This Time Bitcoin’s Price Increase is Both Logical and Sustainable

As somebody with a trading background, the market dynamics of bitcoin are a constant fascination. It is still a young currency and the market has therefore spent the last few years searching for a true value, or rather a price that reflects that value.  Unlike with, say, the Euro when it was launched, it is a currency whose issuance and supply is modeled on commodities rather than conventional currencies. The limited supply and increasing difficulty of mining should, depending on adoption rates, result in a fairly predictable upward path over time. That price instability should, therefore, in theory not last too long.

That, of course has been a long way from the actuality. Initially bitcoin saw wild swings in price, rocketing from under $100 to well over $1000 in around 4 months before more than halving in two weeks. There is still uncertainty as to what caused that “bubblette” and it is likely that we will never truly know. It has always looked to me like a “Bunker Hunt” kind of move. At that level of issuance and price, and given the profits on the way up, it would have only taken a relatively small (in Wall Street or hedge fund terms) position to push the thing skywards. The resultant collapse certainly looked like one big long trying to exit.

Whatever the reason, though, once the retracement was over, at around $200 in January of last year, things have been relatively stable. For most of 2015, bitcoin stayed in a roughly $200-$300 range against the U.S. dollar which, while massive in currency terms, was actually a vast improvement.  BTC/USD busted out of that range at the end of the year, however, and is now up around $450. That raises the question, are we in for another bout of hypervolatility?

The answer, at least in my opinion which is based on around 30 years of direct experience in traded financial markets, is no, and for one basic reason. Whereas 2013’s spike was a mystery in many ways, this run up is happening for a recognizable, indeed even predictable reason. It is a reason that is receiving a lot of blame at the moment, for falls in both global stock markets and commodities: China.

For those that are unfamiliar with or new to bitcoin it is worth pointing out at this point that the majority of bitcoin trading has originated in China ever since the government there realized the futility of attempting to effectively ban a peer to peer currency, which is somewhat akin to trying to ban the internet. There is nothing new to China dominating exchange volume, but, according to bitcoincharts.com, the percentage of trades against the Chinese Yuan (CNY) has been creeping up recently, and stands at 81% for the last 30 days.

When something is traded primarily against one currency it moves broadly in a direction opposite to that currency. All else being equal gold, for example, trades lower as the dollar strengthens. In this case as the Chinese government allows the previously pegged Yuan to weaken, so it results in relative bitcoin strength. That is no doubt exaggerated by the fact that Chinese investors, unaccustomed to seeing real swings in the value of their currency, are exchanging whatever they can for something that can’t be devalued by a government.

The fact that this run up is logical, therefore, enables the market to perform one of its primary functions and act as a forward discounting mechanism. Some degree of future appreciation is built into the current price, which adds at least some degree of stability. In addition, the attention that bitcoin now has from Wall Street and other trading desks combined with the ability to short the currency allows the market to check any spike upwards naturally by simply attracting sellers.

In short, then, this is an appreciation in bitcoin that is perfectly logical and is based on fundamental factors. That makes it far more likely that it will proceed in an orderly fashion and extremely unlikely that it will be followed by a sudden collapse. Supporters of the digital currency should hope that that is the case from here on out, as a more predictable, less volatile price is essential if the number of merchants accepting bitcoin is to once again begin to increase, and that is what will drive sustained growth in price.

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