Writing anything against the price rise in bitcoin is like keeping your head in a guillotine and expecting it to be unhurt. However, at times, one’s got to do what one’s got to do. So, at the risk of ruffling a few feathers among the bitcoin enthusiasts and staunch supporters, I will put forth my two cents on why the latest rally in bitcoin is looking bubbly. Only time will tell whether my argument proves to be correct or falls flat on its face, similar to the ones proclaimed by the legendary investors.
- Bitcoin’s rally is looking like a bubble
- Futures trading will pit the bulls and the short sellers against one another
- Introduction of Nikkei futures trading turned out to be bearish for the Japanese stock market
- Sell 50% bitcoin holdings at the current levels and stay in cash
We had recently warned that bitcoin is topping out in the short-term. While bitcoin fell after our article, the dip was more of a buying opportunity rather than the indication of a top that we were referring to. Whoa, there goes my forecasting capability out of the window.
However, does the rise above $16000 and a market capitalization of above $300 billion make us change our view? Not really. I now believe that we are about to make an intermediate top.
The common gripe among the cryptocurrency enthusiasts is that being a new asset class, bitcoin is not understood by many traditional investors (include me also in this list) who keep questioning its incessant rally. On the other hand, the traditional investors point that the price has gone well ahead of its fundamentals.
There is going to be a big clash between these two school of thoughts with the launch of bitcoin futures.
What can happen after the launch of bitcoin futures trading?
I will try to explain how things will play out according to my opinion.
The launch of bitcoin futures trading will provide an opportunity to the institutional investors to diversify their investments into a new asset class. Nevertheless, it is difficult to fathom how many will buy, especially when the cryptocurrency has risen more than 16 times this year.
Until now, most of the money used to be on the long side of the trade. Some of the sharp falls were a result of profit booking or due to investors not stepping in to buy at lower levels due to the negative news flow. There was never an overhang of short sellers on bitcoin prices, which is going to change from December 10 and December 18.
So, with every part of the rally, there will be an equally bearish short seller who will see an opportunity to benefit from the fall in bitcoin prices. Money will be made both on the way up and the way down.
Will the short sellers jump into the fray at once?
Difficult to say, but my anticipation is that the short sellers are unlikely to jump in to sell bitcoin futures aggressively, especially since bitcoin is backed by a strong upward momentum. Large short sellers are likely to dip their feet with small short positions and watch.
As now we have traders willing to take both sides of the trade, we expect the pace of the ascent to slow down and short positions to start accumulating on every rise. Volatility is also likely to increase in the short-term.
Introduction of futures trading is not always bullish
Though we don’t have an apples to apples comparison for cryptocurrencies, we can look at how the Japanese stock markets were affected by the introduction of Nikkei futures trading in Osaka Securities Exchange.
The Japanese stock market was riding high on the back of a bubble in asset prices, which also boosted the prices of Nikkei stock exchange. The index rose 10 times from 1975 to 1990.
Nikkei futures trading started in Osaka Securities Exchange in 1988 and the Nikkei stock average peaked in end-1989. The descent was equally sharp as the ascent.
Some may point that the crash in Nikkei happened only two years after the futures trading started. However, one must keep in mind that it took 15 years for the Nikkei to rise 10 times while bitcoin has risen 16 times this year itself. Therefore, the fall is also going to be equally vicious.
Signs of excesses in bitcoin
- Almost every cryptocurrency trader(other than hacked.com subscribers) believes that this time it is different and one can make tons of money within a short span of trading in cryptocurrencies. After all, the Winklevoss twins have become billionaires by starting with just $11 million four years back. There is a firm belief that bitcoin is the future, hence, every fall will only rally higher than the previous one. See, all the analysts’ targets.
- Analysts are beating one another in announcing targets on bitcoin. I believe the maximum is $1 million by 2020, by John McAfee. Let’s see if there is any analyst brave enough to top this one, especially in the medium-term time frame of 2-3 years.
- A vertical rally. 16 times increase in value within a year is evidence enough that the rally is overheated. Expecting the same pace of rally in the future is like asking Usain Bolt to complete the marathon with the same speed that he runs the 100 metres race.
- The institutional investors will be eager to jump in to buy bitcoins and once those billions start pouring in, there is no end to the rally. This is not true because the large institutional investors are hugely risk averse. Their money is made in compounding about 15%-25% consistently over the years. It is unlikely that most will enter the fray until bitcoin’s volatility reduces considerably.
- Consider the world’s population of 6 billion and the fact that there will only be 21 million bitcoins mined. Additionally, out of that, millions are either lost or are locked away with only a few millions in circulation. So, the price rise is justified. Well, if Leonardo da Vinci had a few hundred thousand paintings in the market place, his paintings wouldn’t have fetched millions. So, this argument of only 21 million bitcoins that will ever be mined doesn’t hold ground.
OK, so if bitcoin is in a bubble, what should one do with it?
For people who don’t own bitcoin currently, please stay away from it, until you see a large correction.
For the others who own bitcoins, 50% of the positions should be closed right away, above $16,000 levels before the futures trading starts. The other 50% of the position should be held. This can be sold when bearish patterns develop on bitcoin because no one can point the top in a bubble.
Likely scenarios to play out if bitcoin falls
There are two possible scenarios that I believe can happen.
- Bitcoin falls and drags the sentiment down for the whole cryptocurrency universe. It doesn’t take a long time for the sentiment to get sour. In such a case, people who have been hoping that altcoins will rally when bitcoin falls will be in for a rude shock.
- The second scenario is that the current investors in bitcoin will face a stiff resistance from the short sellers. When the existing whales are unable to influence bitcoin prices like before, they are likely to jump to the altcoins because they don’t have to counter short sellers there. In this case, the altcoins recover sharply.
The best way is to cash your bitcoins into dollars and sit out. Once the dust settles down, there will be many opportunities to earn money because cryptocurrencies, as an asset class is here to stay.
Featured image courtesy of Shutterstock.