How can a single Bitcoin, which was trading at only a few hundred dollars two years ago, now be trading at over $6,400? Is there a big Bitcoin bubble? Are skeptics from Russian President Vladimir Putin to JP Morgan Chase CEO Jamie Dimon correct that Bitcoin is a fraud and or pyramid scheme?
Those are important queries, but the biggest boost to Bitcoin actually derives from something not discussed, and a rather unlikely source: its competition — other digital currencies and their related Initial Coin Offering (ICOs).
Hundreds of digital currencies have raised funds through ICOs. Like their regulated IPO (Initial Public Offering) cousins, ICOs seek to raise money to build a digital token and the ecosystem surrounding it.
Digital lake of liquidity
Through the first three quarters of this year alone, in excess of $1.2 billion has been raised for over 100 ICOs. When the funds are actually invested in the ICOs, the currency used is — by and large — Bitcoin. Therefore, Bitcoin serves as the predominant liquid asset behind all these ICOs. And of all the cryptocurrencies out there, Bitcoin is the most widely traded and can easily be converted into cash. As a result, the price of Bitcoin has continued to grow exponentially. A similar, but less pronounced phenomena, has occurred with Ether, the second most traded digital currency after Bitcoin. (Ether itself, raised $18 million for their ICO in 2014, much of it in Bitcoin.)
Not only are most ICOs funded using Bitcoin, they continue to use Bitcoin and the “Digital Lake of Liquidity” in their transactions once actual digital currencies or coins are up and running. Don’t get me wrong, the rubber has not hit the road for many of these ICOs, and the majority of actual currencies have not entered circulation. Unfortunately for investors, they may never do so and there are scant regulations to protect investors from such a circumstance. That said, for those ICOs that do have an actual digital currency in circulation (and there are over 100 of them) they also use the “Digital Lake of Liquidity” to accept funds and to perform payout services. When they do so, they primarily use Bitcoin.
These other currencies trade their denominations with Bitcoin not only because Bitcoins are so widely held by so many investors, but because of the volume of trading on digital currency exchanges. Such large volume is part and parcel to the “Digital Lake of Liquidity,” which when trading affords traders the best-executed prices (since there is so much competition within the marketplace). There are currently more than 1,100 other currencies. Not all of them participate in trade.
It is difficult, if not impossible, to break down and quantify this liquidity phenomena. In large part, the difficulty is due to the lack of regulation over ICOs and digital currencies in the U.S. and abroad. There is little reporting or transparency to inform investors of what is taking place.
While the “Digital Lake of Liquidity” phenomena is not something commonly discussed among digital currency enthusiasts, or anyone else, it certainly does not explain the recent volatility of Bitcoin, nor other concerns, such as the following;
A pyramid shape?
There’s little doubt that if the originators of the digital currency intended Bitcoin to be a fraud, the mechanics of it would work out wonderfully. New investors (including ICO investors) could keep the endeavour afloat as older investors cash out. As long as new money keeps coming in and redemptions aren’t excessive, it could operate like a traditional pyramid ponzi scam.
At the same time, there is certainly no evidence that when Bitcoin was established there was any intent to be involved in a fraud. Heck, we don’t even know the inventor(s)!
Furthermore, Bitcoin and other digital currencies are increasingly being used in commerce. If an individual purchases or invests in such a currency and then actually buys something — a hotel room or a car, for example — it is certainly something of value. Nobody is getting ripped off there. That’s not a fraud. That’s not a ponzi scheme.
Bitcoin isn’t tied to anything tangible or real we can touch and feel. That fact further decreases price stability. If a digital currency were to be tied to a tangible asset, it would even out price fluctuations, not to mention open up the possibility of backing up investor claims. This innovation in digital currency is something that has been discussed, and tried, but not put into popular practical use.
Recent wild price swings for Bitcoin are suspect. Amid negative news, including but not limited to ICO and digital currency bans in China, South Korea and Russia, prices have — after initially dropping — soared to record highs. Such should be a clarion call for a deep dive look from financial enforcement officials to determine if prices have been manipulated.
Bitcoin and the digital currency ecosystem have been fast forwarding at incredible speeds. A week of watching what’s taking place might seems equal to several months in other markets.
I don’t think any of the developers of these current currencies or the related exchange trading platforms have it quite right. That said, the digital ecosystem isn’t going away. The extent of its continued rapid growth is ultimately tied to greater innovation coupled with the adoption of basic rudimentary regulations for investor protections.
To date, amid all the incredible innovations, there are no existing digital white knights. At some point, however, some will get it right.
01 Jun 2018 - Righting Regulation