How Low Can Bitcoin Go?

It has not been a great 24 – 48 hours for bitcoin.  Depending on which pricing index one favors, the price of bitcoin has dropped 36 percent in the last two days and 20 – 24 percent in the last 24 hours or so.  According to the PYMNTS bitcoin price index, bitcoin’s low water mark was $178 yesterday afternoon.  Bitcoin’s price first dropped below $200 at 1 pm EST.  That price did recover some; by midnight bitcoin was still bellow $200 but was hovering just below it, at around the $190 mark.

“The price will continue to be volatile and driven by speculators in the short term,” Gil Luria, an analyst at Wedbush Securities Inc. told Bloomberg. “Nothing about the technology and its promise have changed, but in the short term, that does not drive the price.”

That is one of the more positive outlooks on the prospects for the rapidly deflating digital currency. It is also an increasingly common refrain, particularly among bitcoin investors.  Bitcoin’s potential is as a protocol, and like the internet in its early days, the bitcoin protocol, after some refinement (and testing by fire in the marketplace,) is an underlying technology that could still be revolutionary.

Less positives minds – like those at the Washington Post wonkblog – are running headlines this morning that refer to bitcoin as “A Ponzi scheme for redistributing wealth from one libertarian to another.”

So why the sudden crash?  In some sense, this hasn’t been all that sudden – the price of bitcoin has been declining for the last 13 months since hitting a $1,100-1,200 per bitcoin price late in 2013.  The deflation of bitcoin began picking up speed toward the end of December, and though free-fall is probably too dramatic a description for what has been happening during the first two weeks of 2015, it is not too dramatic a description for the last 24 hours or so.

Most commentators on the issue are locating the essential problem in the bitcoin mining community, those responsible for creating the public ledger by essentially unlocking more bitcoin.  The protocol is designed to make it progressively more difficult to unlock bitcoin, which in turn requires greater super-computing power to yield more bitcoin. As long as bitcoin is high value, not a problem – the bitcoin netted covers the cost of mining it. However, as those costs go up (which they have exponentially) and the price of bitcoin comes down, bitcoin miners are facing the same problem people drilling for oil in North Dakota are facing in the face of falling oil prices and house flippers in Las Vegas and South Florida faced when the real-estate bubble burst: a de-leveraging crisis that has left miners with an odd Catch-22.

Loans were taken out in fiat currency to purchase the equipment to mine bitcoin, which puts pressure on miners to both keep mining (to generate more of their only asset) and to sell off their bitcoin so as not to default on their loans.  Both continue to put downward pressure on the price of bitcoin.

Oil is intrinsically valuable, and OPEC can cut production, which would likely cause prices to start climbing again. When the housing market crashed and threatened to take the U.S. dollar with it, the central bank stepped in to stabilize the market.

No one needs bitcoin to make a car run, and by design there is no Federal Reserve to cushion the blow in the event of a de-leveraging crisis like the one bitcoin now faces.  How serious the blow is remains to be seen – bitcoin can and might bounce back, particularly as enthusiasts use the price drop to pick up more bitcoin. Plus, investors remain interested in the potential for low cost, secure transactions, particularly cross-border, that bitcoin enables.

However, with such dramatic shifts in price, it seems fair to say that bitcoin’s chances for easy mainstream adoption have been damaged in the last few days.