Two weeks ago the crypto market saw an enormous drop in value: dropping approximately 40% of its value in the following 7 days. Retail investors rushed to “buy the dip” and grab what they believed to be cheap crypto. Youtube and Reddit flooded with “gurus” showing their 3x, 10x and even 100x leverage positions as they scrambled for the holy discount.
While this might seem like an exciting opportunity if you’ve been waiting to grab some crypto as the bull market raged on, it might just be one of the worst times to buy. But you might be thinking, “risk = reward” right?
Well, getting leveraged directly in the wake of US$500 Billion being wiped from the market sure is risky. But will it return that reward that you’re looking for? My answer is most likely not. At least not until some big ticket items get cleared up in the crypto space.
Before we get into the specifics of why I think this way, I want to make it extremely clear that I’m a firm believer in the cryptocurrency project at large and I have a reasonable investment in the market. However, I also believe in making calculated risks and basing my buying behaviour of the best past data available…
So here’s a really really quick breakdown of why I think that this is the worst time sink serious cash into the crypto markets.
The Fabled “Dead Cat Bounce”
In trading terms a dead cat bounce refers to a short lived recovery of an asset that’s on a warpath to new lows. Larger downtrends are quite often interrupted by these intermittent patches of upward movement that leads a lot of unsuspecting retail traders to think they’ve reached the bottom of the dip and are buying at just the right time…
False signals like these are one of the primary ways you can guarantee that you lose money in markets.
You might be wondering why I’m so adamant that crypto markets are actually on a larger downtrend.
Well, the start of the problem is the majority of the “advice” peddled by unwitting future debtors on the internet, is that they approach crypto investing from a highly technical standpoint and either refuse to, or just unknowingly pass over the real-world problems that cryptocurrency is currently facing.
Purely technical analysis may have worked well in the past when crypto was less of a “real-world” asset, and didn’t have so many actors interfering with its growth. But now, cryptocurrency has entered in a realm of maturity where it actually has contend with governments, multi-national companies and investment firms treating it like a real asset that exists outside of the blinking screens of traders and crypto-nerds from 2014…
Here’s two fundamental reasons that I see as the biggest obstacles to cryptos price recovery in the short term:
- Bitcoins Energy Problem
- China’s New Restrictions
Bitcoin’s current “mining” process uses way too much power for investors and potential future users to contend with. This has always been a major critique of Bitcoin, but it came to a head with Elon Musk backflipping on his decision to use the cryptocurrency as a payment method for Tesla’s electric vehicles. He cited its major energy usage as the key concern. This announcement caused a sharp dip in Bitcoin’s price and fear spread quickly throughout the broader market.
If the most publicly crypto-positive CEO in the world can’t find a way to get around the energy usage dilemma, this spells as enormous issue for Bitcoin moving forward.
To put just how massive Bitcoin’s energy use is in perspective, it currently uses the same amount of power as Argentina, or nearly 10 times the total amount of energy used by Google, Facebook and Microsoft combined…
Renewables Won’t Work Anytime Soon
Lots of investors and crypto enthusiasts around the world seem to think that Bitcoin’s energy problem can be solved by the adoption of energy efficient alternative cryptocurrencies or through the use of renewable technology. While this is a nice idea in theory it’s completely impractical in the short term.
65% of all Bitcoin mining occurs in China, where the cheapest and dirtiest possible fuel sources are used to power the enormous warehouses of computers that process Bitcoin’s complicated cryptographic puzzles.
To expect these Chinese companies and quite often, black market operations to go out and purchase solar panels that can create an energy output equivalent of 6 times (Google + Microsoft + Facebook) is patently insane.
So, how can Bitcoin save its skin? Transitioning to renewables is a time and money consuming alternative that fails the enterprise in the short term. If it can’t feasibly change its energy source, then: Bitcoin must change the way that it is mined.
Bitcoin Mining Has to Change
The current mining system Bitcoin runs on is called Proof of Work. It works in a similar way to real world mining. Instead of having people in hard hats with little lights on them dive underground to pull out shiny rocks, computers do real work by solving extremely complicated cryptographic puzzles that validate and record transactions on the Bitcoin blockchain. The “miners” are rewarded for completing this work by being given new Bitcoins.
The problem with the Proof of Work system is that just like real world mining, it becomes harder and harder to extract resources the deeper you dig. Since Bitcoin mining has become extremely popular in 2017, mining efficiency has decreased by over 100%, meaning that as Bitcoins become more scarce, ever-increasing amounts of processing power and energy are required to create them.
The competing system that Ethereum is about to try out for the very first time is called Proof of Stake. This system only requires computers to validate new blocks rather than actually “mining” them. This works by temporarily taking a sizeable chunk of the stakeholder’s cryptocurrency for a few minutes and uses that as a form of insurance whilst validating and recording transactions. If this stakeholder were to be a malicious hacker seeking to alter the blockchain then their cryptocurrency would be immediately taken from them, and it would disappear back into the network as a consequence. This heavily incentivizes users to make sure they’re doing the right thing, or they’ll lose a massive chunk of their holdings. Because Proof of Stake doesn’t have to solve enormously complicated cryptographic puzzles and only requires users to stake their crypto, it uses on average 99% less energy per transaction, making it the obvious choice from an environmental perspective.
Unfortunately for Bitcoin in the short term: the current miners are the largest driving force in the Bitcoin ecosystem. Mining solves a problem for them. Taking away the Proof of Work mining would make bitcoin unviable for its most important group of holders and would cause an enormous upset in global markets. There are also a whole host of other security / functionality issues that Proof of Stake must contend with as well, but that’s another discussion entirely.
Ultimately, unless Bitcoin can transition successfully to a Proof of Stake system or something of similar efficiency, or actually figure out a way to quickly reduce its emissions, it seems as though its most poignant issue is here to stay, making it a very risky short term investment for anyone looking to “buy the dip”.
China banning things it sees as disruptive to the domestic economy or the broader political system is nothing new: Facebook, Amazon, Netflix, Google, Instagram, Snapchat, Twitter, YouTube, iTunes and Harrison Ford are all completely banned in China, and they seem to be doing just fine without the backing of Chinese capital.
However, these new restrictions aren’t just the usual flavour of red tape from China, these new restrictions fundamentally scale back the working parts of Bitcoin.
The trading aspect of Bitcoin has been illegal in China since 2017, but on the 18th of May this year the Chinese government announced a series of further restrictions that will inhibit the trading of cryptocurrency domestically: zero protections are to be allocated to any Chinese citizen who incurs a loss whilst trading any cryptocurrency asset, with the government arguing that cryptocurrency “seriously violates people’s asset safety”.
“The Chinese government does not like the highly volatile, speculative nature of the cryptocurrency market.”
Stated Fan Long, a co-founder of Conflux, a government-backed public blockchain network in China. He added that Chinese authorities have serious potential to take further action to restrict the ways in which Chinese citizens exchange Yuan into cryptocurrencies in the ‘over-the-counter’ market.
Following these announcements of Sunday the 23rd, Huobi, a major Chinese cryptocurrency exchange announced that futures, contracts, exchange-traded products and leveraged investment instruments will be suspended to Chinese users and that no new mining equipment will be sold via their supply chain.
While China has prohibited cryptocurrency exchanges from operating within its borders, it hasn’t made the ownership of digital currencies by its citizens illegal and banning them entirely would be an extremely difficult task. Despite this, many individual banks in China still enforce a zero-crypto policy with Alipay one of the largest finance and transaction firms in China, publicly stating they will instantly ban any user from their bank account if they find evidence of crypto trading.
Mining Operations Under Threat
Now, not all of the new restrictions imposed by China directly target cryptocurrency, many of them are just efforts to rein in all energy intensive areas of the broader economy. Inner Mongolia, an autonomous province of China has officially outlawed the mining of cryptocurrency because of its energy usage.
This in itself doesn’t even come close to spelling disaster for Bitcoin mining, but it does create cause for concern surrounding the larger operations in China. There are currently more than 100,000 mining operations at work in China, with small-scale operations being the minority in this number. Because Bitcoin mining is so energy intensive and competitive the profit margin for small operations isn’t enticing.
According to former Chinese crypto “veteran” Gieno Miao, despite the recent crackdowns Bitcoin and general crypto mining is “here to stay”. He states that so long as mining remains legal in China, then as long as there is demand, Chinese manufactures will ensure that they meet it.
The warpath that the Chinese government is on currently, combined with the actions of China’s largest crypto exchanges prohibiting the sale of new mining units may just be some of the initial cracks forming in the wider project. Whilst these issues are still being ironed out, it would be worth approaching Proof of Work cryptocurrencies and Bitcoin in particular, with a good deal of caution.
So, is now the right time to buy some crypto? We’ve just witnessed a stunning crash, surely, it’d be a wise idea to pick up some Bitcoin and other cryptocurrencies at a discount?
I’d say:
No.
From a technical standpoint, if we’re going to base our buying activity off past data, the Bitcoin crash of 2017 saw a similar pattern of buying activity in the wake of an enormous dip, with tens of thousands of retail investors thinking they had reached the bottom.
Big investment firms understand the intricacies of mass market psychology and they have software capable of giving them real-time insights into the market that you and I just don’t have access to. It’s very likely that the current “bounce-back” we are seeing is large buyers waiting for another up-cycle in which they can sell at the top of and take the most amount of profit possible.
Furthermore, the problems posed by Tesla’s pullback and China’s recent restrictions are not things that go away overnight or magically disappear into the haze of short-term positive market sentiment.
They are fundamental issues at the heart of the broader cryptocurrency project, and the sketchy “analysts” on YouTube using technical tools to look at graphs for various support lines and other pointless technical info are deluded if they think that charting tools are going to give them some sort of insight into this real-world issue.
Personally, until I can see even the glimmer of an exit strategy for Bitcoin in terms of its energy usage, I don’t think that it’s feasible to imagine prices skyrocketing to all-time highs in the near future. Big institutions aren’t going to throw their capital at Bitcoin because they see a little green line moving up over the new few days and get a bad case of FOMO. They’re going to the smart thing and wait until Bitcoin can prove itself as a viable and working model for the future of decentralized finance.
Right now, it’s very easy to feel like you might be missing your chance to “buy the dip” but there’s (as far as I can see) no good reason for money to come flooding back into Bitcoin any time soon. The panic selling is far from over, and another solid day or two of Bitcoin descending deeper into the red will definitely shatter a lot of these so-called “diamond hands”. It’d be a terrible thing to have the soft skin usually protected by a condensed carbon exterior exposed to the keen edge of a falling knife.
Do the smart thing and wait for real world information to surface about the future of cryptocurrency before you buy in at some arbitrary price you imagine to be “cheap”, because in reality, there’s no limit to how far prices can fall when things get really bad.
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