Though it may be something of an unpopular opinion, and those heavily invested in bitcoin may not want to hear about it, this article will attempt to explain why bitcoin’s high-flying glory days may now be over with, and why it might no longer be the fantastic long-term investment seemingly everybody believes it to be. In short, we present to you the bear case for bitcoin.
While it may seem passé to kick bitcoin when its already down, it is worth reminding oneself of the downside risk in any investment, as reality has the tendency to supersede hopes and dreams, especially when it comes to the world of finance and moneymaking. In this article we go over 5 major factors that may very well prohibit bitcoin from once again flying to the moon, and that are worth keeping in mind before taking out a second loan or mortgage payment to gamble on the bitcoin boat.
I. Bitcoin a Utility, Not an Investment
“(Bitcoin) is not a speculative investment even though it is being used as such by other people.” – Eric Schmidt, Executive Chairman of Google
To understand the true nature of bitcoin and for what it was originally intended by Satoshi Nakamoto, it’s important to remember that bitcoin was never meant to be an investment in the first place – it was intended to be a currency in order to facilitate the exchange of wealth in a digital environment. This concept seems to have been totally lost on anyone who entered the scene in the post MtGOX-era of bitcoin, those who joined the crypto community because they wanted to experience the same massive run-up in gains experienced by bitcoin in late 2013.
Likewise, this “third generation” of crypto holders, who watch bitcoin climb from $1,000 to $19,000 in 2017/2018 have been trying to get in on the action, hoping to partake in another massive upswing that they expect to occur if not in the next couple of years then by the end of this one.
Society’s adoption of bitcoin is often compared to being in the stages of the internet in the early 1990s, presenting a strong case for its continued explosion in price.
II. Bitcoin Not a Normal Commodity
“The price of any commodity tends to gravitate toward the production cost. If the price is below cost, then production slows down. If the price is above cost, profit can be made by generating and selling more. At the same time, the increased production would increase the difficulty, pushing the cost of generating towards the price. In later years, when new coin generation is a small percentage of the existing supply, market price will dictate the cost of production more than the other way around.” – Satoshi Nakamoto, creator of bitcoin.
Unlike any other tradeable commodity (say gold, rice, and natural gas), the innate, fundamental, intrinsic properties of bitcoin are in constant flux. Bitcoin’s ability to act as a currency, as originally intended, has been under scrutiny for quite some time. Since transaction fees for bitcoin are measured in units of BTC, which rise and fall along with the price of bitcoin, this means that the more expensive bitcoin becomes, the more expensive transaction fees become. Accordingly, the more popular bitcoin becomes, the more transaction fees rise due increasing competition to fit a transaction in the next upcoming block.
In late December 2017 / early January 2018, during BTC’s meteoric rise to (almost) $20k, the average transaction fee exceeded $100 as the Bitcoin Network became overloaded with transaction requests, with those shelling out less for a fee having to wait sometimes days for a transaction to be confirmed. It is pretty much inarguable that at this high a fee and this lengthy a transaction time, bitcoin is literally “priced out” as a payment option, only available to those with massive wealth or who can afford to wait extended periods of time for a confirmation. Though the introduction of SegWit and the Lightning Network have indeed done much to reduce transaction fees (they are currently at levels lower than that of 2 years ago), the unmistakable correlation between price, popularity and transaction fee will undoubtedly remain inherent to bitcoin’s functionality.
Total bitcoin transaction fees collected per 24 hours, in BTC. Source: blockchain.info
This self-regulating nature is not to be found with classic commodities, or even equities like stocks and bonds, for that matter. The cost to trade an ounce of gold or a share of stock always remains at a flat rate, regardless of the popularity of the item being traded or the price of the item. Furthermore, this rate is always calculated in terms of fiat currency (USD, EUR, JPY, etc.), whereas bitcoin exchange trading fees are always calculated in terms of BTC. Thus, trading fees – much like transaction fees – increase in terms of fiat price along with price of bitcoin. Therefore, as the price of BTC increases, it actually loses its inherent utility as a currency. This would suggest that the days of large, exponential gains in price are over for bitcoin.
III. Increasing Competition
“The idea with the distributed ledger system is to say, ‘how can we take the useful parts of Bitcoin – or at least the ledger idea – and integrate it with businesses that have legal reputations?’” – Tim Swanson, cryptocurrency researcher
It is true that prices of altcoins rise and fall in tandem with bitcoin, as bitcoin is seen as “the leader of the pack” in terms of the risky investment category of cryptocurrencies (all other coins being even more risky investments). However, with the introduction of more fiat-based altcoin pairings (such as USD/ETH, USD/LTC, USD/BCH, etc.), traders can now skip the step of having to buy bitcoin in order to gain access to other coin markets. This means that top alts are becoming “unbound” to the price of bitcoin and have the ability to move up and down based on their own merits rather than based on how well BTC is doing.
Bitcoin’s dominance of the total coin market capitalization has been in a downtrend since early 2017. Source: coinmarketcap.com
There are now over 1600tradeable cryptocurrencies listed across more than 200exchanges. Though the vast, vast majority of the total coin market capitalization is based on speculative potential rather than real-world utility, a few top alts like Ripple (XRP) are actually making a name for themselves in the international business community, increasingly being adopted by banks and payment networks for its settlement infrastructure technology. As a result of its increasing adoption by major financial players, Ripple currently enjoys the #3 spot on the list of biggest cryptocurrencies, with a market cap value of over $21 billion.
Ripple, Ethereum (ETH), IOTA (MIOTA) and NEO (NEO) are giving bitcoin a run for its money by making technological expansions and improvements on the original blockchain technology as developed by Satoshi Nakamoto. These coins (and many, many more) hope to fill gaps in a potential market space once cornered entirely by bitcoin, and some are finding considerable success. Though bitcoin maintains a strong lead over its competitors, possessing a market cap over twice as large as the next closest coin (ETH), it is likely that altcoins will continue finding ways to seep into areas of the digital economy left unpenetrated by bitcoin. Thus, bitcoin’s dominance of the total coin market cap will continue its downward trend as the general public becomes increasingly comfortable with the idea of using digital currencies. As anyone who ever tried to buy coffee with cryptocurrency knows, this process of mass adoption is moving very slowly, but it is in fact moving, and the truth is there is room for dozens – if not hundreds – of different cryptocurrencies to thrive on the world stage.
IV. Unsustainable Electricity Consumption
“In simplified terms, bitcoin mining is a competition to waste the most electricity possible by doing pointless arithmetic quintillions of times a second.” – Alex Hern, author for The Guardian
The Bitcoin Network consumes more electricity per day than the countries colored in orange on this world map.
As of January 2018, the Bitcoin Network used more electricity per day than all the electric cars in the world. Its current usage surpasses that used by many small countries and rivals that of some mid-sized countries, such as Argentina and Chile. For a very long time, up until the 1st quarter of 2016, the hash rate for bitcoin (the amount of calculations being performed by a miner in order to mine the next block) was under one million terahashes (one petahash) per second. As the price of BTC began to rise and bitcoin mining became a more lucrative enterprise, the mining difficulty level increased accordingly, rising by huge leaps in order to account for the increased flux of miners.
The difficulty level for bitcoin mining has increased dramatically over the last 2 years. Source: blockchain.info
Though the price of bitcoin has declined significantly since January, the hash rate and mining difficulty have not, meaning bitcoin miners must continue to spend tremendous amounts of electricity keeping their mining rigs going for less than half the profit they would have received at the beginning of the year. Interestingly, the biggest jump in mining difficulty to ever occur happened between the 3rd and 6th of June of this year, during a period when the price of BTC remained relatively flat. By design, difficulty and hash rate levels for the Bitcoin Network will never decrease, and in the future it will require even more energy to mine bitcoin that it currently does, unless such advancements are made in mining hardware technology that allow circuits to process more hashes per second while simultaneously using less energy.
Estimated number of terawatts consumed by the Bitcoin Network per year. Source: bitcoinenergyconsumption.com
For now, however, the Bitcoin Network is on track to consume the world’s entire energy supply before the end of the next decade, unless mining efficiency can be drastically improved before then. Although bitcoin mining remains a profitable undertaking in most countries around the world, this may no longer be the case if the price of BTC drops below $5,000 per coin or the cost of mining electricity significantly increases. At this point, mining will be limited to places with cheap electricity, making it more prone to centralization and the possibility of a dreaded 51% attack.
V. Declining Number of Full Nodes
“In a few decades when the reward gets too small, the transaction fee will become the main compensation for (miner) nodes. I’m sure that in 20 years there will either be very large transaction volume or no volume.” – Satoshi Nakamoto
When’s the last time you met somebody who actually ran a full bitcoin node on their own computer, aka somebody who had downloaded the complete blockchain and kept their Bitcoin Core client up and running for multiple hours a day? Shorting of owning a paper wallet (containing the address and private key of a bitcoin wallet) which must eventually be imported to what will likely be a 3rd party-controlled wallet in order to spend it contents, you will likely never possess absolute control over your own bitcoins. Running your own full node is the only way to achieve this, which requires not only a strong, fast internet connection but also having close to 170 GB of free hard drive space (maybe more depending on when you are reading this) in order to maintain your own copy of the blockchain.
Bitcoin Core setup screen — the heart of every node.
Sustaining a robust number of nodes is a key component to bitcoin’s decentralization. As more and more people rely upon 3rd party services (like Coinbase, Exodus and Trezor) to maintain a copy of the blockchain in order to access the contents of their wallet, bitcoin becomes more of a centralized entity, moving further away from Satoshi Nakamoto’s vision of acting as a decentralized currency. Trusted 3rd party services usually never pose a problem that would part a user from their private keys, but just imagine if one day Coinbase was to be hacked or go offline – how would its users access their bitcoin? In short, they wouldn’t. A large number of nodes is also what keeps the Bitcoin Network healthy. It allows for speedy communication in the network and prevents lengthy delays in transaction processing. If a country were to suddenly lose all its bitcoin nodes, it might take longer for a citizen within the country to process a transaction, dependent on where the next closest node was and the speed of the internet connection going to and from the user.
Total number of active bitcoin nodes over the last 2 years. Source: earn.com
Since early March of this year, the number of independently-operated full bitcoin nodes has been on the decline. Whether because of BTC’s slide in price, an increasing disinterest among node operators, or the increasing burden placed upon a node operator by the ever-growing size of bitcoin blockchain, the trend of decreasing nodes is a worldwide phenomenon and may eventually become a real problem for bitcoin. Indeed, the blockchain will likely reach an unwieldy 200 GB in size before the end of the year and will surpass 1 TB (terabyte) around the year 2034. No doubt the average hard drive will be able to accommodate a bitcoin blockchain by then, but the question remains, will people still want to?
Bitcoin node numbers by country over the last 2 years. Source: earn.com
There are currently less than 10,000 bitcoin nodes running at any given time, down significantly from its peak of 12,770 reached on November 7th, 2017. This means, on average, each node is responsible for processing close to $66,000 worth of BTC transactions per day, or almost $24 million worth of transactions per year, going by today’s price of BTC ($6,470) and current daily transaction estimates. That’s quite a bit of responsibility to put on an individual doing something out of their goodwill, and if its not for the sake of a 3rd party enterprise, for no profit to themselves. The growing size of the bitcoin blockchain and the shrinking number of full nodes do not add to bitcoin’s sustainability, decentralized nature or competitiveness with altcoins that can achieve the same outcome while demanding less from its users.
In summation, there’s a lot to keep in mind before going all-in on your next bitcoin investment. We’re not saying with certainty that bitcoin’s glory days are behind it, or that it can’t cross the $20,000 mark before the end of the year — what we are saying is that bitcoin isn’t a classical investment and doesn’t follow classical investment behavior.
First and foremost, bitcoin is a currency and should be treated as such. It’s not meant for investing, but rather as a means of digitally exchanging value. Second, it’s self-regulating: unlike gold or rice or oil, its innate properties are constantly changing by design of its software. Third, new contenders aiming to overthrow the reign of bitcoin are being introduced to crypto markets on a daily basis, and several of those have already begin chipping away at its dominance. Fourth, the amount of energy the Bitcoin Network needs to survive is overwhelming and simply unsustainable, especially if the price of BTC decreases or the price of electricity increases. Finally, running a full bitcoin node is becoming quite a chore and is falling out of favor with long-time network participants.
Keeping an eye on the progress of the figures discussed at length above will serve one well before plunking down a good portion of their hard-earned into their next bitcoin investment.