Prior to the financial crisis in 2008, cryptographic money was only used by Cypher Punks, the original gangsters or “OGs”. I’ll skip that rabbit hole and focus on where I think we are today and the worst-case and best-case scenarios I foresee. But first, some observations of the current cryptocurrency and financial markets.
The Recent Bull Cycle in Crypto
In 2021, more crypto wallets were created than in any previous year of Bitcoin’s then 12-year existence. Coincidentally, the most recent all-time high of $68,000 was also reached. The “Moon-Boys” were shouting $100K Christmas! Some have defined this type of market as “reflexive”, which basically means people prefer to buy when the “number go up” and forecasts can seem within reach. Unfortunately, reflexive markets result in volatility to the downside when “number going down”.
This fact alone could be used to define crypto as speculative mania. However, this would be disregarding the current state of the global financial systems. After all, some attribute the inflated prices of stocks and crypto to the weakening US dollar.
The Current State of the US Financial System
My previous article highlighted the latest inflation numbers reported by the Bureau of Labor Statistics as well as the returns of several major legacy financial instruments and the importance of protecting purchasing power against a weakening currency. Link:
To recap the CPI report, inflation rose by 7% annually on average. The latest unemployment rate as of January is 4%, down from a peak 2020-level of 15%. The Fed has indicated their money printer has stopped going Brrrrrrrrr!
Blockchain; The technology behind Bitcoin
The best description I have heard for Bitcoin is “It’s everything you don’t understand about money combined with everything you don’t understand about computers.” The key technological breakthroughs that Bitcoin represents is 1) the elimination of “double-spending”, 2) having its ledger of transactions supported by decentralized computers and 3) a mining difficulty rate that auto-adjusts as mining power increases or decreases.
Double-spending is simply stated as the rejection of new coins being spent that are not legitimate. You cannot sell your Bitcoin more than once. The ledger of all Bitcoin transactions is recorded by blocks that are mined by entities that earn Bitcoin in return. Each block references the block before it, resulting in a chain of blocks called the blockchain. In the 13 years of Bitcoin’s existence, there has never been a report of a double-spend.
Bitcoin is decentralized, which simply means there are no brick-and-mortar facilities that control the Bitcoin network. Instead, it is supported by mining rigs across the globe and on separate power grids. The benefit of this design is no centralized authority can halt its operation.
Miners record all transactions and generate an encrypted hash. Bitcoin’s consensus algorithm, which is encoded in the Bitcoin code, verifies the hashed result does not exceed a certain value (i.e., contains a certain number of leading zeroes). Other miners review the block and confirm their agreement to add the new block to the blockchain. The lucky miner that solved the block first receives the block reward in new Bitcoin and the process starts anew.
When mining power increases or decreases, the number of leading zeroes is adjusted accordingly. The more zeroes required, the higher the computing power or hash rate is needed to solve the algorithm. In 2021, China banned Bitcoin mining, resulting in a significant number of miners to shutdown their operations and move abroad. This resulted in a sudden decrease in hash rate which subsequently led to a decrease in the difficulty rate. For those miners that were able to operate uninterrupted, they witnessed an increase in their percentage of hash rate without having to add mining rigs, resulting in increased gross revenue.
Worse-case Scenarios for Bitcoin
Bitcoin and cryptocurrency are “risk-on” assets. If there is an increased flight to safety, they will suffer along with stocks and gold. We saw this play out in March 2020 during the start of Covid cases in the US. I have no crystal ball as to which event will trigger the next flight to safety but do expect Bitcoin to behave the same way when the trigger is pulled.
Bitcoin is software code and has been susceptible to bugs in the past. The first major bug was reported in 2010 when someone created 184 billion Bitcoin through a vulnerability in the software. Source: https://news.bitcoin.com/an-in-depth-look-at-bitcoins-first-chain-split-satoshi-helps-reverse-the-creation-of-184-billion-btc/
Bitcoin does not have a bug bounty program like other blockchains. As a result, there might still be vulnerabilities in the code that have yet to be discovered. Any attempts to add features to the Bitcoin code could also introduce vulnerabilities. (Are you sure we want NFTs on the Bitcoin blockchain?)
Bitcoin ownership is centralized. Despite efforts to ensure decentralization of the network; ownership is very top-heavy. As of this writing, 94% of the total available Bitcoin was held in 2% of wallet addresses. Each wallet owner likely has their own target exit price or event. SOURCE: https://bitinfocharts.com/top-100-richest-bitcoin-addresses.html
Best-case Scenarios for Bitcoin
- The next richest person on the planet buys Bitcoin and tweets about it. We already have Elon on-board! Now we just need to get the rest of the richest to “buy our bags”.
- The Fed reverses course and resumes money printing.
- A Bitcoin ETF is finally approved in the US.
- El Salvador successfully becomes the first Bitcoin nation and removes all dependence from the IMF. Other countries follow suit.
- Sovereign Central Bank Digital Currencies (CBDCs) become mainstream and allow the masses to adopt crypto technology. (Followed by their discovery of controls put on the use of CBDCs and their transition to Bitcoin et al.)
- The NFT mania dies down, releasing funds tied up in NFTs to go to Bitcoin.
- A bug bounty program is funded and announced. (Low hanging fruit in my opinion)
Author: Stephen Stubblefield, Sanctuary DEX Technical Advisor