Here’s One Way the Bitcoin Bubble Doesn’t Burst

Lets Face It, This is A Bitcoin Litecoin Ethereum Bubble

Coinbase is the #1 App on the Apple App Store and your Barber/Grocery Clerk/Grandmother are all buying in. Prices have surged unbelievable amounts in the past few days (let alone year). My hunch is that most people buying in now are trying to get rich and are not trying to escape the grasp of the evil Wall Street empire.

Keep in mind, just because there is a price bubble doesn’t mean the technology isn’t awesome. The prices of Bitcoin or Litecoin could go down 90% and the tech would be just as mind blowing.

Its also possible I’m wrong and that prices just keep going up. Many point to this chart showing internet adoption:

Bubbles that did not pop

The key to all these tech was ADOPTION – people used them. This chart is also talking about ADOPTION and not PRICE. These are two different things, but brings me to a point:

People drawn in by trying to get rich might just stick around and ADOPT crypto tech.

Clearly millions of people are flooding into the crypto space, and if they don’t SELL but start to transact with each other using Bitcoin or Litecoin – then prices might not come back down.

Bitcoin Needs A Killer App

Just as email is what made people use the internet Bitcoin doesn’t have that killer app. Its hard to buy and sell crypto – its confusing. Coinbase has done just an OK job of being a Bitcoin gateway for people and they are crushing it. But still – sending payments from Coinbase to another person isn’t obvious. Thats not what Coinbase was designed for (it was designed to overcharge you for crypto purchases).

Enter: Square.

Maybe this is the App that turns Bitcoin into “Venmo” and drives adoption. Square’s founder and CEO is Jack Dorsey the CEO of Twitter. I couldnt find anything about the number of Square Cash users, but here is some insight on the app network.

Square Bitcoin App

The reviews claim that buying Bitcoin on the app is very easy and intuitive. People also trust Square.

All these people speculating on Bitcoin price could suddenly find themselves transacting quickly and easily using Bitcoin. They could adopt it. That might keep prices up, or even be a catalyst for higher prices.

In the end we’re in the first or second inning of all this tech. Prices will do what they will but its clear that crypto is here to stay.

Why Bother with Litecoin?

Bitcoin’s recent price rise to all time highs has been quite amazing. Not so much that it hit $6k but that it happened in mere weeks. Ethereum has been doing, well, nothing. My unqualified opinon is that the ICO market is capping ETH prices(read here). But whats Litecoins excuse?

The chart below shows just how much Bitcoin has risen since April of 2017. The little triangle shows when ICO madness started kicking in which I think keeps ETH prices down. Litecoin over this period has done absolutely nothing.

Top Cypto Coin Chart
Comparison of BTC ETH LTC

Yes its true that many people will sell the “alts” (litecoin, ethereum, dash et all) to buy Bitcoin during strong moves. But has Bitcoin exerts in dominance just what is the purpose of a “Bitcoin Lite”? This isn’t a knock on Charlie Lee the (creator of Litecoin) I just think originally he wanted to be the #1 crypto and he lost that game. Litecoin is often branded as “Silver to Bitcoin’s Gold”.  Other coins like Dash say “this is why we’re better than Bitcoin“. Other coins like ZCash offer true anonymity.

Yes people wax poetically that Litecoin could be used for transactions in small denominations because Bitcoins transaction fees are higher – but I don’t think there is a big market for actual “spending” in Bitcoin. i.e. how many nerds are out there buying coffee with Bitcoin? I’d guess very few as everyone seems to assume Bitcoin is going to $10,000 plus in price.

In this moment there is no need for a “Silver to Bitcoins gold”. Litecoins network seems healthy if you check the stats. I’m not here to say Litecoin dies tomorrow. But I think if you’re speculating that its price will play “catch up” to Bitcoin you’ll have to wait a very long time (think mass crypto adoption). (Unless Bitcoin blows itself up with a forking or some other such catastrophic incident, of course).

 

How to Hedge SegWit – The Bitcoin Fork

August 1st is when the fun begins in Bitcoin. “BIP148” (aka “User Activated Soft Fork” dubbed UASF) is activated and the world finds out whether Bitcoin stays together or splits in two. If this is unfamiliar to you, then read here, or here or just give “SegWit” a googling. Avoid trying to research this on twitter, because you will find little outside of ad-hominem attacks between groups who cant agree on the best way to scale bitcoin. While I only have a peripheral understanding of the arguments what I do understand is that there is a real possibility of any of the following:

  1. The majority gets together and Bitcoin moves forward intact
  2. Bitcoin splits in two
  3. Bitcoin splits in two…hundred.

Why is there so much Bitcoin infighting?

I think it boils down to how much money is involved now. Bitcoin mining generates roughly $4million/day (1,700 bitcoins mined per day * $2,500/bitcoin). Thats big money. Money is a leading cause of divorce, and it appears thats whats ahead for Bitcoin.

How Does a Fork Impact Bitcoins Price?

At a minimum we will see Bitcoin transactions slow a great deal starting on August 1st. The Bitcoin community has argued about this for months, and it seems that even if Bitcoin does not fork there is a significant number of people who won’t go quietly into the night. If you hold Bitcoin today and there is a fork, you’ll likely end up with two new “types” of Bitcoin in your wallet (this happens automatically).

Ethereum went through a fork not too long ago, and it was pretty seamless. If you had Ethereum in your wallet, the next day you woke up to both the “new” ethereum and the “old” ethereum in your wallet.

Certainly Bitcoin splitting would hurt the price, at least initially.  Regardless of outcome party lines are so split that it’s hard to envision smooth sailing over the next few months. Who knows which version of Bitcoin to bet on? The general public is just warming up to Bitcoin and crypto – and know there will be several versions? Picture logging into your Coinbase account, ready to buy bitcoin for the first time. Surprise! There are now two versions. Which do you chose?

To me, this paints an ugly short term picture. I think this could hurt or at least keep a lid on Bitcoin prices for the short term.

How to you Hedge the Bitcoin Fork?

  1. Keep holding you Bitcoin and come back in 6 months. Its quite possible the fork produces two (or more!) versions of Bitcoin which both attract investment and you will have equally or more crypto value in a few months. Or, one of the two versions rockets ahead in price. No one knows whats on the other side of this forking.
  2. Move to cash. Bitcoins had a nice run…let the dust settle then figure out where to allocate your funds. (Side note, I’ve heard Tether can help here but have not investigated).
  3. Other Crypto: More below:

There are some very viable alternatives to Bitcoin, that are more or less copies of Bitcoins code. Many don’t realize that you can simply copy bitcoins current code, paste it into a distinct infrastructure and, voila, you have your own cryptocurrency. While this is indeed a massive oversimplification, the point is while two groups are hell bent on controlling the future of bitcoin, others are taking what they love about Bitcoin, making a few tweaks, and providing a cohesive alternative. Cohesive meaning the people with skin in the game aren’t at each others throats.

I chose the two below because they already have a fairly substantial market cap and existing mining hardware for bitcoin could flip to mine these other currencies. Bitcoin mining hardware isn’t “fungible” to all cryptocurrencies. Bitcoin mining hardware cant mine Ethereum for example.

This detail about mining is important. If you run a large mining operation you can’t simple close up shop because you think Bitcoins future is destroyed. There are bills to pay. You can however move to an alternative currency and I suspect most of these guys have fork contingency plans in place. Note that you could write dissertations on each currency. So, do some homework before investing.

My best bets to pickup Bitcoin market share?

  • Dash – Has a voting system in place (which resolves issues like forking quickly) and a unique structure to help fund future development.
  • Litecoin – Widely available its probably more accessible to new investors (at the time of this writing). Coinbase for example has Litecoin, but not dash. Litecoin’s sales pitch is essentially that its network is lighter and faster that Bitcoin.

It’s very hard to say what the best play is – what makes this so murky is the political split between Bitcoin factions. To me this is what makes investing in other currencies such an attractive idea.

After the Bitcoin Fork

Six months from now the dust should be settling and the crypto landscape will definitely look different. Its hard to remember that just a few years ago none of this existed and now its a multi billion dollar industry. Remember, regardless of what happens with the Bitcoin fork there are incredible developments ahead. 10 years from know this will all be just a blip on the radar – maybe that means there is no wrong way to play it.

 

Coinbase: Convienience for a Cost

Coinbase Can be Costly

The alternative title for this post was set to be “Coinbase: Spread ’em!”, but its probably best to tone it down.

Whats Coinbase?

For those in the US, Coinbase is arguably the most convenient and mainstream way to purchase Bitcoin, Ethereum and Litecoin. They link to your bank account and will allow you to buy and sell crypto with the click of a button. They offer relative security in that they have “grade A” investors like the New York Stock Exchange. (This would be in comparison to some non US exchanges owned by…???) I personally use Coinbase and have recommended them to friends.

Coinbase Exchange
Coinbase Exchange Logo

Coinbase is superficially a retail application that routes orders to their exchange, GDAX which offers more advanced functionality.

According to CoinMarketCap, GDAX is the 7th largest crypto exchange by volume.

With the recent price explosion in crypto, CoinBase has had many issues with downtime. Often when markets were at the jumpiest users would see the following screen:

Coinbase Exchange Down
Coinbase Error

This is obviously quite unsettling if you need to sell. Coinbase claims to have been getting slammed with new users claiming to have added 40,000 users in one particular day in May. I think they can be a bit forgiven for underestimating just how fast things would escalate going into June.

Uptime aside, I think its important for users to really understand the price they are paying for this convenience and security.

How [I Speculate] Coinbase Works

Coinbase does not give users the ability to place limit orders – for that you have to use GDAX. Coinbase gives you a live price at which you can buy or sell the crypto of your choice. That price comes from GDAX, and that is where they “source liquidity” (i.e. actually buy or sell). When you buy they then pull money from your bank account or credit card. This opens Coinbase up to two principal points of risk

  1. Price Risk – Coinbase guarantees you a price for a few seconds, during which the actual price could move. Coinbase still has to grant you the quoted price, even though the price may have changed between when they quote you and when you click “Buy”.
  2. “Funding” Risk – Your crypto is not available under Coinbase has received the funds from your bank. However you could probably find ways to cancel the funds transfer and stick Coinbase with the crypto you bought. This leaves them with unwanted inventory and the associated risk. Coinbase caps how much you can buy or sell, and you need special permission for higher levels to greatly mitigate this risk.
Coinbase Order Screen
Coinbase Order Screen

This risk is baked into the price when you receive a quote and pay their fee. It appears in two places:

  1. Transparent Fees: 1.49%-3.99% in the US
  2. Crypto Pricing (Not Very Transparent): They “spread” you, meaning they increase the price over (buying) or under (if selling) where the actual market is trading. For example, the actual mid point price for Bitcoin might be $2,000, but Coinbase will sell you Bitcoin for $2,010. Note that if you use GDAX you can place limit orders and have better control of your price.

I surmise that when markets get really crazy, spreads widen out. Meaning the price Coinbase is quoting you will be father away from where actual market is trading. This is what happens in stock and options trading: market makers widen their bid/ask quotes to reduce their risk.

Here is a real time example using Coinbase on iOS:

Buy 1 Bitcoin:

Coinbase Offer Price: 2284.65

Coinbase Fees: $34.04

Total: $2,318.91

Simultaneous market on GDAX:

GDAX: Bid $2,268 x Ask $2,273

Therefore Coinbase is going to sell me 1 Bitcoin at $2,318.91, then simultaneously buy on GDAX for a worst case $2,273. They clear $45 from the trade or about 2%. For the security and convenience of using Coinbase, I’d argue thats not a terrible price.

Its possible that they also have a matching engine which would pair or match my buy order off against another Coinbase user that is selling. This means that they could fill both of our orders “mid market” (halfway between the GDAX bid/ask) which would be a price of $2,270. That adds a few more dollars of profit for them.

Not a bad business.

The Flash Crash

Last week Ethereum [ETH] prices “Flash Crashed” on the GDAX/Coinbase exchange. Price went from ~$320 to $0.10 and then back to the $300’s in seconds. Heaps of money were made and lost, and Coinbase is sorting it out trying to make it right. Clearly, this was not a good thing. Yet, even “mature” exchange (like the NYSE) can flash crash and have outages. The important thing is that Coinbase is trying to make it right and that in the end will build trust. How did it happen? From Coinbase:

On 21 June 2017 at 12:30pm PT, a multimillion dollar market sell was placed on the GDAX ETH-USD order book. This resulted in orders being filled from $317.81 to $224.48, translating into a book slippage of 29.4%. This slippage started a cascade of approximately 800 stop loss orders and margin funding liquidations, causing ETH to temporarily trade as low as $0.10.

Our initial investigations show no indication of wrongdoing or account takeovers. We understand this event can be frustrating for our customers. Our matching engine operated as intended throughout this event and trading with advanced features like margin always carries inherent risk.

We are continuing to conduct a thorough investigation and will keep customers updated with any resulting actions. With that in mind, it is important to note that these trades are final in accordance with our GDAX Trading Rules (Section 3.1). Honoring properly executed orders is critical to maintaining the integrity of an exchange.

In response to the large price movement we decided to temporarily halt trading of ETH-USD. Once we confirmed all systems were operating correctly, we restored trading in accordance with our Downtime Process(Section 5).

Because there really isn’t a linkage between global crypto exchanges I think the fallout was pretty minimal. Had other exchanges traded more in lockstep with GDAX we may have seen sustained issues from this event.

Conclusion

For US investors and those abroad with access to Coinbase I think they are best of pure from a purely “retail” or buy and hold (HODL) perspective. For active traders or those a bit more technologically inclined GDAX is a better alternative. Gemini is another US exchange which merits mentioning here as a US based competitor to GDAX. These platforms offer better security and a more regulated environment than not US competitors and while that may come at a slight cost, its valuable insurance.