BITCOIN

THE SOLUTION
THAT NEVER WAS

VINEET
DHANDHANIA
B lue W ater
C apital 5 JULY 2022
CONTENTS

Topic Page number

A. WHY BITCOIN
1. Future of currency 2
2. Democratization of the financial world 5
3. Finite, therefore immune to mismanagement 7

B. VALUE DRIVERS
1. Adoption to be value accretive 8
2. Drivers of market price 9
3. Source of value 9
4. Store of value 10

C. WHAT LIES AHEAD

1. Catalysts to downfall 11
2. Triggers that may cause downfall 13
3. What to look out for 16

Note: Those who are well-versed with bitcoin might want to skip the first two sections and move
straight to the last section.

Copyright Bluewater Capital, 2022 1

A. WHY BITCOIN

Let’s examine the usual arguments that bitcoin proponents offer in support of why bitcoin is
valuable.

1. Future of currency

Technological marvel
Blockchain, the revolutionary concept that underpins bitcoin, is
indeed a novel idea. It can help build trust in a system by Bitcoin is a technological
providing a shared record of truth. The idea has many gainful marvel; it’s the future of
applications in various industries. Bear with me as I state
currency
something obvious - blockchain is not same as bitcoin. Bitcoin is
– Bitcoin proponents
an application of blockchain, one among many. Merely being
powered by an innovative concept does not automatically make
bitcoin a superior currency. A necessary condition for a currency to
be superior to others would be transaction efficiency. Let’s
examine if bitcoin payment mechanism is more efficient in terms
of time and cost compared to those of the conventional payment
mechanism in fiat currency.

Transaction time
As the world is increasingly getting digital, shopping and commerce and their associated
payments are going electronic. Payment processors such as Visa and Mastercard handle
thousands of transactions per second. In 2020, PayPal processed over 40 million transactions per
day. Payment wallets such as China's Alipay processed 256,000 payment transactions per second
during its peak Single's Day shopping festival in 20171. India's PayTM claims to be able to handle
60,000 transactions per second. India's Unified Payment Interface (UPI), a leading open banking
payment infrastructure, has reportedly scaled up to a capacity of 50,000-70,000 transactions per
second.
What about bitcoin? With a multitude of complex algorithms running in the background for a
simple money transfer, bitcoin processes a measly 4-5 transactions per second. Clearly, bitcoin
cannot handle even a small fraction of the number of transactions that are routinely handled by
modern FinTech infrastructure.

Transaction cost
There are two parts to the costs associated with affecting a bitcoin payment transaction –
1. Fees charged by intermediaries (exchanges/wallets), and
2. The cost of mining i.e. cost of the computational effort spend to commit a transaction to the
blockchain. Total cost of a bitcoin payment transaction has varied widely in the past, averaging
~$140 per transaction so far this year; refer to the chart below for the trend in transaction
cost.

1 https://knowledge.wharton.upenn.edu/article/how-will-chinas-overseas-mobile-payment-
systems-fare

Copyright Bluewater Capital, 2022 2

Cost per bitcoin transaction – Miners’ revenue divided by number of transactions

Source: Blockchain.com

Such high cost implies that while bitcoin may be competitive for large international payments, it
is certainly not suitable for small day-to-day payments and hence it cannot play the role of a
currency. Further, the use of blockchain is not limited to cryptocurrencies. The conventional
banking and financial institutions have roped in smart contract solution providers and blockchain
experts to implement blockchain-based international money transfer mechanisms.

Added competition from CBDCs

In order to utilize the benefits of digital technologies, as applicable, central banks around the
globe are studying cryptocurrencies, in particular the blockchain mechanism, and exploring their
use cases. One of the outcomes of such endeavours is what has come to be called as Central
Bank Digital Currency (CBDC), which is a digital counterpart of the respective fiat currency. CBDC
use cases have been found to be different for wholesale and retail transactions. Nigeria has
launched a CBDC meant for retail use. Several countries are piloting their own CBDCs, including
China, South Korea, Russia, Saudi Arabia, South Africa among others. CBDCs aim to cherry-pick
the useful aspects of cryptocurrencies and overlaying them on top of the extant fiat currency
based systems, thereby helping fiat currencies compete better with cryptocurrencies.

Unsurprisingly, bitcoin adoption isn’t on the rise. Refer to the following chart.

Copyright Bluewater Capital, 2022 3

Transactions on the Bitcoin Network (Daily, 7-day moving average)

Conclusion: While innovative technologies power bitcoin, it doesn’t stand up to fiat

currencies as a medium of exchange.

Copyright Bluewater Capital, 2022 4

2. Democratization of the financial world

Taking power away from governments and placing it in the hands of people may appeal to the
rebel hidden inside. Regulations exist to protect us but they don’t get their due credit. In fact,
regulations are often seen in a negative light. Decentralization and anonymity which underpin
bitcoin’s mechanisms are touted as tools to democratize the monetary system by escaping
monetary repression by central banks and capital controls by governments. Overblown notions of
monetary repression only serve as justifications that bitcoin proponents offer themselves and
others for buying bitcoins. Decentralization and anonymity are actually quite unfavourably placed
on a cost-benefit scale. They are designed to prevent accountability and such absence of
accountability enables fraud and criminal activity.

Crypto scams
Being unregulated, the crypto world has been a magnet for scammers. Since its infancy, it has
been plagued with a multitude of scams. It continues to have a Wild West vibe to this day. When
it comes to security, bitcoin proponents eagerly explain the cryptographic encryption methods
and the Proof-of-work consensus algorithms. While all may be good at the kernel, the problems
lie in the intermediary layers between the core of the bitcoin system and the user/investor. The
bitcoin ecosystem has its set of intermediary actors. In the absence of any regulatory scrutiny,
such intermediaries, such as custodial wallets, could easily scam their users. As a matter of fact,
it’s often hard to say whether a scam was committed by hackers or simply by insiders. Scores of
fake crypto wallets have stolen billions of dollars from unsuspecting users. Earlier this year Trend
Micro1 reported to have discovered as many as 249 fake wallets. Numerous exchanges have lost
billions in hacks over the years. Last year, FTC2 reports a twelve-fold increase in the incidence of
crypto scams from the same period a year ago. Refer to chart below for the trend.

Chart: Cryptocurrency scam

reports and reported dollar
losses by quarter (Q1 2017 –
Q1 2021)
Source: FTC, USA

Reports and reported losses

to cryptocurrency investment
scams increased sharply from
October 2020 through March
2021

1 https://news.trendmicro.com/2022/01/20/watch-out-for-fake-crypto-wallet-apps-4-3m-stolen-
metamask-imtoken-bitpie-trust-wallet-and-more
2 www.ftc.gov/news-events/data-visualizations/data-spotlight/2021/05/cryptocurrency-buzz-
drives-record-investment-scam-losses

Copyright Bluewater Capital, 2022 5

Rising number of new and more gullible crypto investors may be driving such a rapid growth of
crypto scams. Chainalysis1 estimates that as high as $14 billion worth of cryptocurrencies could
have been lost to frauds.

Certainly, the traditional finance world is also susceptible to hacking. However, bitcoin’s design
makes it a more attractive choice for hacking. A fraudulent credit card transaction can be reversed
by the bank. Bitcoin payments are irreversible, unless the community decides to roll back addition
of blocks (that store transaction information). Such irreversibility is an added incentive for hackers
to attack bitcoin addresses because once an attack is successful there is virtually no chance of a
roll back. Besides, bitcoin transactions are nearly anonymous. Attempts to link addresses to real
world identities have been successful at times but there is any element of chance involved. With
time, bitcoin forensics are likely to get better though, so there is hope.

Vehicle for criminal activity

Existing outside of the regulated markets and having a design that renders itself naturally to
circumventing law, bitcoin has also become the preferred vehicle for payments associated with
criminal activity such as tax evasion, dark web transactions, money laundering, blackmailing and
extortion. Bitcoin makes it safer for a scammer looking to orchestrate Ponzi schemes such as
Bitcoin Savings & Trust.

Governments are spending money and efforts in developing crypto regulations, improving
forensics and strengthening law enforcement. Personally, I don’t support spending taxpayers’
money for dubious get-rich-quick misadventures.

Conclusion: From a security point of view, owning bitcoin is a risky proposition.

Decentralization of control, as against regulator control, has proved to be more a
bane than a boon.

1 https://blog.chainalysis.com/reports/2022-crypto-crime-report-introduction

Copyright Bluewater Capital, 2022 6

3. Finite, therefore immune to mismanagement
Finite
Bitcoin is said to be finite. Before we explore whether it is really finite, first we look at whether
being finite is at all a desirable quality for a currency? The Bretton Woods system required
currencies to be backed by gold, ensuring that the currencies were virtually finite. Evidence
indicates that both inflation and economic growth were much more volatile during the gold-
backed system than since its collapse. There were many more economic downturns during the
gold-backed currency system than after its collapse. Pegging currencies to gold hastened the
spread of financial crises from one country to another. Abandoning gold standard allowed central
banks to adjust monetary policy quickly in response to any emerging adverse situation, which
was not possible when currencies were finite. Being finite isn’t a virtue, not for a currency. Besides,
bitcoin isn’t really finite in the true sense. While bitcoin per se is finite, it is only one of a virtually
infinite number of such currencies. One could develop bitcoin2, bitcoin3 and so on. It’s like an
infinite set of individually finite sets. As a matter of fact, there already are thousands of other
cryptocurrencies; most of them attempt to differentiate themselves in how they work and what
they do, while, in essence, they are not really very different inasmuch as their viability as a
currency is concerned. Bitcoin itself has been “forked” multiple times spawning new variants out
of thin air. In sum, “bitcoin” is not really finite. A significant inference of this discussion is that even
if bitcoin replaces fiat currencies someday, it cannot command the price of gold as it is not finite.
The only exception to this would be if “bitcoin” becomes the only cryptocurrency that continues
to be perceived as valuable; other cryptocurrencies either leave the fray or assume other roles,
and no new cryptocurrency comes up with the aim of competing with bitcoin. However, there is
no reason to believe that bitcoin will continue to rule uncontested in perpetuity.

Money printing
Since the collapse of the gold standard that was established under the Bretton Woods system,
central banks have faced many difficult economic situations and have experimented with the
levers available to them in a bid to navigate through the situations. The early days of bitcoin
coincided with one such experiment - Quantitative Easing (QE) - engineered in the aftermath of
the Great Recession of the late 2000s and the subsequent reversal (Quantitative Tightening or
QT). More recently, in a bid to fend off the economic fallout of the COVID-19 pandemic, central
banks undertook quantitative easing at a much larger scale than ever before, raising widespread
concerns about the outcome of the eventual quantitative tightening. Bitcoin proponents
piggybacked on such concerns, adding that bitcoin is the answer to fiat currency
“mismanagement” by central banks. As we stand today, quantitative easing has ended and
tightening is underway. Risky assets witnessed sharp corrections as excess money started to get
sucked out. Had bitcoin proponents been right, bitcoin would have acted as a safe haven. Instead,
bitcoin has seen its price eroding alongside other risky assets while the dollar is virtually
unaffected. At least in this instance, investors have continued to put their trust on fiat currencies,
not bitcoin, debunking the no-trust-in-fiat notions. Bitcoin has actually demonstrated striking
resemblance to speculative assets.

Conclusion: Bitcoin is just an instance of a class of digital assets; there can be

infinitely many such assets. Markets still believe that fiat currencies are safe while
bitcoin is merely a speculative fad.

Copyright Bluewater Capital, 2022 7

B. VALUE DRIVERS

1. Adoption to be value accretive – Myth!

Bitcoin proponents often credit increasing adoption of bitcoin for its continued appreciation in
value. This idea doesn’t hold water because the economic value created by bitcoin’s use as a
currency does not flow into bitcoin itself. The benefit of increased adoption of bitcoin, if any, will
be enjoyed by those who use it. As an analogy, a shopping list that you make on the Notepad
application in Microsoft Windows would be useful to you, but not to Microsoft. Fiat currencies
offer a closer analogy. Using a fiat currency for daily transactions doesn’t automatically increase
its value. A related by equally invalid idea is that the value of a global, secure, decentralized
monetary network has to be more than zero. Again, the token utilized by the network itself
doesn’t gain value from the usage of the network.

One can argue that people would need to have bitcoin before they can spend it. So if more and
more merchants start accepting bitcoin, consumers would want to keep some handy. In other
words, growing bitcoin adoption would create usage demand. However, it is worth noting that
merchants are typically not keen to accept bitcoin. Barring enthusiasts, only those merchants
consider accepting bitcoin that count owners of bitcoin as a sufficiently large chunk of their
customer base or whose public image gets a fillip from appearing technologically progressive.
More often the push for bitcoin acceptance has come from bitcoin-holding consumers. Also,
rarely do merchants hold the bitcoins they receive. They utilize the services of payment
processors to mitigate any risk of bitcoin price fluctuation through a back-to-back sell down of
received bitcoin. Then again, even at those merchant outlets that do accept payment in bitcoin,
only an occasional customer actually pays in bitcoin. For the most part, accepting payment in
bitcoin is done primarily for optics, not to actually meet a real customer demand. Furthermore,
considering that bitcoin payments are expensive, its adoption for small transactions is very
unlikely. High cost and absence of a real need imply that bitcoin payment transactions are not
going to grow; the same can also be noted in past transaction data. Finally, on the off chance that
adoption does grow, the resultant usage demand from consumers will plateau when they have
enough bitcoins to make their purchases, eventually putting an end to the fuel that could propel
bitcoin any higher.

Copyright Bluewater Capital, 2022 8

2. Drivers of market price

Bitcoin’s journey from being worth a fraction of a cent to being worth tens of thousands of
dollars started in 2010 when some enthusiasts used bitcoin to make an occasional payment to
each other. Reportedly, it caught the attention of some dark web market participants. As they
went about with their business, bitcoin’s price rose multi-fold. Word spread about a novel high-
tech currency making steady gains, drawing in the tech-savvy lot, bidding the price up further.
Continued appreciation and resultant publicity caught yet more people's attention. More fresh
money came in, bidding the price up further. Essentially, a virtuous cycle was set into motion
driving prices up as more and more people wanted to invest in the currency of the future. As the
snowballing bitcoin gathered critical mass, ecosystems developed across the world; access to
crypto investing got easier bringing in a deluge of fresh money, catapulting bitcoin to
stratospheric highs. It’s a classic example of Greater Fool theory. An investor bought bitcoin at a
high price in the hope that a greater fool will buy it from her at an even higher price sometime in
the future.

3. Source of value – Collective Belief System

The value of an equity share is backed by the expected future cash flows from business activity.
Fiat currencies are backed by the faith and credit of governments. Non-utility assets such as gold
and bitcoin are backed only by a Collective Belief System. Such assets have value only because
people believe they do. In fact, in case of bitcoin, even applicability of the collective belief system
could be challenged. I do not think that people even believe bitcoin has value. They just want to
believe that bitcoin has value. More on that later. For now, let’s assume that people do actually
believe that bitcoin holds value. Now, while such belief systems are resilient in the short term but
they are definitely not unassailable. Pearls, being a similar non-utility asset deriving its value from
a collective belief system, were very expensive a few centuries ago, but aren’t anymore. Today,
change happens very quickly. Do diamonds face the same threat? Surely, and in not so distant
future we might see diamonds in the dust. How about gold? Possibly gold will face the same fate
but its value perception is quite deeply ingrained so it is going to be very resilient. It will need a
paradigm shift to cause such an upheaval that could displace gold from its position. Bitcoin pales
in comparison to the universal value perception of gold. It attracted investors fast; its fall could be
faster.

Copyright Bluewater Capital, 2022 9

3. Store of value

Bitcoin proponents believe it can upend gold’s long-standing position as the ultimate store of
value. Gold is non-corrosive so its weight and formulation remains unchanged over long periods
of time. It is rare so it holds value but not so rare that transactions become impossible. It is
obviously finite. It is a global commodity. It has been accepted as a store of value since millennia.
Bitcoin’s origin is arbitrary. As discussed earlier, it is not finite. It exhibits very high volatility. Its
survival depends on a fragile ecosystem. Should bitcoin’s price fall too low, it could disrupt the
mining operations. If that happens, bitcoin would be worth nothing. Ever since its inception,
bitcoin attracted its fair share of criticism. No bitcoin investor could possibly have missed hearing
enough of bitcoin’s issues. However, many are reluctant to acknowledge them. Dominated by
greed, bitcoin proponents often demonstrate confirmation bias, in that they screen out anything
that highlights bitcoin’s issues while latching on to any news that point to bitcoin gaining
acceptance, even if in El Salvador. The complex nature of bitcoin does not help either. Proponents
dismiss cynics with a “you don’t get it” or a “you’re a dinosaur”; at best it affords them a false
sense of comfort. No matter how much they deny the issues, they know better. As I said earlier,
many of them don’t really believe that bitcoin has value, just that they want to believe that it
does. It’s an important difference. The fact that the investors are well aware of bitcoin’s issues,
notwithstanding their unwillingness to acknowledge them, keeps them on edge. Such fragile
confidence explains why bitcoin behaves like a speculative stock and not like a safe haven when
the market goes risk-off. Had the investors really believed in bitcoin, it would have behaved like a
store of value during downturns in risky asset markets. Investors’ shaky trust in bitcoin also
manifests itself in bitcoin’s perennially high volatility and frequent large drawdowns, putting to
rest any notions of bitcoin being a store of value.

The price chart below clearly highlights the volatile nature of bitcoin.

Price (USD)

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C. WHAT LIES AHEAD

Speculative liquid asset markets such as stock markets tend to overshoot beyond their value
when there is too much optimism or too much pessimism. In a similar vein, the crypto world is a
perfect example of digital technologies overshooting their utility. It is increasingly getting
detached from the real world. Value can’t be created from nothing. It’s a matter of time when
bitcoin’s value will dwindle down to zero. Let’s explore what might be the potential triggers that
can prove lethal to bitcoin. Before that, let’s take a look at the factors that are unlikely to be the
triggers themselves but can catalyse bitcoin’s fall.

1: CATALYSTS TO DOWNFALL

Catalyst 1: Regulatory clampdown

Ever since bitcoin acquired its critical mass of popularity, it has been under constant regulatory
scrutiny for the following reasons -
• Criminal activity – As has been spoken earlier, bitcoin has been a preferred vehicle for a wide
range of criminal activity. Governments all over the world have been evolving tools to counter
this undesirable development. Unsurprisingly, countries have exhibited varying degrees of
hostility towards bitcoin. Some have prohibited use of bitcoin while some others have
restricted mining bitcoins. Many others have put restrictions on intermediation by financial
institutions.
• Weakening of policy tools – Tax evasion, enabled by bitcoin, will dampen tax collection
thereby weaken the government’s ability to redistribute wealth and fund welfare programs.
Bitcoin being inflexible, it renders ineffective the ability of central banks to pull monetary levers
in order to adjust to changing economic conditions.
• Deflation risk – Bitcoin is naturally deflationary. Of course, the set of cryptocurrencies takes
together is infinitely large and hence not deflationary. However, bitcoin, by itself, is indeed
deflationary. Deflation adversely impacts demand. Low but sustained inflation is desirable.
These are well-researched topics; enough has been written about them so I will skip the details.
If bitcoin replaces fiat currency then the world economy will see similar problems which used to
occur under the Bretton Woods system.

Catalyst 2: Growing environment activism

Bitcoin mining is energy-intensive. The bitcoin ecosystem is estimated to consume about 150
terawatt-hours of electricity annually, thereby being directly responsible for 60 million tons of
carbon dioxide emission. A world that is cutting back on emissions and is adopting cleaner and
greener energy sources to meet the energy needs of its population cannot afford an unnecessary
misadventure that is exacerbating the problem of global warming as we speak. Besides, bitcoin
mining produces large quantities of electronic waste arising from discarded computing hardware.
Less than 20% of electronic waste is formally recycled. The remaining ends up in landfills and
local water bodies or is incinerated or informally recycled. The outcome is pollution of soil, air and
water.

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Catalyst 3: Forking
In their attempts to solve for the design issues of bitcoin, whether those associated with
transaction efficiency or mining viability (discussed later), the bitcoin community will need to fork
new variants out of bitcoin in the future. Every such instance of forking will require the investors
to decide which forks to go with and which ones to forgo. In other words, a buy-and-hold
strategy is not going to be an option. More importantly, a bad decision can have a very large
adverse impact on the eventual realized returns. Whenever such forking instances occur, many
investors could get disenchanted and exit.

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2. TRIGGERS THAT MAY CAUSE DOWNFALL

Trigger 1: Worsening mining economics

• Rising cost of energy - Bitcoin cannot survive without a healthy mining community. The
miners face a number of challenges. Being energy-intensive, the cost of energy is a significant
part of the total cost of mining. Years of under-investment in fossil fuel based sources,
inadequate replacement investment in renewable energy sources, geopolitical issues in the
fossil fuel source regions, and QE-driven fast economic recovery - all of them have contributed
in setting energy price into a bullish trajectory; this could easily last a few quarters, possibly
much longer. There will be a corresponding increase in mining cost.
• Halving - A bitcoin “halving” event is when the reward for mining a new block is halved. By
design, is occurs when 210,000 new blocks are added to the blockchain, which takes roughly
four years. The last halving occurred in 2020 and the next one is predicted to happen in 2024.
It will continue until the predefined cap of total 21 million bitcoins is reached. Each halving
event cuts mining rewards by half. After the 21 million cap is reached, there would be no
reward for mining. The miners will then have to depend on transaction fees only.
• Reward correlation with price - Mining rewards come in bitcoins so as bitcoin price falls, so
do mining profits. The beginning of QT marked a sharp fall in the price of bitcoin. As discussed
earlier, bitcoin has demonstrated striking resemblance to speculative assets. Its price is heavily
influenced by the level of fiat money supply. Harsh economic events can cause a precipitous
fall in bitcoin’s price, potentially rendering mining unviable.

As can be seen in the chart below, the revenue earned by miners per unit of hash rate (a measure
of the processing power of the network) has fallen considerably since 2018.

Bitcoin miner revenue per TH/s (7-day moving average)

• Concentration risk - Another risk associated with mining is concentration. Bitcoin is

vulnerable to what is known as 51% attack. Bitcoin mining isn’t as decentralized as it is
thought to be. Reportedly, there have been times when greater than half of all mining activity
was concentrated in the hands of an individual or group of individuals. Such concentration can
happen again, especially if mining rewards become less predictable. If such a miner turns
rogue, the integrity of the bitcoin ecosystem can be compromised.

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Trigger 2: Investor base exhaustion
Earlier in this article, we discussed how the Greater Fool theory was at play in setting into motion
the virtuous cycle that catapulted bitcoin to its meteoric highs. The cycle needs a perpetual
supply of new money chasing bitcoin to keep running. Obviously, it cannot go on in perpetuity.
Therefore, the relevant question is – when will the supply of new money end? Timing the end is
indeed going to be hard. Let’s look at how it might happen and, at least, raise the right questions,
even if we do not have the answers already.

There are two sources of new money –

1. Existing investors putting in more money, and
2. New investors dabbling for the first time

Existing investors – They have all the accounts already set up with wallet service providers or
other intermediaries so they can be nimble-footed when the market offers good entry
opportunities. However, the existing investors have also witnessed high volatility in their crypto
portfolio, especially recently as bitcoin price fell sharply from the highs of around $68000 to
under $20000. There is no credible data source but from hearsay I gather that when bitcoin was
making new highs, many retail investors were hoping to double down if it fell to $30000 levels.
The same is indirectly corroborated in the chart below. Referring to point A in the chart, notice
the greatly increased trading volume (dark grey bars) once bitcoin price fell to $30000 levels.

Bitcoin price (USD)

Source: www.seekingalpha.com

After failing to decisively scale back above $30000 for some time, the fall resumed; refer to point
B in the chart. As soon as the fall resumed, volume came back down, indicating that probably
those who doubled down at $30000 finally surrendered. A typical investor does not put in any
fresh money at such a time. The key takeaway is that the existing investors will probably not
double down further, at least not in a hurry.

New investors – Improved access has attracted successively less savvy layers of the society to
bitcoin. Despite having had no encounter with bitcoin in their day-to-day lives, many less savvy
investors are getting inquisitive about it. A typical financially literate person has considered
investing in bitcoin some time or the other. A bulk to the newbie set of bitcoin investors can
barely distinguish between blockchain and bitcoin. When such investors join the fray chasing …

Copyright Bluewater Capital, 2022 14

… quick gains from bitcoin’s rise, it is a red flag for me. It is hard to say whether this is the last leg
in the virtuous cycle that bitcoin has been enjoying, but that is probable. A couple of quarters
ago, Facebook reported a fall in subscriber base; the first time in its history. More recently, a
similar story unfolded at Netflix. I will refrain from drawing direct parallels with Facebook and
Netflix but they do serve to remind us that the new money tap will run dry someday. Refer to the
chart below. The number of active address on the bitcoin network has fallen from its peak of
2021.
Number of active addresses on the bitcoin network (7-day moving average)

This exhaustion of investor base is sure to happen sometime unless some other trigger brings
bitcoin to naught sooner.

When the new money music stops, bitcoin will fail to scale the previous highs. Time will pass
without bitcoin giving the high returns people have come to expect from it. Some investors will
lose patience and exit, triggering a fall. Now, since bitcoin has always been very volatile, many
investors will tolerate drawdowns to an extent. The better informed institutional investors will
seek to exit before things exacerbate. At the same time, some investors will instead go “bottom
fishing”, emboldened by a fleeting support to bitcoin by a space-exploring billionaire with
millions of followers, many fanboys among them, on social media and who would make a quick
billion or two from trading bitcoins in between his tweets, supporting bitcoin at first only to take
a U-turn shortly after. Oh, did I mention the same billionaire also showed a short-lived interest in
dogecoin too, a cryptocurrency whose only use case seems to be “fun”. Coming back to our
discussion, stronger out flows driven by the institutions will keep bitcoin from staging a
significant comeback. More and more investors will begin to lose patience and a classic vicious
cycle will ensue. Exits will push the price lower, worrying the remaining investors, who will in turn
begin to lose patience. When such a cycle sets in, selling begets selling. The cycle will lose steam
at times as bouts of doubling down will outdo the selling pressure. The result will be a wavelike
price pattern, instead of a one-way crash, akin to speculative asset markets. Eventually, the fact
that most investors are in it for a quick buck and not because they really believe in the future of
bitcoin will cause its undoing. I would not write the obituary for bitcoin just yet because a
collective belief system that has gone past a threshold of popularity does not die easily. At the
same time, I will not be surprised if the bitcoin ecosystem collapses before the ongoing
Quantitative Tightening ends.

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3. WHAT TO LOOK OUT FOR

I will end with some questions. Of late, bitcoin has been trading in a relatively narrow range,
hovering around the $20000 mark. It has already fallen much from its 2021 highs.

The questions -
• Are the existing investors looking forward to doubling down at lower levels or are they frozen
with fear?
• Are too many of the new investors yet to join the bitcoin party or are most of them already in
(and worrying about the recent sharp fall)?

We need to be watchful of any data/development that indicates one way or the other on the
above questions.

Concluding remarks: A bitcoin believer’s idea of utopia is one where the

government’s competence is doubted, its intent is looked at with suspicion and the
banking system is distrusted. Regulations have their merit. The trust-based system of
financial intermediaries have stood the test of time. Bitcoin achieved decentralization
at the cost of using technology that doesn’t scale well, isn’t secure, isn’t efficient, isn’t
resilient either. In all likelihood, the eventual outcome of this whole bitcoin affair
would be that the traditional financial systems will adopt blockchain and other useful
crypto concepts such as smart contracts, tokenization, etc. wherever useful. As
regards bitcoin, evidence suggests that its creator didn’t intend to make a get-rich-
quick scheme that FOMO-stricken investors have turned it into. The high price that
people are paying for bitcoin is only backed by hopes of finding a greater fool.

Copyright Bluewater Capital, 2022 16

Thank you

Title page image credit: Alesia Kozik

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