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"Given that we know more about bitcoin, the size of the market, the futures contracts, that could lead to a moderation in bitcoin’s volatility.”

Is Bitcoin More Resilient than Altcoins?

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"Given that we know more about bitcoin, the size of the market, the futures contracts, that could lead to a moderation in bitcoin’s volatility.”

A rising tide lifts all boats, they say. And that seems to be the mantra for bitcoin, with the price of the original and most valuable cryptocurrency tending to move in tandem with the broader market for “altcoins”, such as Ripple, Litecoin and Ethereum.

In December last year, the bitcoin price rocketed to $19,000 while the total market capitalization of cryptocurrencies had climbed beyond $800bn by January 2018, up from just $18bn a year earlier, according to CoinMarketCap, a data provider. But the crypto bubble has largely burst, with bitcoin bumping along at a $6,000-$8,000 range since June and the crypto market losing three-quarters of its value to stand at $200bn.

Bitcoin USD price - All times (source: wikimedia/Ster3oPro)
Bitcoin USD price – All times (source: wikimedia/Ster3oPro)

Crypto Bubble

The falling market value of the burgeoning digital currencies came alongside increased volatility in mainstream financial markets, such as stocks. But the crypto crash was painful, leaving investors who bet on the volatile assets nursing heavy losses.

“The crypto coins and tokens generally are correlated with one another, and investors tend to enter and exit the entire asset class together,” says David Yermack, finance chair at NYU’s Stern School of Business.

And yet in recent weeks divergence in the price of crypto has emerged. Bitcoin has rallied, at least in the short-term, to about $6,700 — up by some 17% on three months ago. Analysts caution against drawing conclusions from the short-term price of volatile coins, but it is true that bitcoin has been more stable than its rival cryptos.

Ethereum has tanked by 48% to $233 over the three months. An announcement by its founder Vitalik Buterin of plans for a blockchain consensus algorithm, adding safety guarantees for investors who have been unnerved by hacking, was unable to prop up its faltering price. In January, Ethereum traded at over $1,300.

Litecoin, meanwhile, has lost 39% of its value over the past three months to trade at $49. Ripple had been on a downward spiral, too, until a recent rally to $53 on the back of news that a long-anticipated cross-border transaction service for banks was imminent.

Such events highlight the volatile and speculative nature of trading cryptos, according to Campbell Harvey, an investment strategy advisor at Man Group, an active asset management firm.

“These cryptocurrencies, in general you can’t fundamentally value them,” he says. “It’s difficult to come up with a valuation, given the lack of fundamentals to put into a valuation model. It attributes to the uncertainty around these [cryptos] and the volatility.”

Bitcoin Bubbles historic data (source: wikimedia/Kurzycz)
Bitcoin Bubbles historic data (source: wikimedia/Kurzycz)

Bitcoin’s Resilience

But bitcoin has held its value much better than rivals in recent months. Most advocates are optimistic on the price, with bitcoin bull Tom Lee, co-founder of Fundstrat Global Advisors, a Wall Street research firm, resolutely sticking to his forecast of a $20,000 pricing by year-end.

Why could bitcoin be more resilient relative to other cryptos? One potential reason could be the geopolitical environment. Turkey’s economic, political and civil turmoil seems likely to have spurred a recent influx of investor dollars into cryptocurrencies, analysts say. Turkish exchanges Btcturk, Koinim and Paribu report a recent spike in bitcoin trading volumes, with the former seeing a 100% rise in bitcoin/lira volumes.

Turkish investors could be turning to the historically volatile bitcoin, remarkably, for stability. The 10-day swings in the lira relative to the US dollar now exceed those for bitcoin, according to Bloomberg data. The Turkish lira has lost 40% of its value against the US dollar since the start of the year amid the economic crisis engulfing the country.

Other factors have contributed to the divergence in crypto prices. NYU’s Yermack says there may be a perception among investors that bitcoin is “safer” simply due to the size of its market capitalization, but he adds that “there is no question that even bitcoin is very risky”.

 

Nevertheless, bitcoin’s dominance rate, or the measure of its total crypto market share, in August breached the psychological 50% market for the first time since last year’s bull run. This suggests that bitcoin is more in demand than rival altcoins and could indicate the start of a new tear, as bitcoin is a common route for fiat money to enter the crypto market.

More than 170 “cryptofunds” have been established, which invest in the digital assets and startups making products or services with them, according to research firm Autonomous Next.

Bitcoin: Trusted by Conservative Investors?

Also, investors who are skittish about newer cryptos could be expected to transfer their funds from altcoins to bitcoins amid the bear market. “In a sense, bitcoin is an alternative to mainstream currencies and it’s often even considered as part of an alternative economy and has more trust by more conservative investors,” says Jens Martin, assistant finance professor at the University of Amsterdam

He adds: “In addition, there are many stakeholders who invested a significant amount in its environment, such as miners, developers, which help to keep it stable.”

And bitcoin dominates trading volume and is the only digital coin tradable in the futures markets. The CBOE and CME exchanges launched bitcoin futures in around December last year, opening up bitcoin to more institutional investors and increasing trading volume and liquidity.

The derivatives could also pave the way for the first bitcoin exchange-traded fund (ETF), further lending bitcoin legitimacy as an asset class. Man Group’s Harvey says: “Bitcoin is the bellwether, the barometer [of the cryptocurrency market].

“And it has the longest track record, with the original publication in 2008, ten years ago. Given that we know more about bitcoin, the size of the market, the futures contracts, that could lead to a moderation in bitcoin’s volatility.”

A Bitcoin ETF?

An ETF is viewed as a vital step towards bringing bitcoin into mainstream finance and becoming trusted by institutional investors. Many have been wary of the risk and volatility of the entire crypto asset class, says Amsterdam’s Martin: “And by now the [crypto] market cap is quite significant, so you need large players involved,” he says.

But investors have been left disappointed by a succession of rejections and postponements of bitcoin ETFs by the Securities and Exchange Commission (SEC), the US watchdog, including the rejection of a fund mooted by Cameron and Tyler Winklevoss, the first “bitcoin billionaires”.

The SEC will rule on more ETFs later this year. But it is understood to be hesitant due to investor risk. This month it temporarily suspended trading of two Stockholm-listed crypto ETF products that had begun trading in the US, over the counter.

Policymakers are among the biggest risks to all crypto prices, as they are highly correlated to regulatory action, according to research by the Bank for International Settlements.

The report says markets do not generally react to news about central banks creating their own digital currencies. But they get jittery on regulatory announcements on the legal status of cryptos and initial coin offerings (ICOs), in which a company crowdfunds finance in exchange for giving investors digital tokens.

“We find whenever there is a regulatory event about constraining the market, you see a big negative price impact,” says Emmanuel De George, assistant professor of accounting at London Business School. “The market clearly, in terms of real preference, is saying it doesn’t really want to be regulated.”

Regulatory Scrutiny

A bitcoin ATM. (source: reuters/arnd wiegmann)
A bitcoin ATM. (source: reuters/arnd wiegmann)

The market cap of altcoins has been affected by ICOs much more so than bitcoin, however. About $13bn was raised through ICOs between April 2014 and May 2018, across over 50 countries and by over 650 issuers, according to research by London Business School and other academics.

ICOs have soared in popularity among startups as a means to raise capital, with typically over 100 new ICOs a month. But fears have been growing that the freewheeling market is vulnerable to trader manipulation, while potential money-laundering and tax avoidance are also concerning. Some ICOs experience falls in value of 75% or more within a few months of the issue date.

The bigger worry for investors are ICO scams, in which fake firms raise money and issue worthless tokens before disappearing. “There are hundreds of cryptocurrencies invented out of thin air,” says Sviatoslav Rosov, director of EMEA capital markets policy at the CFA Institute, an association of investment professionals. “And all have the usual caveats: volatility, lack of liquidity, and outright fraud.”

He says that investors should “beware” because the cryptocurrency market offers them little, if any, protection. As such, it is drawing the ire of policymakers. The UK has called for the “Wild West” crypto markets to be regulated, while China, which banned ICOs, warned of criminals attracting retail investors into Ponzi schemes using buzzwords such as “virtual money”.

Yet it is difficult to regulate a market that exists, largely, on decentralized platforms and whose owners tend to covet their anonymity. “Regulators are trying to fit these [crypto] products into the existing systems of regulation or expand the existing system to cover them, but at the same time the people making products are designing them to avoid this,” says Rosov. “It’s a game of cat and mouse.”

Regulation is at odds with the defining principles of cryptocurrencies: that they are fast, frictionless and free from government control, he says. “If you have to start asking people for lots of ID and utility bills to get an account at Coinbase, and report to HMRC when you make any profit, it just looks like the existing financial system.”

But Rosov does agree that increased regulatory scrutiny would potentially draw more institutional investors into the crypto market, which could in theory increase prices. “Not everyone wants to avoid regulation,” he says. “Some people want regulators to come in and create a stable marketplace that rich people trust.”

Future-Gazing

Cryptocurrency mining machine
Cryptocurrency mining machine

There are some factors that could reverse the trend of bitcoin highs and altcoin lows. Martin says that at bitcoin’s zenith, the price of owning and trading the asset was too high for people to use bitcoin as anything other than an investment. The total value of all transaction fees paid to bitcoin miners reached $22.7m in December 2017, up from just $580,000 in October.

“People were forced to use other cryptos as trading [bitcoin] became very expensive,” he says. A similar upward swing in the bitcoin price could see money pour instead into altcoins.

Some analysts also see Ethereum as having a stronger application than bitcoin — one reason why investors think it could increase in value. Ethereum provides a decentralized processing platform, or blockchain, essentially a ledger stored across thousands of computers which makes it harder to tamper with than traditional methods of storing information.

Through Ethereum other services can be built, from payments to games. The Ethereum Enterprise Alliance is already testing enterprise uses for the blockchain, and it’s members include oil giant BP and investment bank JPMorgan.

Martin adds: “Ethereum has a very strong value proposition, because it offers better means to incorporate tokenization for third parties. Hence many new ICOs used it as the basic blockchain. However, we see the ICOs currently in a bear market, hurting as well Ethereum. But if that changes, Ethereum could very well become more popular.”

The biggest test for crypto prices will come from an economic correction, analysts believe. The situation in Turkey lends credence to the theory that cryptos could be akin to haven assets during a fiat currency crisis. But the CFA Institute’s Rosov says that although bitcoin has more of a track record than altcoins, none have been tested during a global economic downturn.

“If that happens in the wider economy it’s not clear how these assets and their exchanges will function,” he says. As ever when trading volatile and speculate assets, nothing is guaranteed.

Note: The opinions expressed in this article are the author's own and do not necessarily reflect the view of Alvexo on the matter.