Today was a great day to make our first post. It would seem a good place to start for anyone interest in Bitcoin is to know the answer to the question Is it risky? Bitcoin has dropped today under $11,000. Cryptocurrency Is Risky.
Compare Cryptocurrency To US Dollars
The reason there are risks is because it is backed by basically nothing. You might respond that the US dollar is no longer backed by gold and that is true. Keep in mind that the US dollar is backed by America. 321 million Americans back the dollar. Then you have a billions of others who want to do business with America adding support to the sovereignty of the US dollar. More than the people you have the US economy which is the strongest in the world. You have hundreds of global conglomerates that are based out of the US doing business all over the world. U.S. GDP was estimated to be $19.3 trillion in 2017. More important to the value of the GDP is the strength of the economy and all the little businesses that support the US economy and all the business done around the world by these US businesses. Keep in mind that biggest fortune 500 businesses only create 30% of the US work force. These are the factors that make the US dollar the most stable currency in the world backed by the longest running democracy.
Cryptocurrency backed by virtual strangers
Keep in mind who buys and supports virtual currency. Virtual computers all over the world linked together run and operated by phantom people you don’t know. Not everyone behind the currency is on the dark web but be honest with yourself and think about who is running the mining operations that keep currencies running. You don’t really know for sure but your best guess is the 500 pound hacker living in his mama’s basement. Most of the time it’s not the pimple face brilliant high IQ kid. Those kids are going to ivy league schools and launching startups.
Who buys virtual currency?
People who can’t put their money in real green backs. Drug dealers and thieves that can’t put money in banks without triggering government notification alarms. Now think about for a minute how the mafia was put out of business in the US. The government went after the accountants and money. It will only be a matter of time before governments start to regulate in some fashion. There are already restrictions around the world. All it would take is governments preventing transfer of virtual profits into banks causing virtual currency to become less liquid.
What prevents the bitcoin price from dropping?
You should understand what determines the value of bitcoin. It’s simple economics. The more people buying and holding bitcoin cause demand and the value to rise. When people sell the price drops. To maintain a constant valuation more people need to buy then sell. When there is a large amount of sales the price drops. As the price drops more people sell. The more people who sell and don’t hold, the faster the price falls. There is no floor to how low it can go and no ceiling on how high it can go.
During the Great Depression that basically tanked the US economy there was a run on banks. This means that everyone tried to pull their money out of their saving accounts because banks ran out of money and closed down keeping customer deposits in the process. The US government had to step in and create protections so banks couldn’t run out of money again. Think about how a bank operates. The take deposits from savers and then lend out that money to someone else at a higher interest rate. Sure banks charge fees to make a profit but a majority of their profits come from taking deposits and lending it to someone else at a higher interest rate. When the borrowers fail to pay back those loans and fire bankruptcy that money is gone. Banks need to make sure they loan money to entities that will reliably make good on the agreement.
The mortgage crisis of the last decade was caused by bad loans but more importantly the companies that insured those loans had balance sheets that went upside down. Banks made increasingly risky loans because they had the ability to insure those loans. The problem was that the insurance companies couldn’t make good on all the contracts they had made. The crisis was addressed by putting increased restrictions on banks but also those insurance packages. When you buy a home and get a mortgage there is something called PMI. This is a fee the bank charges the borrower if there is not enough collateral in the property. These are mechanisms to lower risk and ensure that the person making the loan gets paid. As you can see in the mortgage example the money is not backed by nothing but a physical property. The property is owned by someone who probably has a job. If the owner loses their job they don’t suddenly stop paying the mortgage in most cases they get a new job and continue making good on the contract.
Factors that affect Bitcoin valuation.
1) News of government regulation is one of the biggest risk factors.
If you live in a country that might start preventing you from transferring real money to your bank account from your virtual wallet, this causes the virtual currency to be less liquid. If the value keeps going up a lot of bitcoin owners won’t care much because they can continue to hold. The problem comes when the price drops and people want to convert it to cash. They have to transfer it to a middle man who take additional fees to turn the virtual coins into liquid cash. Or they have to open a bank account in another country that allows it and then transfer it to their bank at home. Again this causes the owners to incur additional fees creating less value in the virtual currency.
2) Virtual wallets and exchanges halt trading.
Just like a run on a bank or a stock exchange making a bid drop virtual exchanges can halt trading. If there are crazy fluctuations in price the exchanges are going to shut down until they understand what is going on or normalcy returns. Coin base is the largest virtual wallet and they halted trading on Thursday Dec 21, 2017. (article) Earlier in the week they added a new coin and the price spiked and was out of sync with the other exchanges.
3) Futures Trading
Wall Street has got in on the action. There are now contracts to buy coins being traded on wall street. These futures contracts speculate on future values and give owners of the futures contract the right to buy at a future date. Futures are traded like stocks and when the value drops 20% all trading is halted. Owners of bitcoin can buy these future contracts to protect and insure their investments so there is a ripple effect when futures trading is stopped on the value of the underlying asset. Just like the mortgage insurance when home prices dropped during the financial crisis.
4) Broken Computers
Part of the sovereignty of bitcoin’s value is the ability of miners and back end computers all over the world to run the virtual currency. If these computers go down then trades can’t take place. Trades and transactions are done very slowly. The amount of times between trades is also related to the valuation. Slow trades by computers all over the world cause problems. Internet outages and hackers taking down networks cause problems.
With bit coin like real dollars if someone steals them from you then they are gone. We know for example that North Korea has targeted bitcoin holders in South Korea twice and stole millions of dollars. This kind of theft causes the value to drop because if you keep buying bitcoins and they keep getting stolen would you continue to buy them? Remember transactions volume and the number of holders of coins is what determines the valuation.