Last weekend, the world’s most popular digital currency broke through $US58,000 for the first time, meaning it had doubled in value since the start of this year. The surge came days after Nouriel Roubini, a leading economist, had suggested that there was a “massive amount” of price manipulation in the market, with “a bunch of insiders and whales controlling the entire system”; and after JP Morgan, the American investment bank, had put out a weighty report suggesting that the true value of bitcoin was probably closer to $US25,000.
Source: James Dean, The Times
Reasons behind bitcoin’s extraordinary rise
Such a price would still be quite an achievement for a digital coin that was almost worthless when it was launched in 2009. At one point yesterday, it dropped by $US10,000 in a short time before paring losses to trade 4.9 per cent lower at dollars $US54,938.88.
Despite being in circulation for nearly 12 years, investors continue to puzzle over the driving forces behind the remarkable rise of the bitcoin price. There are several popular theories.
Pump-and-dump schemes involve rapidly buying a particular asset with the intention of inflating the price before cashing out as close to the peak as possible. There are hundreds of bitcoin pump-and-dump groups on Telegram and other encrypted, anonymised chatrooms that keep schemers out of reach of the authorities.
Big Pump Signal and its spin-offs are among the largest, with about 200,000 subscribers each. It has simple instructions for would-be pumpers and dumpers. They are given a time and date for when the pump will take place and on which digital currency exchange. At the last minute, they are told which digital coin to buy and then to spread news of the pump on social media. On Sunday a message posted on the group said that its next pump “will be the biggest pump we have ever done”.
There is a theory that bitcoin “whales” are behind many of the pump-and-dump schemes. The 100 largest bitcoin accounts hold about 16 per cent of all bitcoins in circulation and the 2,500 largest hold close to 60 per cent. Some are controlled by digital currency exchanges, but the majority have unknown owners. Many are thought to be owned by the same individuals behind the pump-and-dump schemes.
A large number of the whale accounts are dormant, meaning that a substantial amount of bitcoin is parked outside the reach of the market. This reduces liquidity and amplifies price movements.
By far the largest source of liquidity is not the US dollar but tether, a so-called stable coin pegged one-to-one to the value of the greenback. Tether Limited, the creator of tether, claims publicly that it backs every tether coin with the equivalent amount of cash dollars or other reserve assets.
Tether effectively allows traders to buy and sell bitcoin faster on digital currency exchanges, especially where their home currency is not US dollars. Several exchanges without direct access to the US banking system, including Binance, Asia’s largest, accept tether and other stable coins only as a means by which to buy and sell bitcoin.
Three years ago, tether accounted for less than 1 per cent of bitcoin trading. Today it is behind 50 per cent to 60 per cent of bitcoin trades, according to research by NYDIG, a financial technology company. Others suggest that the figure is closer to 70 per cent.
Tether has been credited with improving liquidity in the bitcoin market and steadily boosting the bitcoin price as more and more tether is created. However, rumours have long circulated that at least some tether is being created out of nothing to artificially inflate the bitcoin price. A class action against Tether Limited claims that the company has issued “extraordinary amounts of unbacked tether to manipulate cryptocurrency prices”, creating the “largest bubble in human history”.
Tether Limited “vigorously disputes” the allegations, saying that tether is “fully backed by reserves” and that its digital coins are not used “for the purpose of controlling the pricing of crypto assets”. Still, American finance and justice authorities been investigating tether since it began to take off in early 2018. And Tether Limited has yet to publish an independent audit.
A theory that began to take hold last year is that bitcoin is more akin to gold than currency. That is, it is more effective as a store of wealth and a hedge against inflation than as a means of transacting. The theory spread while central banks were printing trillions of dollars and pumping them into the global economy to ease the damage being done by the pandemic, devaluing traditional currencies.
Unlike traditional money, there is a finite supply of bitcoin: only 21 million bitcoins can be created and about 18.6 million are already in circulation. Proponents of bitcoin believe that this “digital scarcity” gives it the edge over traditional currency as an inflation hedge.
The theory has gained traction to the point that sizeable companies have swapped cash for bitcoin. Microstrategy, an American software group, started converting cash to bitcoin last August and continues to do so. Tesla, the world’s largest carmaker by value, made waves last month when it said it had parked dollars 1.5 billion of its cash in bitcoin. Predictions quickly followed that other big companies would follow suit.
Elon Musk, Tesla’s chief executive, describes bitcoin as a “less dumb” version of cash. “Money is just data that allows us to avoid the inconvenience of barter,” he said at the weekend. However, he also suggested that the prices of bitcoin and other digital currencies “seem high”. Financiers believe bitcoin needs to become less volatile to challenge gold as a safe-haven asset. Such an event appears to be some way off: yesterday (Monday) bitcoin slumped as low as dollars 47,400, 18 per cent off its weekend high, before recovering.
There remains a broad-based hardcore of bitcoin fans that care less about the price of the digital coin than they do about the reason it was created: as a decentralised currency out of reach of real-world central banks and financial institutions. They want the project to succeed, for bitcoin to become an alternative to money, and they will “hodl” — bitcoin slang for “hold” — no matter how high or low the price goes.
Individuals such as these provide the bedrock to the wider chaos in the market, effectively giving a floor to the price and thereby encouraging speculation. It is perhaps the reason why bitcoin keeps bouncing back whenever it is written off.