Bitcoin Falls Over 20%

In my article yesterday, I said bitcoin would hit an all-time high and then have a correction because it was overbought due to extreme speculation from China. It didn’t take long for that prognostication to come to fruition as bitcoin hit an all-time high on some exchanges before crashing 23%. The Coindesk website has an average of the leading bitcoin exchange prices. The high for the day was $1,153.02 and the low of the day was 887.47. The price dropped almost $200 in an hour. Since then, it has rebounded by about $80 and is now down only 14%. As someone who supports Bitcoin, I think it’s important for there to be realistic price expectations so the detractors don’t have the opportunity to say bitcoin is a fraud because of any volatility it experiences. Some people like to make headlines by making wild estimates of where bitcoin can go, but I view these with similar disdain as the excitement surrounding the Dow hitting 20,000. We must avoid being headline driven and instead think critically.

The reason for bitcoin’s rally is Chinese demand which stems from speculation and those trying to skirt the government’s capital controls. Those trying to skirt controls buy bitcoin in yuan and convert the bitcoin to dollars. Besides having capital controls to end the outflows caused by the weakening Chinese economy, China also instituted new rules on cash transactions. Earlier this year, the government made a law where banks must now report all yuan-denominated cash transactions over 50,000 yuan which is equal to about $7,100. This is a dramatic lowering from the 200,000 threshold which is what the law was previously. Cross-border transfers of more than 2000,000 yuan by individuals is also subject to being reported to the government. The government wants access to as much information as possible. If you control the money, you control the people. This is why bitcoin is so disruptive as no one controls the money in it. This causes fear by those who are in power.

The reason why bitcoin fell today is because the yuan rose to its highest value versus the dollar since the middle of November. The onshore yuan increased 0.7% to 6.8830 per dollar in Shanghai. The yuan had a 2-day record offshore rally as it increased 2.5%. There’s not 100% proof, but the reversal was likely caused by the People’s Bank Of China. It’s a perfect time for it to make this move because most traders were caught leaning the wrong way which made it have a powerful impact on the market. The chart below shows borrowing costs skyrocketing as we are seeing a similar short squeeze to the one about 12 months ago.

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This move is aimed to create stability in the yuan, but doesn’t help China’s case to have the yuan become a global reserve currency. Governments like the free market until it works against them. It happens with all governments as they try to manipulate the system to limit any pain from occurring. This is how bubbles are created. Then when the bubbles burst, the free market is blamed. Trump is about to take office. He has criticized China for its currency manipulation. Trump is right that China manipulates its currency, but he thinks China wants its currency weak. China is trying to keep the yuan from crashing further because it doesn’t want capital outflows. Trump is campaigning on a weak dollar, so if China doesn’t manipulate its currency, Trump’s won’t get his wishes as it will continue to lose value. Median projections have the yuan falling to 7.15 per dollar by the end of the year.

I showed you the trading of bitcoin with a breakdown of where it was coming from in my last article. Today China represents over 96% of the trading in bitcoin, so it’s obvious the decline is coming from the yuan appreciation. As further evidence, Chris Burniske, who leads blockchain products at AKR Investment Management, told Forbes Chinese bitcoin exchanges were trading at a discount to American exchanges. This shows the decline in Chinese demand because usually the Chinese exchanges trade at a premium since China has a higher level of demand.

Biases are a tough nut to crack because often the people who are the most biased have the most information on the subject. As an example, in bitcoin, the people who are most knowledgeable about the subject also have a bias because their businesses rely on it. There aren’t many people who rely on bitcoin for their job, who will criticize it. There aren’t many people who are knowledgeable about bitcoin and highly critical of it. Therefore, the explanations as to why the latest crash won’t lead to another large decline like we saw after the peak was hit in late November 2013 are biased. These people who are giving the explanations, don’t want bitcoin to fall. However, their points are still valid.

An exchange representative from the Chinese bitcoin exchange Huobi told Coindesk that the weekly trading volume in 2013 was 393,000 bitcoins and today there was 735 million bitcoins traded. The amplitude of the week in 2013 was 103% while the price rose more steadily this time. In my opinion, this doesn’t prove anything. Bitcoin being more liquid doesn’t prevent its price from falling quickly. Today I saw a prediction that bitcoin would rise to $3,000 by the end of the year. This could be a psychological example of bitcoin getting overheated.

Zero Hedge reported China is discussing cracking down on bitcoin, but I haven’t seen any news stories to back up this claim. This is a risk, but not something I see as likely because China wants to try to open its markets up more. Since China hasn’t done anything yet, it signals it might not want to crackdown on it. The more integrated bitcoin gets in China, the harder it would be to crackdown on it. It’s much more difficult than India’s cash ban as bitcoin isn’t government created currency. It’s also tougher than blocking Facebook because Chinese people don’t necessarily want to use it since they have their own alternatives.

The bright side of bitcoin being tied to the Chinese yuan is it is expected to further depreciate. As a bitcoin proponent, I’m happy the price of bitcoin corrected so the froth caused by speculation was wiped out of the market. I’m bullish on bitcoin becoming used more frequently over time. I also think it is a great store of value.

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