Since the beginning of 2017, cryptocurrencies have been the number one topic of conversation. Breaching 1,000$ in January 2017 and constantly testing new highs, Bitcoin has caught everyone’s attention, making its way to mainstream media such as CNBC and CNN.
Being the new kids on the block, cryptocurrencies are disrupting industries, reshaping business plans, challenging the definition of long-term investment, attracting non-accredited investors and promising to solve problems quickly and effectively.
The promise of astonishing returns, well over what the stock market can offer over a short period of time, has attracted a lot of new investors. The crypto-currency market is no longer dominated by techies, as it’s seeing a growing number of less tech savvy individuals. These new investors come into the market with little or no understanding of the technology, no trading background and expect high returns. They have been given this idea that investing in cryptocurrencies will make them rich quick. They don’t perform adequate due diligence and invest blindly. This creates volatility and irrational behavior in the markets. Investors expose themselves to more risk without considering its suitability.
Traditional valuation is already a challenging task on its own, but valuating cryptocurrencies makes it even more difficult by being riskier, less liquid and less covered.
Traditional valuation tools, such as Discounted Cash Flow models, don’t apply because most of those crypto companies are not into operation, lack the existence of a product and are solely based on a whitepaper and pretty marketing. Even bitcoin, the most mature cryptocurrency, is not used as a currency. No one pays their house, car or college tuition with Bitcoins. Cryptocurrencies are used as a speculative asset, traded in the hope to make a profit — it is not used for its initial utility as described on its whitepaper . Thus, the traditional fundamental analysis cannot be used. Technical analysis can also be ineffective due to the low market cap of those cryptocurrencies. Large institutional investors can have a large impact, not explained by technical analysis.
The valuation of cryptocurrency is mostly based on two factors, it’s utility value and speculative value. The former, is the solution/improvement the coin/token aims to provide to a problem or situation, meaning it real use as a currency. The latter is the perceived return the investor hopes to make when buying and selling the coin/token.
The speculative value is generally created by those less tech-savvy investors investing in an irrational manner with poor due diligence. Those are also the one “panic selling” increasing the volatility of the market.
A potential cycle for cryptocurrency:
Intuitively, since cryptocurrencies are in their early stage and not operational, their utility value can be very low, and their price is usually driven by their speculative value. In turn, it is usually driven by the hype around them. This might be the result of a successful marketing campaign, advertisement from a known influencer or from a very ambitious project that gets everyone’s attention. During an extraordinary bull market like 2017, enthusiasm is high, everyone wants to get a piece of the cake, creating this phenomenon known as “FOMO” (Fear of Missing Out). This makes people invest solely on the basis of fear of missing out on extraordinary returns. This is problematic because investors end up investing in the best marketing campaigns and not necessarily in the best cryptocurrencies. Some ICO’s have been able to raise tens of millions of dollars that way, without having a good product backing it up.
When expectations are high, so are the prices. However, as time goes by, crypto-companies have to deliver on their roadmap but often get delayed due to normal business activity and difficulty to build distributed systems. Yet, these normal delays appear to be bad news and drive the price down. Moreover, these “bad” news lead less savvy investors to sell, driving the price further down. This makes the speculative value of the coin/token go down without having its utility value change. The speculation can drive the price lower than its utility value selling it at a discounted price.
As time goes by, the cryptocurrencies that are selling at a discount and have a real use see their price rise again from demand for their utility purpose. This creates a new bull market as people start buying the currency for its utility value, demand picks up, it gets speculators attention who in turn buy the currency and drive the price up. This later leads to more exposure attracting the less sophisticated investors and creating a new bull cycle.
An important aspect to notice is that the more the utility value of the coin/token increases, the more it is stable. This would suggest that the cryptocurrency market will be less volatile with time. We haven’t reached that point yet and might need to wait a couple of years.
a. 2013–2014
The first big crash of Bitcoin occurred in April 2013 with a price drop of 70%, going from $230 to $70 overnight, and took 7 months to recover. This was due to mainstream media covering the topic for the first time and creating euphoria that faded as quick as it started. At that time, the utility value of bitcoin was lower than today’s value meaning the price was mainly driven by speculators. The price of bitcoin bounced back to $1,150 in November of that same year due to new investors coming in and a positive stance from regulators. Two weeks later it tumbled down again, this time more than 50% to $500. It bounced around going back up to $870 before dropping to $440 mainly because of the famous trading platform Mt. Gox being hacked. All this volatility created doubt and fear amongst investors and putting bitcoin on a downward trend from 2013 to 2016. Just between November 2013 and February 2014 Bitcoin lost more than 62% of its value.
b. 2017
2017 as a whole is a bull year for cryptocurrencies but it did have its ups and downs. Such as the 36% fall from almost $3,000 in June to $1,870 in mid-July, due to the dividing thoughts around bitcoin, its usefulness compared to other cryptocurrencies and a possible hard fork . We also have the September crash from $5,000 bitcoin back down to $3,000 mainly due to China cracking down ICOs and rumors of banning trading crypto-currency.
The last few crashes have been characterized by internal issues leading to large scale panic, concerns about bitcoin’s legitimacy, regulatory crackdowns questioning the future of cryptocurrencies, and a series of negative events creating a behavior of panic selling.
c. Crash of 2018
The crash of early 2018 is from multiple events that have been popping up and created FUD — fear, uncertainty and doubt — in the market. Negatives news have been coming from everywhere in the world in a coordinated manner that dragged the price of bitcoin from almost $20,000 in December 2017 to $6,250 in February 2018. The market cap of cryptocurrencies went from $828 billions to below $300 billions.
Multiple regulatory interventions participated to this FUD. The SEC took a closer look at ICOs and the roles companies and advisors played in raising funds. China attempted to block access to overseas trading options, threatening to freeze assets. People in China found a way to counter the earlier attempts of the Chinese government to prevent them from trading cryptocurrencies by trading overseas especially in Hong Kong and Singapore. South Korea, who welcomed cryptocurrencies with open arms also announced that they were in talks of potential regulations.
On the other hand, regulatory events have not been the only thing driving the cryptocurrency market down. News like Mt.Gox selling $405 million worth of bitcoins between January and February, CoinCheck the Japanese trading platform, being victim of a massive virtual currency heist ($530 million) and Binance, one of the most well-known exchange, having some users accounts being hacked all added to the market turmoil.
In that effect, such a high number of negative news after the bitcoin ATH in December, which happened during the initiation of the bitcoin futures market, lead some people to think that the market is highly manipulated. However, this cannot be ascertained for sure.
At the very least, those past three months have shaken several features of the cryptocurrency market. The speculative value of those cryptocurrencies has been going down considerably. Establishing a floor at $6,550 for bitcoin. Is this the floor corresponding to the utility value of bitcoin? It cannot be known. However, one thing is for sure, the utility value of bitcoin has increased since 2013, thus the real value of bitcoin is worth more today than it was in 2013. The floor of bitcoin’s utility value might have been $70 in April 2013 and might be $6,550 today. While not a guarantee, this might hold true in the future — having the utility of bitcoin and other cryptocurrencies higher in the future than they are today. As time goes by, the technology underneath these coins/tokens will grow, be used and thus lead to an increase in the utility value and price. 2018 is the year of delivery, more and more crypto company are holding up on their roadmap and launching their platform or product.
Moreover, the number of countries competing to position themselves as being blockchain friendly is exploding. They know they can win big by allowing blockchain and cryptocurrencies to grow unimpeded. Plus, some of the biggest company in the world have already partnered with many crypto projects: Goldman Sachs have recently funded the purchase of Poloniex, a well-known cryptocurrency exchange, by Circle; Barclays have recently partnered with Coinbase to enable its institutional clients to have an exposure to cryptocurrencies; bitcoin is accepted by PayPal, Overstock, Expedia and many others, Arizona states accepts bitcoin as a mean of tax payment. Those news, among many others, clearly demonstrate that massive attention and investment are directed to the cryptocurrency market. This is for a reason.
Having said that, I am confident in saying that the cryptocurrency market will recover. That those coins/tokens with real use cases, good teams and coding will recover and go to new all-time highs. In the meantime, many others will certainly go to zero. All of those crashes are healthy for this market, as they help for price discovery (floors), drive speculators out (short term), and push those crypto-company to deliver on their promises.
