The Moment of Truth for Bitcoin and the Cryptocurrency Market

December 22, 2017 (seekingalpha.com)

Summary

• The chorus of voices labeling Bitcoin a huge speculative bubble is growing louder.

• 2017 was a pivotal year for the future of cryptocurrencies, but 2018 is likely to be more insightful regarding their ultimate fate.

• Bitcoin's meteoric rise has ushered in a new era and represents the birth of a new asset class. How digital currencies mature remains an open question.

One of the most notable developments in financial markets during 2017 was the phenomenal rally in cryptocurrencies and their ascent into a new, unique asset class. Throughout the year the mainstream view remained dismissive regarding the prospects of Bitcoin and its crypto-rivals. Yet, it is becoming increasingly clear that this phenomenon has deeper roots and, notwithstanding the vertiginous volatility, it is unlikely to fade away.

Very few could have foreseen the almost surreal pace of appreciation that took place in the past twelve months. In fact, the surging momentum of the Bitcoin rally was unlike anything we have seen in the past. This lack of historical precedent makes it exceptionally interesting, as well as challenging to investigate what triggered this phenomenon and which drivers continue to fuel it.

Admittedly, the substantial correction we saw the past week in cryptocurrency price movements renewed an element of uncertainty about the longer-term direction and, essentially, the fate of Bitcoin.

As a result, the chorus of voices predicting an imminent collapse in the crypto-market grew louder, to some extent silencing the optimists who expect further acceleration amid this meteoric rally. In light of the unprecedented nature of this phenomenon, widely divergent views about what lies ahead are to be expected. Nonetheless, the view that the digital currencies’ massive surge this year is nothing but a huge speculative price bubble, while logical, is inherently flawed.

A more sober examination of what we are actually witnessing is the volatile phase that typically precedes broader acceptance of a newly introduced asset class. If indeed Bitcoin becomes broadly accepted as an alternative global currency, its market capitalization is bound to grow further over the longer term. Until then and until the coexisting -- at the time of this writing -- irrational exuberance and the fatalistic predictions of Bitcoin’s premature demise subside, extraordinary volatility spikes will dominate price action in the cryptocurrency market.

Let us not forget the key developments that transpired in 2017, such as the introduction of Bitcoin futures by CME Group and Cboe Global Markets, which point to a wider recognition of the role that cryptocurrencies have the potential to play in financial markets. Meanwhile, emerging economies as well as a host of technologically advanced countries, including Japan and South Korea, are increasingly adopting a more open stance with regard to Bitcoin transactions. This is, in large part, why 2017 will go down in history as a pivotal year for digital currencies. At the same time, blockchain technology continues to evolve, and it is reasonable to expect that future iterations will address existing security vulnerabilities and facilitate a swifter adoption process, providing a more complete, credible and accessible alternative payment method.

The relentless rise of Bitcoin has also been underpinned by the high degree of difficulty that funds faced in shorting the digital currency. This is gradually changing with the inception of Bitcoin futures, but up until recently it served as a deterrent for speculators to aggressively initiate short positions. It is also especially challenging to identify reliable hedges with sufficient correlation to Bitcoin price movements. As a result, the cryptocurrency market has been relatively sheltered from external forces that tend to cause ripple effects in financial markets. This fostered conditions favorable for “long-only” speculative strategies, which, combined with the current low-volatility environment that encourages increased leverage and momentum trading, served as an excellent propellant for Bitcoin to skyrocket the way it did. In the short term, this tailwind is about to gradually run its course, and that will likely translate into a trend reversal, potentially quite sharp.

The moment of truth for Bitcoin and the cryptocurrency market will arrive after the critical correction that will inevitably ensue. At that point, it will be easier to assess whether digital currencies possess the necessary resilience to survive a concerted onslaught of external market pressures. The reaction of short-term momentum traders -- who ostensibly dominate the digital currency market-- in the face of a technical reversal remains a crucial unknown factor.

It is important not to lose sight of the fact that cryptocurrencies are built on a technological foundation that grants them a unique and lasting advantage over traditional currencies. This is why the probability of an eventual widespread cryptocurrency adoption as an integral part of the financial system is significantly higher than currently anticipated. It is, however, far too early to predict which cryptocurrencies will actually survive the ongoing tectonic shifts that are likely to redefine the future monetary landscape. In that regard, 2018 will be quite interesting, eventful and, hopefully, insightful.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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