Forget Superman, there's a new hero in town. For the retail investor, cryptocurrencies proved to be out of this world in 2017, with numerous virtual coins delivering four-, five-, and in some rarer instances six-digit percentage gains during the year. Though arguable, it could be the single-greatest year we've ever witnessed for any asset class throughout history.
Just how good were cryptocurrencies? At the end of 2016, the combined market cap of every single virtual coin combined equaled just $17.7 billion. However, by late December, the aggregate value of all cryptocurrencies combined had risen to as high as $654 billion. That's an increase in value of almost 3,600% in one year. Comparatively, the stock market has delivered historic returns of about 7% per year, inclusive of dividend reinvestment and adjusted for inflation.
Bitcoin carries cryptocurrencies to a record year
Even though bitcoin technically underperformed its peers in 2017 on a percentage basis, it's still credited with having put the crypto craze on its back for years. Remember, this is a virtual coin that, when first traded at the start of this decade, could have been picked up from $0.003 per coin. Nowadays, bitcoin is vacillating between $13,000 and $17,000 per coin.
Investors in bitcoin continue to be fascinated by its potential to be a payment facilitator, as well as its application of blockchain technology. Bitcoin currently has more merchants willing to accept its coin as legal tender than any other cryptocurrency. It's also a regulated form of tender in Japan as of mid-2017.
For those unfamiliar with blockchain technology, think of it as the infrastructure that underlies most cryptocurrencies. It's the digital and decentralized ledger that's responsible for recording all transactions without the need for a third-party intermediary, which is often a bank. Bitcoin's blockchain set in motion the rush by hundreds of other cryptocurrencies to evolve new and unique blockchains to market to enterprise clients and retail consumers who crave decentralization, privacy, and efficiency. Blockchain has the potential to improve security, reduce transaction fees, and expedite settlement times, especially for cross-border transactions.
News flash: Bitcoin plunges are really common
However, bitcoin comes with more than just euphoria. It also comes with a ton of volatility. Retail investors are what predominantly drive its price, since institutional investors haven't been willing to trade on decentralized cryptocurrency exchanges. And it's no secret that retail investors tend to wear their emotions on their sleeves, leading to quick swings higher and lower in bitcoin.
According to data aggregated by Mauldin Economics from Coindesk, bitcoin has plunged by a minimum of 22% from peak to trough 20 times since April 2013.
As a reminder, Bitcoin crashes at least once per quarter pic.twitter.com/nUJpeS7lcT-- zerohedge (@zerohedge) Dec. 22, 2017
As you can see in the tweet above, bitcoin tends to collapse about once a quarter, although there's no specific rhyme or reason to the timing of the pullbacks. You'll also note that Mauldin has listed 18 of these pullbacks, with two additional pullbacks of 26% and nearly 50% occurring in December 2017 on a peak-to-trough basis not being depicted in the chart above.
Quite a few of these pullbacks were severe. In fact, 13 of 20 saw bitcoin lose at least a third of its value, with seven topping 44% in lost value. Yes, bitcoin has come out smelling like a rose after each and every decline thus far, just as the stock market has over the long run, but that's not to say that the resolve of bitcoin investors, and their medicine cabinets full of antacids, aren't constantly being put to the test.
Here's what could cause bitcoin to plunge by 22% or more in 2018
In 2018, there are no shortage of catalysts that could cause yet another crash in the price of bitcoin.
For starters, bitcoin is going to be facing what I'd refer to as a "fairer" market this year. Prior to the kickoff of bitcoin futures trading with CBOE Global Markets on Dec. 10, bitcoins could simply be bought or sold. There was no good way for skeptics to make money off of a move lower in bitcoin, which certainly incentivized buying. With multiple platforms offering, or set to offer, bitcoin futures trading, and a number of platforms filing for bitcoin ETFs, skeptics will have a much easier means of exerting their influence this year.
Government regulations could play a key role in bitcoin's 2018 performance. Even though it benefited from being accepted as legal currency in Japan and gained legitimacy via futures trading in the U.S., bitcoin was also banned in Morocco last year, joining around a half-dozen countries that have outlawed it and other cryptocurrencies. This year, it's possible that Russia joins the list of countries that have closed the door on cryptos like bitcoin.
Another issue is intense competition in the crypto space. Bitcoin currently sits at the head of the table in terms of merchant acceptance and market cap, but its slow processing times and high transactions costs could easily lead to it being supplanted as the leading cryptocurrency. There are virtually no barriers to entry in the space, and blockchain evolutions could very easily make bitcoin yesterday's news.
Finally, short-term emotions are a rollercoaster ride that can turn on a dime. As long as retail investors remain the primary force behind bitcoin, it runs the risk of multiple wild swings higher and lower. After all, retail investors have a long history of overestimating the uptake of new technology and eventually being disappointed.
If you plan to hang onto bitcoin or buy into bitcoin in 2018, make sure to stock up on antacids.