed in both coming months and years.
The past weekend rounded up the recent trend of brutally high-volume selling on Chinese bitcoin exchanges.
On 28th September, bitcoin dropped to a new five-month low of $372.35. The previous record low for CoinDesk's Bitcoin Price Index (BPI), is the six-month bottom reached on 10th April at $360.84.
Touted explanations fall short
One possibility put forward was the principle of asset allocation – effectively, people are finding other places to put their money as the bitcoin price continues its long slide.
Other hypotheses have ranged from Citigroup's proposal that merchants selling into the market upon accepting bitcoin as payment forced down valuations, to the even more unlikely explanation by the Wall Street Journal last week that Chinese citizens may be converting RMB to USD via offshore bitcoin trades.
In practice, there is nowhere near enough merchant trade to contribute to such a huge increase in volumes, while converting out of RMB in the way that the WSJ reporters speculated would be impossible without Beijing officials noting the yawning gap in underlying yuan outflows on bitcoin exchanges, especially given how closely such activities are monitored on the mainland already.
"[In terms of] getting money out of China, [customers] could sell bitcoins just as well on Bitstamp or any other exchange that is not based there," Kacper Ciesla, the founder of data provider Bitcoinity, told me.
Other economists argued that a rising US dollar has been weighing on bitcoin, but correlation between such a tiny market and such a giant one doesn't hold up well, either.
Falling prices vs rising volumes
The reasons behind the selling lie in the glaring conflict of a situation in which there is steady value erosion accompanied by what appears to be progressively increased trading volumes.
As bitcoin has tumbled lately, volumes have made new daily highs, with over 140,000 BTC being traded per day in the last few weeks for US$55m–$60m, according to data provided by Coinity.org. That is twice the $30m daily volume high reached before the summer.
Rising volumes and declining prices do not naturally come together since when an asset is being more heavily sold than it is bought, buyers typically stay away from the market until there are no more sellers left.
While illegal in many regulated markets, price support is not prohibited in bitcoin's case since the asset is widely unregulated. If carried out for only short spaces of time the practice can be cathartic in that it introduces needed liquidity to exchange floors.
Liquidity is the lifeblood of long-term pricing strength, and thus there is some logic to the idea of large-volume traders and market makers forcing volumes through exchanges by deliberately repurchasing units on the back end and selling them off exchanges, even if this does erode the price in the short run, Cielsa said, adding:
"Bitcoin market seems to have these waves of activity, and when they happen, volume rises on all exchanges [regardless of price direction]."
Hefty margins on OTC transactions
As the value of bitcoin has been tumbling into the zone of pre-December 2013 levels, it appears that there is a big gap forming between what the exchanges in China are reporting and what individual traders are in fact practicing using their own Rolodexes.
Ohio-based trader Dan Mercede buys from exchanges, including Bitstamp and Lake BTC, and sells mostly in the form of over-the-counter (OTC) transactions to his own regional customer base of private clients. He said former long-term holders of bitcoin that sold out in weeks past are getting back into the market in a big way now the price is dropping further.
"Demand is really high with low prices and all the sellers that [were] holders before are actually returning buyers again right now," he said.
Mercede, who is CEO of Cryptocoin Capital Management (CCM), claims he has made an average return of between 8%–15% per day mostly by buying off Chinese exchanges and selling locally, or vice-versa.
"I can get some crazy returns right now," said Mercede, who cited a trade this weekend where he purchased 20 BTC at $375 and resold the units at $560 to a client within hours. CCM has been executing similar trades for amounts up to 50 BTC per trade a number of times in September, according to Mercede.
It is common practice in North America for retail investors to buy at premiums via local trusted brokers in the case of many asset classes. What is unusual is that customers are happy to pay such large premiums. Many speculate this is the direct result of exchanges being associated with countries such as China and Russia, which do not resonate well with the American public.
CCM is in the process of looking at registering with the US Securities & Exchange Commission (SEC) so that it can expand its product suite, and Mercede is also raising additional cash to service bitcoin arbitrage transactions beyond the borders of his home state.
Waiting game recommended
Holding for the long term is what Roger Ver advises. He is the man who is known among the bitcoin community by the alias 'Bitcoin Jesus', a moniker bestowed for his early role in kick-starting the cryptocurrency by handing out free bitcoins and stirring up sentiment over the virtual payment unit.
Ver told CoinDesk that, while he thinks current levels look quite cheap in terms of presenting buying opportunities, this pales in comparison to the scale of the long-term outlook.
"The horizon should be more like three to four years," said Ver, referring to the length of time investors should wait to see huge gains again like they did at the end of 2013.
Looking between the averages
In terms of the short-term scenario, data on trading prices when taken together with volume shifts, helps to uncover the true picture.
In the six-month period from 1st April 2013 to 1st November 2013, the average purchase price of bitcoin was $111.56 across the four exchanges participating in CoinDesk's BPI.
Year to date, the average purchase price shot up dramatically, to $563.68. For the whole 18-month period combined, however, the average purchase price is notably lower at $337.61.
Most sellers who bought at $337.61 or thereabouts over the past 18 months will have sold out at $452 (this is the price of the year-to-date purchase price average of $563.68 minus the six-month prior average of $111.56). This is the exact point at which the currency was sold – once on the way down, and then around a week ago in the course of rising back up.
Offloading in the mid-$400s today yields most 18-month holders an average capital gain of 34%. Buyers have openly said that they were hoping to catch another 10-fold rise in bitcoin. These customers, once they have sold out, appear to be repurchasing at slightly lower levels again.
If the price averages are to be used as a reliable proxy of value going forward, then bitcoin looks ready to fall to around $337.61, and then bounce back up suddenly to over $500.
Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.
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