In the past week, selling pressure on Bitcoin from mining companies that process payments in the digital currency has accelerated, prompting more rounds of selling and falling prices. The onslaught pushed the CoinDesk Bitcoin Price Index as low as $173 on January 14 the first time it traded below $200 since November 2013 before rebounding higher yesterday.
The challenge faced by mining companies is that while they are paid in Bitcoins, their operational costs are paid in hard currencies and maintenance costs have been rising as the difficulty of mining new Bitcoins increases. As prices have declined, the payments processors earn less, yet still have to pay out expenses in hard currencies with Bitcoins that are worth less. Weve seen a lot of these guys folding basically in the last few weeks because its not even worth it for them to power the equipment to do the payments processing, says Greg Schvey, partner at TradeBlock, a New Yorkbased Bitcoin trading data center.
Mining processor troubles hit the headlines January 12 when London-based Bitcoin mining service company CEX.io temporarily halted operations because they had become unprofitable. Suspension of CEX.io cloud mining service is only a forced temporary measure, the result of cloud mining costs exceeding mining profit, stated Jeffrey Smith, chief information officer, in a blog post to follow on a Tweet in which he made the initial announcement. CEX.io is looking for lower cloud mining and maintenance costs based or higher Bitcoin prices to allow it to resume operations. Smith told CoinDesk that Bitcoin prices would need to rise to $320 for the company to resume operations, absent any cost savings for operations.
The next day, CoinTerra of Austin, Texas, reported it has been forced to default on $4.25 million of secured notes after being shut out of its data center where the firm ran its mining operation. CoinTerras service provider, C7 Data Centers of Bluffdale, Utah, has sued it for nonpayment of fees. Who would predict the downfall that Bitcoin has taken, in terms of price and difficulty and all that? CoinTerra CEO Ravi Iyengar told CoinDesk January 15. A lot of things have happened that were not foreseen. Iyengar told CoinDesk its next step would depend on how C7 proceeds.
By any measure, Bitcoin is a volatile and inefficient market in which spot prices in hard currencies on exchanges, most of which are outside the U.S., can gyrate wildly in a single day and are vulnerable to disruptions in exchange operations and potential hacking of stored digital currencies. For example, on January 5, Sloveniabased Bitstamp exchange, a leading trader in Bitcoin and U.S. dollars, discontinued service after a hack of some of its wallets, raising worries of another repeat of the collapse of the Mt. Gox exchange in Tokyo a year earlier. Bitstamp restored trading on January 9.
Since the CoinDesk Bitcoin Price Index skyrocketed to a high of $1,147.25 on December 4, 2013, market gyrations have continued even as more venture capital and new start-ups expanded the reach of Bitcoin and the scope of its ecosystem, as its advocates call it. In 2014 prices rode a roller coaster in the first half of the year, then began a bumpy decline in the second half, falling from $665.73 on June 3 to $319.70 on December 31, 2014.
On January 14 the dollar price of Bitcoin plunged 21.9 percent (from $226.98) to end the day at $177.28, then recovered 18.7 percent to $210.46 at the end of the January 15. Given that Bitcoin is traded around the clock, seven days a week, the Bitcoin market close is determined as the last trade just before midnight UTC, also known as Greenwich Mean Time.
Bitcoin veterans are undeterred by the recent volatility. Ive been involved in the Bitcoin space since 2011 and Ive witnessed several different periods where theres market movement and then new equilibrium levels are set, [and the current turmoil] is no different from what Ive tended to see over the last couple of years, says Paul Chou, co-founder and CEO of LedgerX, a Bitcoin trading company that has applied for approval from the Commodities Futures Trading Commission to operate as a derivatives exchange and clearinghouse.
Schvey at TradeBlock says the current shakeout in payment processors will lead to a new equilibrium. What happens is at a certain point miners are paid out by the network in an amount proportional to the computational power they deliver, he says. So people with higher operational costs are pulling out of the market. That, in turn, will reduce the competitive pressure on surviving mining companies, which means that those other people will reach profitability faster, will earn more Bitcoins for the some amount of computing power, which also means they will have less incentive to go out and dump [coins] in the market, he explains. Even if Bitcoins are worth less, by reducing operating costs, the surviving payment processors will have less incentive to sell, he explains.
Some market participants question the claim that selling by miners has driven down the price of Bitcoin. Its just an assumption people are making, says a trader who does proprietary trades for institutional investors. It could be true, but where is the evidence? he asks. The trader says it is more likely that the temporary suspension of trading at Bitstamp early in January is the larger factor that has spooked the markets the same way the collapse of Mt. Gox did a year ago.
Regardless of the cause, selling pressures can be mitigated if more investors come into the Bitcoin market. A U.S.-regulated derivatives market could bring in those needed investors, according to Chou at LedgerX. With a functioning derivatives market, payments processors could enter contracts to protect downside losses and avoid the prospect of having to dump Bitcoins in times of market stress, he explains.
Historically in other asset classes, not only Bitcoin, as people jump on and board and start to use derivative instruments to monetize that volatility, what we tend to see is that naturally the underlying spot and asset class volatility goes down, Chou says. I expect to see the same thing in the Bitcoin ecosystem as well.