Why is bitcoin falling?

This post was inspired by my good friend Saeid (pictured right) who often asks me “Why did the price fall?”

When there are more sellers than buyers, the price decreases. When there are more buyers than sellers, the price increases. Equilibrium is where both buyers and sellers are happy with the price and go on about their day. This doesn’t exist, except at 0 and even then there would likely be bagholders unhappy that no one wants to buy the asset from them. That’s all to say that the market determines the price.

When the price falls suddenly, everyone wants to know why. No one really knows exactly why, but it’s generally because the price has reached a point where market participants need or want to sell. We can speculate on several reasons why they would be content selling. It’s fun and might provide insight for you, but at the end of the day, we will never know the exact reason.

TLDR: My opinion on the price fall is: a normal and healthy correction in price after a significant run. Possible selling pressure due to Tether news (which is actually good news) combined with leverage traders being liquidated triggering a chain sell off. The price will possibly move down further — there’s strong price support at $41,000 USD (that doesn’t mean it’ll go there or bounce from there, just an indicator). If you’re a long term holder or recently bought, I wouldn’t recommend selling. My prediction is bitcoin will hit $150,000 CAD before it goes anywhere near $20,000 again and will happen within the next 12 months.

To make this exercise into price movement easier to understand, I like to look at the bitcoin market using 3 general market participants. Investors, Traders, and Speculators. They may all be distinct, but I assume there’s a lot of overlap. Investors understand Bitcoin and its purpose or usefulness. They’re buying bitcoin to use it or hold it for the medium to long term.

Traders may or may not understand Bitcoin, but they understand markets and how to read charts. Typically they will use TA (technical analysis to determine when to buy and when to sell.) They don’t necessarily care about Bitcoin, but about managing risk and making profit.

Arguably almost all Bitcoiners are actually speculators; usually in the sense that they are speculating that bitcoin will continue to outperform every other asset class because of central banks’ reliance on printing money to solve problems. I’m referring more to FOMO (fear of missing out) Speculators. These people don’t understand Bitcoin, but see it rising in price and want a piece of the action.

Each of these generalized market participants will hopefully help make the following a little more clear.

Profit Taking

Taking profit is a very natural, prudent action to take, especially after such a significant rally in price. Traders will sell some bitcoin to lock-in gains converting those unrealized profits into realized profits. Some of the price fall has to do with traders selling bitcoin to take profit.

Working Capital

Many Bitcoin businesses need to sell bitcoin to pay their bills. Bitcoin miners are the largest category needing to sell the bitcoin they mine to pay for equipment and energy costs.

Re-balancing

Other businesses that accept or deal with bitcoin may have to sell bitcoin as part of certain asset ratio requirements. This is often called re-balancing. These can be public companies, exchange-traded funds, exchange, etc. If their required ratio is 80% cash and 20% bitcoin and bitcoin increases significantly in price, they will have to sell some to re-balance to that ratio.

Weak Hands

Weak hands is a fun trading meme. In my case, it refers to speculators who sell (their hands) after a small dip in price because they can’t emotionally handle holding the unrealized loss. Therefore, locking in that loss. Retail investors have arrived already to this 2020/21 bull run and with them are always lots of FOMO speculators. When anything goes south, weak hands are the first to sell and many did in the past 24 hours.

One must have Diamond Hands in times of great volatility.

News Headlines

In the Bitcoin space we’ve had a love/hate relationship with headlines. In the past, it was euphoric for Bitcoin to be mentioned, but now, with few exceptions, it’s just misinformed and grossly poor journalism. The Tether situation is the most recent and ongoing issue with bitcoin and a very serious one too.

Tether is a stable coin resembling the US Dollar, it’s a digital token that is completely centralized but it allows traders to buy, sell, trade, or move money around quickly within the entire cryptocurrency network. There are many stable coins and they’re called stable coins because they’re meant to be pegged 1–1 with the US Dollar. In Tether’s case, there’s been on going speculation that not only is Tether not backed 1–1 by US Dollars, but that Tether has artificially inflated the entire bitcoin market cap as a result.

Today, that turned out to be false. The New York Attorney General settled it’s case with Bitfinex, iFinex, and Tether (all the same company, effectively.) The headline, however, was “Bitcoin tumbles as Tether accused of billion-dollar fraud.” Tether was accused of billion-dollar fraud, among other things, but that was in April of 2019.

This news seems to have negatively impacted the price even though it’s actually bullish news. One of the most serious and imminent issues facing bitcoin was effectively put to rest.

Government Bans — Regulator Comments

It’s almost every other week that some government is banning bitcoin or bitcoin mining. It used to have an impact, but lately bitcoin doesn’t budge. I lost count how many times China banned bitcoin — I honestly thought a country could only ban it once. Now news of India looking to ban the cryptocurrency and issue its own is coming out. Governments banning bitcoin and cryptocurrencies is one thing, but issuing their own?

The only thing a government-backed digital stable coin will be good for is more efficient issuing of more currency. I suppose that’s good for stimulus cheques and UBI.

Regulators also issue statements about bitcoin and cryptocurrencies from time to time. Most recently Jallet Yellen, the current US Treasury Secretary, made nasty statements about bitcoin. It’s not surprising though, she used to head the Central Bank, the literal antithetical entity to bitcoin. I won’t argue with her comments here, I may have an article for a series of rebuttals to bitcoin critiques in the future.

These statements affect how traders, speculators, and corporations view bitcoin.

Liquidity Volatility

Due to the finite supply of bitcoin, as it becomes more useful or popular, there will inevitably be a supply crises. There will only ever be 21 million bitcoins and there are 18,597,787 currently in circulation (at the time of writing this.) What’s more, is there’s ~1,500,000 bitcoins that haven’t moved in 10 years. And it’s estimated that closer to 3.7m bitcoin are lost forever. Lost bitcoin can’t be recovered — a blessing and a curse.

Long-holders holders store their bitcoin away in cold storage. Now with banks and funds buying bitcoin to facilitate institutional-size trades and corporations like Tesla, Square, Motley Fool, and Micro Strategy adding it to the balance sheet, even more bitcoin is being locked up. This leads to liquidity issues; there just isn’t much bitcoin available in constant circulation. In fact, in late 2020 it was estimated only 4.2m bitcoins were in constant circulation.

While this is generally bullish for bitcoin, it makes for more drastic price movements (volatility), typically up, but as we’re seeing right now, down.

Leverage

Leverage trading has become very popular, especially amongst new, inexperienced traders and speculators. This has been seen all over from traditional finance to cryptocurrency trading. This is not to hate on young Gen Z traders at all, but from literally the time they quit soccer practice and sucking on oranges during half-time, they’ve only ever seen the stock market go up. “Number go up” is also a funny meme, but it’s so popular because it’s literally true for so many.

This had led to over confidence in trading ability and aggressive trading tactics like using leverage. Using leverage is just like it sounds, you’re using a tool to maximize efficiency. In this case, the tool is cash and the efficiency is returns.

Leverage Table (Margin Requirement Missing)

Any broker or exchange offers leveraged trading by providing you with the additional funds to trade. Just as there’s massive upside, the same is true for the downside. In order to trade with leverage you need fulfill a margin requirement, a certain % of the trade value in your account. This protects the broker if the trade goes poorly. If, for example, the asset you’re trading with leverage goes down too much, you will get a margin call, meaning you need to top off the margin requirement otherwise you’ll be liquidated.

Typically margin trading requires some certification, knowledge test, or an interview where you provide your experience, net worth, and salary. In cryptocurrency trading, this isn’t usually required. As long as you have funds, you’re good to go. Most traditional finance brokers allow for or advise 2–10x leverage, with exceptions. Cryptocurrency exchanges offer up to 100x trading leverage.

As I’m sure you can see, this perfect storm of confidence, “market only go up”, leverage capabilities, and stimulus cheques, can lead to liquidation events. In fact, that’s just what happened with $5.6 billion in liquidations in the past 24 hours.

Liquidation Chart — Data source: http://bybt.com

There are several other reasons for price falls, but my overarching point is that many things contribute to them. We’re still within a healthy bull market. These cycles have quite noticeable trends, albeit with not as many historical reference points as other assets. I expect the bitcoin price to hit $150,000 CAD this year. The meme of bitcoin being a digital gold has merit and it’s playing out as such. It’s not unreasonable for anyone to have a small amount as part of their portfolio.

There is nothing fundamentally wrong with Bitcoin that caused this correction. It’s just the nature of the beast. Bitcoin started as a idea for a more fair, ideal money. It still has a long way to go, but it’s well on its way. Volatility is a part of that journey. If you can’t stomach the lows, do you deserve the highs?