Author: Matthew Cochrane | May 16, 2018
Why the plunge could continue
Bitcoin's price volatility is a wonder to behold. Owners who got in on the world's first cryptocurrency craze as recently as a year ago have enjoyed wonderful success and are currently up about 577%, though late comers who bought in at the turn of the New Year are down almost 40%. Of course, in the interim, depending on the exact time and day you bought, you might be wildly up or down on your investment.
Opinions about the future of bitcoin vary almost as much as the price! Serial entrepreneur Mark Cuban has opined that bitcoin has value but the price (when it was around $3,000) might be in a bubble. Fellow billionaire entrepreneur Richard Branson is a strong believer in bitcoin and believes blockchain technology could bring about an economic revolution. Meanwhile, none other than illustrious investor Warren Buffett has warned investors to stay away, recently saying the cryptocurrency was "probably rat poison squared."
While I am not nearly qualified enough to make predictions about the future of bitcoin, I do see some red flags that suggest bitcoin's decline may not be over. In fact, I believe bitcoin prices could still drop by 50% or more over the next 12 months. Here are eight reasons why.
1. Bitcoin's slow network
Bitcoin's blockchain network is still painfully slow, especially when compared to some existing -- and widely used -- payment methods. At the end of 2017, the average time to confirm a bitcoin transaction was 78 minutes. It is estimated that the bitcoin network can only handle between 3.3 and 7.0 transactions per second. Other cryptocurrencies can facilitate multiple times that number of transactions per second. PayPal Holdings Inc. core platform can almost handle 200 transactions per second. Visa Inc. can process as many as 24,000 transactions per second. Bitcoin's road to be taken seriously as a currency is going to be awfully steep if its blockchain network cannot scale better and process transactions faster.
2. High transaction costs
There are lots of transaction fees to consider when using cryptocurrencies to make purchases including exchange, network, and wallet fees. While the fees change almost daily, the average transaction fee for bitcoin is still above $1, according to BitInfoCharts.com. For Ethereum, the fees are about $0.42; for Litecoin, the fees averaged a mere $0.17. Again, compare that to the average credit card where the no fees are directly passed on to the consumer. Besides having one of the slowest networks, bitcoin is also one of the most expensive means to facilitate a transaction.
3. Increased competition
Being slow and expensive has attracted a lot of competition and, now, bitcoin is far from the only cryptocurrency game in town. While it was the first, some say that gave it a first mover disadvantage. It still has the largest market cap (approximately $158 billion), but there are several others investors should know about:
Ethereum, with a market cap of about $67 billion, has garnered a lot of attraction from big businesses for its blockchain model.
Ripple XRP's market cap is over $33 billion and could be the world's answer to cross-border payments.
Many believe Litecoin could become "the go-to medium of exchange for digital currency users" as it is superior to bitcoin by nearly any metric, including transaction speed and cost. Litecoin is currently the sixth-largest cryptocurrency with a market cap of about $8.5 billion.
These are some of the largest but there are hundreds more. One attempt to count the number of cryptocurrencies on the market put the final tally at 1,658. Of course, by the time you read this, that number will almost assuredly be higher.
4. The innovation is the blockchain, not bitcoin
The innovation is the blockchain, not bitcoin
Another possibility is that blockchain technology lives up to all the hype and bitcoin and the other cryptocurrencies are simply deemed unnecessary. I don't think the likelihood of this scenario playing out is too far-fetched. Even bitcoin bulls seem more enamored with blockchain than any single cryptocurrency. Richard Branson, a bitcoin investor, said it was blockchain technology that could bring about an "economic revolution," not bitcoin.
It's not just individuals besotted by blockchain, but some of the world's largest and most innovative companies that are now experimenting with blockchain as well. Earlier this year, Alphabet Inc, the parent company of Google, introduced a blockchain service to support its cloud platform, much like International Business Machines Corp and Microsoft Corporation have been offering for some time.
Other companies are also utilizing blockchain technology in new and exciting ways. In late 2016, Broadridge Financial Solutions, Inc. acquired technological assets from Inveshare, Inc. that would enable it to use blockchain for proxy voting. Nasdaq, Inc. used blockchain to issue a private company's shares to an investor.
In this future scenario, the effective use of blockchain tech by different companies might commoditize cryptocurrencies, including bitcoin.
5. Wild volatility makes for a poor store of value
Some believe bitcoin won't be used for future transactions as much as for a virtual store of value, a digital gold if you will. PayPal co-founder Peter Thiel is one supporter of this theory, saying bitcoin could become an "online equivalent to gold." But, with major swings in prices, this seems improbable at best. Gold and other precious metals have been used as safe places to invest money for centuries and, while gold does fluctuate in price over long periods of time, it doesn't hold a candle to bitcoin's wild fluctuations. Nobody looking for a safe place for monetary value is looking to store it in an asset that they have no reasonable idea how it will be priced in a month's time, much less a year.
6. Increased regulations
New laws and regulations from sitting governments may yet pose the biggest threat to bitcoin prices. Six countries, including Bangladesh, Bolivia, Ecuador, Kyrgyzstan, Morocco, and Nepal, have banned bitcoin outright. Vietnam has banned transactions being facilitated in bitcoin. China has banned initial coin offerings and access to foreign cryptocurrency exchanges. South Korea outlawed anonymous accounts from trading cryptocurrencies and will be taxing cryptocurrencies 24% in 2018. All of these moves were accompanied by steep drops in cryptocurrency prices. Now just think how much prices would drop if the E.U. or U.S. stepped in with heavy-handed regulations.
7. Too expensive to mine
With bitcoin's meteoric rise in price over the past year, bitcoin mining became a profitable venture. But, with the price already dropping 40% year-to-date, it is not guaranteed to always be so. Based on the current cost of electricity, a bitcoin costs an average of $4,758 to mine in the United States and, in other countries, it can cost much more. If the price of bitcoin continues to drop, many miners could rightly conclude it is no longer profitable to continue the practice and cause further stress on an already slow system.
8. Not secure enough
If I lose my credit card, whether by theft or my own carelessness, I can call my bank and have a replacement sent instantly. By law, I am not held liable for any of the losses. True, ultimately all consumers pay the penalty for fraudulent losses through fees, but that seems like a small price to pay for security.
If I keep my money in the bank, it is insured by the FDIC. If I forget my bank account's password, I can call my bank and have it reset. With bitcoin, there are none of these protections and I am not sold on the proposition that the public will ever want that system over the one currently in place.
There are epic tales of woe and loss in bitcoin lore. From someone forgetting their password to a bitcoin wallet and almost losing a sum well into the five figures to the miserable soul who lost an estimated $100 million because he threw away the wrong computer server, there are many real-life examples of how one can instantly lose a bitcoin fortune. That doesn't even take into account the epic failure of Mt. Gox, which reportedly lost 7% of all bitcoin in circulation due to a potent mixture of incompetence and fraud.
Beware the risks
Again, I'm no soothsayer. I have no idea what the price of bitcoin will be in one week, one month, or one year. There just seems to be a host of risks associated with having this asset that would make me extremely uncomfortable owning it from this point on. Of course, these risks were all present a year ago and I would have said the same thing then.
In any case, it is important to understand the risks involved when making any investment. With bitcoin, there are definitely reasons to believe that the world's first cryptocurrency faces threats from its own asset class as well as external forces, such as public sentiment and government regulation that are aligned against it. Buyer beware!
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Matthew Cochrane owns shares of Alphabet (A shares) and Microsoft. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Visa. He has no position in any cryptocurrencies mentioned. The Motley Fool owns shares of Broadridge Financial Solutions. The Motley Fool is short shares of IBM. The Motley Fool recommends Nasdaq and has no position in any cryptocurrencies mentioned. The Motley Fool has a disclosure policy.