BITCOIN investors have had a hell of a ride this year. If you had bought one of the digital tokens last December, it would have cost you nearly $20,000. As 鶹ý went to press, that coin was now worth around $3300 – and still falling. Ouch.
Of course, the cryptocurrency has seen plenty of ups and downs in its 10-year history, but this bust looks bad. In fact, falling prices could derail the entire thing.
That’s because as the value of bitcoin goes down, it becomes uneconomical to keep the tech behind it running. Bitcoin relies on a distributed ledger of transactions – known as the blockchain – that is constantly updated, ensuring that everyone always sees the same record of who paid what bitcoins to whom.
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“This bitcoin bust looks bad. In fact, falling prices could derail the entire thing”
The blockchain is kept going by miners, who run expensive, energy-hungry computers in exchange for the chance to be rewarded with bitcoins each time they update the ledger.
In the boom times, mining operations sprang up in places with cheap sources of electricity, essentially as a licence to print money. But as bitcoin falls in value, miners are being paid less and less. Unable to cover electricity and hardware costs, many are packing up.
“You have to constantly explore to find cheap power,” says Idon Liu at Node Haven, a company that provides cloud computing services to miners. With bitcoin around the $4000 mark, you need to be buying electricity at no more than 5 cents per kilowatt-hour to break even, he says. But it is hard to find power that cheap. “Now we’re at $4000, people are getting nervous,” says Liu. “They are dumping hundreds of thousands of machines.”
Last month, GigaWatt, a large mining operation near Seattle in Washington, went bankrupt. Pictures online show miners in China clearing out wheelbarrow-loads of servers.
And at least one chip-maker, Nvidia, says it is delaying the release of its latest GPU – a type of chip that powers both video games and mining rigs – because it has a glut that miners have not bought.
The impact of miners quitting can also be measured by the drop in what’s known as bitcoin’s hash rate, a measure of how many mining calculations are being made a second.
Since September, the hash rate has fallen from more than 60 exahash (60 million trillion calculations) per second to less than 40 exahash. It is the first significant drop in bitcoin’s history (see graph).
Bitcoin is designed so that the difficulty of adding to the blockchain scales with the number of active miners. This means mining may well become economical again as more people drop out. But the downturn is having a ripple effect on the industries that have built up around the currency.
In the past couple of years, a host of start-ups have launched as initial coin offerings (ICOs), a way for new firms to raise money by offering crypto-tokens tied to bitcoin in exchange for investment.
People threw millions of dollars at such businesses, but regulators are now saying that many ICO funding rounds were illegal because they were not registered with the appropriate financial authorities.
For example, the US Securities and Exchange Commission recently slapped $250,000 fines on two firms that had offered ICOs and ordered them to repay investors. Most ICOs were funded when bitcoin prices were high, so the devaluation leaves them with weak balance sheets and a risk of going bust.
Reboot the boom
But as grim as things look, bitcoin has life in it yet, says Liu. “This is just another cycle,” he says. For example, when Liu started working in the business, bitcoin was worth $200. “$4000 is still pretty good.”
Garrick Hileman at the London School of Economics, who is also head of research at a cryptocurrency company called Blockchain, agrees. “It’s important to keep this year’s events in context,” he says. “We’ve seen bitcoin fall over 90 per cent on a couple of occasions.”
Taken this way, the current devaluation is simply a readjustment after a boom, but the large size of the boom makes the bust so much harder. “The difference is that regular people got into crypto and are now feeling the pain,” says Jackson Palmer, who created a cryptocurrency called Dogecoin in 2013 as a joke. Five years on, Dogecoin is still going strong – although Palmer is no longer involved with it.
A lot of miners joined the bitcoin network when the price was high, looking to make a quick buck. But with the competition already fierce, new miners were taking out $500,000 business loans to get started, says Hileman. “Those are the people getting into trouble.”
Hileman thinks we should compare what is happening with bitcoin to the dot-com boom of the late 90s. “There’s been this incredible excitement for a new technology,” he says. “But the market can get ahead of fundamental adoption.”
Take Amazon. When the early internet’s bubble burst, the company’s stock price dropped around 90 per cent and it took eight years before it reached 1999 levels again. Today, it is a trillion-dollar company.
“When the price goes up, there’s a bunch of hype. When it goes down, there’s a bunch of hand-wringing”
But not everyone thinks bitcoin has such a bright future. Financial author and campaigner Brett Scott agrees bitcoin is here to stay, but believes it is doomed to a meaningless cycle of boom and bust.
“When the price goes up, there’s a bunch of hype. When the price goes down, there’s a bunch of hand-wringing,” he says. “It’s irrelevant, this is what happens in any speculative market.”
For Scott, talking of a bitcoin bubble is incorrect because it implies bitcoin has a fair price to start with. The dot-com era was a bubble because the investment in companies exaggerated what they were worth. Similarly, the 2008 financial crash followed a bubble in the US mortgage market that overvalued risky loans. In these cases, companies and loans had a value – just not the high one they had been given.
“The underlying reality clashes with the actual price,” says Scott. “The problem is that we don’t know what the underlying reality is for bitcoin.” It has no inherent value, and we still do not really know what it is for, he says.
Hileman thinks that bitcoin’s value will come from its usefulness as an asset, a kind of digital gold. He says that there are about 30 million people now using bitcoin and the number has tripled in the past 18 months.
Despite that uptick, bitcoin still hasn’t found a mainstream role as a rival to digital payment systems like PayPal or Apple Pay. Part of the problem is that bitcoin has an upper limit on the number of transactions that can be added to the blockchain in each update, which curtails the number of payments that can be made each day.
Little appeal
Bitcoin doesn’t offer a reason to switch, says Palmer. Some proponents point to the currency’s lack of government control, but that isn’t exactly a selling point, he says. “The average citizen is not looking for a store of value that’s resilient to state censorship.”
This makes bitcoin both worthless and a target for wild financial speculation, says Scott. “A blank token with no characteristics is always going to be subject to wild price fluctuations.”
So perhaps a bit of oversight is just what bitcoin needs to settle down, says Hileman. His company, Blockchain, is working with authorities to bring cryptocurrencies into the mainstream financial fold. Money centres like Chicago and New York are opening regulated trading platforms for cryptocurrencies.
Even if that doesn’t happen and the bankers ultimately drift away, bitcoin will probably stick around as an object of pure speculation. “Dogecoin is a good barometer for how much hype is left in the cryptocurrency bubble,” says Palmer. Each Dogecoin is only worth a fraction of a cent, but in total people have invested $255 million in the currency, despite its software essentially being abandoned. “Cryptocurrency markets are still highly irrational,” he says.
This article appeared in print under the headline “The great bitcoin crash”
