State Of Bitcoin 2016 – A Summary For Bitcoin Investors
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Bitcoin is constantly swinging in and out of favor with investors and proponents alike. As a follower of bitcoin, you have probably experienced a taste of the highs and lows in this market, whether as a user or an investor, and this fluctuation has probably seeded doubt or hope, depending on which side you sit. Bitcoin, unlike any other market, is dominated by an extremely bullish tight-nit community of miners, developers, investors and users and has so far had very little interaction with a mainstream audience. For this reason, bitcoin acts as a giant echo chamber, whereby even the smallest nugget of news can be spun into what appears to be a positive, market-changing event. This makes it extremely difficult to see through the noise… so what’s really going on with bitcoin?
This article is going to look at some of the key pricing factors in the bitcoin market, and how they might apply upwards or downwards pressure on the price of bitcoin.
Bitcoin works on a decreasing-supply algorithm where the reward for mining a bitcoin block is halved every 210,000 blocks. The reward currently stands at 25BTC and that amount is due to drop at some point in July to 12.5BTC. Mining new blocks is the only way to introduce new coins into the market, and this change will drop the number of new coins ‘minted’ each day from roughly 3,600 to 1,800.
As a result of the reward dropping, a large number of miners that are currently competing to mine blocks will be forced out of the market due to simple economics (the low reward results in them running their mining rig at a loss). It’s likely that the miners will either stop mining altogether or purchase more efficient equipment and move their hashing power into one of the larger ‘mining pools’.
Small miners leave the ecosystem:
In this instance, independent miners with now-redundant rigs will leave the bitcoin ecosystem altogether. As a result mining pools will become more profitable, and hashing power will become slightly more centralized among a few of the larger pools.
While the impact of lots of independent miners leaving the ecosystem is likely to be unnoticeable, it does set a precedent for the future of bitcoin mining:
- If you’re going to mine, you are forced to use a mining pool
- Further centralization in mining pools will worry some investors
It is likely that this centralization goes to further concentrate hashing power in the Chinese mining pools, a topic which is discussed later in this article.
There is an obvious supply impact here, however this halving has been misrepresented by some media outlets as a ‘decrease in supply’ as opposed to a ‘decrease in the growth of supply‘. The latter is not as clear cut and therefore far harder to judge when it comes to valuation.
What does a decrease in bitcoin’s growth of supply mean to investors?
As any investor worth their salt will know, in a free market where information is available and transparent, all future events are priced into the current value of an asset. For example, if the lease on a property was due to expire in 5 years, the cost of renewing that lease would be priced into purchasing the property today i.e. the property will be cheaper than if the lease expired in 100 years.
In the same way, we know as fact that the block reward (i.e. newly minted coins) will drop by 50% at some point in July. At what point does this get priced in? Or is the halving already priced in for bitcoin?
What can be said with a high degree of confidence is that yes, to some extent the halving has been priced in already. The question you need to ask yourself is to what extent? To answer this question you must consider the knowledge of other bitcoin investors:
- Are bitcoin investors aware of the halving? (highly likely)
- Do bitcoin investors fully understand what impact the halving will have?
- If the answer is no, are these investors overestimating or underestimating the impact of the halving?
The fact is that no one knows with certainty how the halving will impact the bitcoin market, it is whether the current price is currently over or underestimating what the impact will be that matters.
The Blocksize Debate
The blocksize debate/brawl is muddying the water for investors. If you’re bullish about the halving, then it may be the blocksize debate that is the noose that is strangling bitcoin.
The blocksize debate has led to a lot of issues for investors, most notable was the public, bitter-tasting exit and sell-off by bitcoin developer, Mike Hearn in January 2016. Despite Hearn’s relative lack of involvement in bitcoin, the media storm that followed is likely to have exacerbated downward pressure on the price, not just due to this one vote of no confidence, but as it highlighted just how toxic (and potentially unresolvable) the debate was becoming.
While any bitcoin developer will tell you that the debate is healthy and important for bitcoin, the length of this debate highlights a weakness in the bitcoin blockchain that can be exploited by altcoins (coding in a better dispute resolution system). Not only this, but the time taken to debate a few lines of code has set expectations for the future – if bitcoin needs to change direction fast and there is more than one valid answer, then there could be catastrophic consequences.
What does this mean for investors?
If bitcoin survives this blockchain debate and demonstrates its ability to successfully adapt to new issues along with future protocols for facilitating change, then you can bet that bitcoin will come through the other side stronger than ever. However, for every day that the blocksize debate continues, more risk is building for investors.
Bitcoin Mining Growth in China
The topic of China regularly comes up on bitcoin discussion boards, particularly among users on reddit’s /r/bitcoin. The discussion is typically filled with speculation that too much hash power in China leads to larger risk to the bitcoin ecosystem. This trend towards China-centric hash power is likely to increase, particularly as internet speeds improve in the country and investment in bitcoin mining continues to expand.
The reality is that centralized hashing power is a potentially dangerous scenario (read the 51% attack), but this is true in any situation, whether the hashing power is centralized in China or Chad. The first consideration you need to make on this particular issue is the motivation behind the Chinese mining pools – let’s take the two extreme mindsets for centralized hashing power:
Motivation 1: negative outlook
Centralize hashing power in China so that a) bitcoin can be destroyed or b) bitcoin can be absorbed by the Chinese economy.
Motivation 2: positive outlook
Invest heavily in bitcoin with state of the art equipment to maximize profits (increased hashing power is an irrelevant side effect).
For most investors, the latter seems like the most reasonable outcome – the primary focus of a business is to make profit. And this corroborates what the head of the largest mining pool in China, Bobby Lee said when questioned on the matter:
Bitcoin will never be centralized because no one is ever stopped from mining Bitcoins. You don’t need a license to participate in the Bitcoin economy. It’s not like (there are) only two (mining) companies. There’s a very healthy mix of companies, so I’m not worried about that at all. I think China is more interested (in Bitcoin), so you see more (Chinese) activity.
While centralization is a definitely concern, it is unlikely to have any impact in the short term. The problem may come in the future as centralization and China’s domination continues to increase without a clear plan on how to facilitate decentralization – this is a concern, and one that should not be ruled out when considering the long-term future of bitcoin.