The logic behind Bitcoin's surge and plunge: Many investors say it's a mystery

Rise: If Bitcoin becomes the second largest non-credit financial currency asset after gold that can hedge various credit market risks, the current price of Bitcoin may just be the beginning.

Fall: If Bitcoin is not recognized by most countries and has limitations in practical use compared to gold, the price of Bitcoin may fall sharply.

There is a saying in the investment market that “three K-lines change your faith.” However, Bitcoin investors joked: “Bitcoin trading fluctuates violently, and we can’t wait for three K-lines. One K-line may wipe us out.”

Bitcoin achieved an impressive 160% increase in 2016. In early 2017, Bitcoin rose first and then fell. In the early morning of January 2, the price of Bitcoin exceeded $1,000 per coin; on January 5, it set a new record high of $1,249 per coin; but on January 6, the price of Bitcoin "flash crashed", plummeting by more than 30% all the way, and fell to a minimum of $730.25 per coin.

The "roller coaster" of Bitcoin has poured cold water on the enthusiastic and irrational investors.

Many Bitcoin investors admitted to the reporter of the International Financial News that the Bitcoin market is too difficult to grasp. When the market will come and why it rises or falls are all mysteries.

Investment Logic

So, what do Bitcoin investors base their transactions on?

The reporter of International Financial News interviewed Bitcoin investor Lin Yao (pseudonym), who set his investment target on Bitcoin after the stock market crashed in the second half of 2015. Lin Yao said that he had paid attention to Bitcoin before, so he knew that there was a positive expectation that Bitcoin production would be halved in 2016.

"In July 2016, the output was halved," Lin Yao pointed out. "According to the Bitcoin open source software protocol, the Bitcoin block reward will be halved every 210,000 blocks. If the Bitcoin output is halved and the purchasing demand remains unchanged, the supply will be tight and the Bitcoin price will rise."

Another reason for his switch to Bitcoin is the development of blockchain technology applications. Lin Yao told reporters: "In recent years, well-known financial institutions and central banks of various countries have become more and more interested in blockchain technology. Although we do not have strong financial strength to follow blockchain projects, investing in Bitcoin is equivalent to investing in blockchain technology in a roundabout way."

As it turned out, Lin Yao's investment decision was a wise one. By mid-June 2016, the price of Bitcoin had risen by more than 200% from its 2015 low, and Lin Yao's initial capital had tripled.

Lin Yao has his own set of principles for Bitcoin investment: "Bitcoin cannot rise indefinitely. If the price of each coin is above 5,000 yuan, it is likely to be inflated."

According to Lin Yao, he gradually left the market after the price of Bitcoin broke through 5,000 yuan per coin on June 17, 2016. In November of the same year, Bitcoin accelerated its rise again to 8,895 yuan per coin. "I don't regret not making money later, after all, Bitcoin is a risky product." Lin Yao took January 12 as an example, when the price of Bitcoin reached 4,902.02 yuan per coin, and the highest intraday price of Bitcoin reached 6,450 yuan per coin the day before. In just one day, it fell through the two important thresholds of 6,000 yuan per coin and 5,000 yuan per coin, with the maximum drop of 24%.

Regulatory storm

Lin Jun (pseudonym), an investor who escaped from a high position, told the reporter of International Financial News: "The reasons for being bullish may be similar. Some investors value Bitcoin's efficient liquidity and decentralization (decentralization means that it is not controlled by individuals, groups or central institutions). Some value the prospects of Bitcoin's underlying basic application blockchain technology. Still others value Bitcoin's highest popularity and acceptance."

As for the multiple "flash crashes" of Bitcoin, Lin Jun believes that it is related to the dynamics of regulatory agencies.

On January 6, 2017, the Shanghai headquarters of the People's Bank of China and the Beijing Business Management Department of the People's Bank of China respectively announced on their official websites that the Shanghai headquarters of the People's Bank of China and the Shanghai Municipal Financial Office jointly with relevant regulatory authorities met with the main persons in charge of China's three major Bitcoin trading platforms - Bihang, Huobi and Bitcoin China - to understand the operation of the platform.

Lin Jun said: "I sold it on that day. Although the price of Bitcoin fell sharply that day, I didn't want to wait for a rebound, so I sold the coins directly and left the market."

On January 11, the central bank inspection team entered Bitcoin China, Huobi.com, Bihang and other Bitcoin and Litecoin trading platforms to conduct on-site inspections on the trading platforms’ implementation of foreign exchange management, anti-money laundering and other related financial laws and regulations, and trading venue management regulations. This news triggered another round of Bitcoin price declines.

In fact, four years ago, Bitcoin also experienced a sharp decline under regulatory pressure. At that time, five ministries and commissions, led by the People's Bank of China, issued a "Notice on Preventing Bitcoin Risks", pointing out that Bitcoin is a specific virtual commodity, does not have monetary attributes such as legal compensation and compulsion, does not have the same legal status as currency, and cannot and should not be circulated and used as currency in the market. Under the pressure of regulators, Bitcoin has been falling all the way, from a historical high of about 8,000 yuan per coin to 1,000 yuan per coin.

Lin Jun said: "The intensive on-site inspections by the central bank have given the market room for imagination. Bitcoin regulation may become stricter in the future, which may affect the activity of Bitcoin transactions."

Trend is hard to judge

It can be said that the basis for the rise and fall of Bitcoin is more vague than that of other investment assets, and the market conditions often catch investors off guard.

Liu Junmin, director of the Virtual Economy and Management Research Center of Nankai University, believes that many people mistakenly regard Bitcoin as a currency for investment, but Bitcoin is not a currency. "Simply put, Bitcoin is like most hyped commodities, and its price is hyped up."

Regarding the price trend of Bitcoin, Xiao Lei, a financial columnist and chief researcher of Golden Wallet, told the reporter of the International Financial News that two different assumptions need to be made.

Xiao Lei pointed out that one hypothesis is that Bitcoin becomes the second largest non-credit financial currency asset after gold that can hedge various credit market risks. If the market gradually recognizes and accepts this concept, and even reaches a tacit understanding and consensus, and some financial institutions around the world begin to hoard a portion of Bitcoin assets as financial reserves, then the current price of Bitcoin may just be the beginning. "Compared with the volume of gold, Bitcoin is pitifully small. The current market value of Bitcoin is only $14 billion. The market value of gold in the physical market alone is $7 trillion, and Bitcoin only accounts for 0.2% of the market value of gold. Assuming that the market value of Bitcoin is increased to 2% of gold, it is equivalent to a 10-fold increase in the market value of Bitcoin. For the terminal market, this means that the price of each Bitcoin will increase 10 times from the existing level to $9,000 per unit (about RMB 63,000 per unit). If its properties can be comparable to gold, this is only a conservative estimate."

Another assumption is that Bitcoin, as a new type of financial transaction unit that has emerged when Internet technology has developed to a certain extent, is too free and independent and has not been recognized by most countries. Compared with gold, it has limitations in practical application. From the perspective of assets, in addition to the convenience and security of transfer, inheritance and holding, simply holding Bitcoin will not bring productive benefits in the process of economic growth, nor will it generate any equity benefits.

"If there is no major turmoil in the global economy and financial markets, the opportunity cost of holding Bitcoin will become higher and higher. When the price driven by safe-haven demand reaches a certain zero point, funds begin to take profits and transfer to other assets. The price of Bitcoin may experience an avalanche-like decline. It is not impossible for it to fall to 500 yuan per bitcoin. Moreover, such a decline will cause a severe blow to market confidence. Pessimism will self-reinforce and the decline may exceed the market's imagination." Xiao Lei said.

Xiao Lei told reporters that there is no stronger or weaker hypothesis between the above two assumptions, and the probability of both occurring is equal. Bitcoin is no longer a simple digital currency that can be described as a bubble. Unlike many emerging digital currency concepts, the Bitcoin industry chain is actually very complete. The huge costs and stakeholders hidden behind Bitcoin are no longer a simple issue of a market value of $14 billion.

Xiao Lei suggested that investors should invest in Bitcoin for the purpose of consumption or collection. It is best to participate in the investment with a one-time consumption mentality and not consider appreciation too much, unless the investors themselves can withstand the drastic price fluctuations or have a very professional arbitrage model to trade.