Where’s the bottom for bitcoin?. Predicting the crash and the next… | by The Gift Of Fire | Nov, 2022

Bitcoin is down 75% in the last year, from a high of around $68,000 to around $16,000 today.

But this isn’t the first bitcoin crash. It’s gone through cycles of extreme optimism and pessimism for the last 10 years:

After the last peak in 2017, it dropped 84%.

After the 2013 peak, it dropped 83%.

If history repeats itself, this cycle down will end somewhere around $10,000 and there will be another cycle up to a higher level, peaking at $200,000 or higher in 2025.

Some bitcoin enthusiasts make predictions with this rainbow chart:

Their forecast says it’s time to buy bitcoin. But it also looks it didn’t predict the last peak price.

Is there a more accurate way to do this? Where does the model come from?

Models for bitcoin’s future

It looks like the rainbow chart was inspired by fitting a curve to past data and projecting that into the future:

The model seemed to keep working for the peak in 2017, but then it overpredicted the peak that happened in 2021.

This model has no logic to it, though, it’s just projecting a trend line into the future.

A more logical argument is the Stock to Flow model, from PlanB.

PlanB’s argument compares bitcoin to gold. Gold is valuable because it’s rare. There’s a certain amount that’s been dug up already, and a smaller amount that gets dug up every year.

The ratio is about 65 to 1, of gold reserves to yearly gold mining.

Silver isn’t as rare. The ratio is only about 22 to 1. And silver is less valuable than gold.

Bitcoin mining produces more bitcoin, but the rate slows down over time. Every 4 years, the code changes so that miners produce half as much bitcoin. The stock to flow ratio increases, over time. Bitcoin gets more valuable, every 4 years.

PlanB made a chart with historical bitcoin prices (colored dots) compared to gold and silver:

The model was made in 2019, and predicted that bitcoin’s price would surge in 2020 after the mining rate halved.

The model predicted bitcoin would hit $55,000.

The actual peak, 2 years later, was $68,000.

This looks more scientific, but it actually has a lot of problems.

It’s still just a logarithmic fit to previous price data, with gold and silver thrown into the same chart to suggest that the order of magnitude is roughly correct.

In the real world, there are things that are scarce that are not valuable.

I have written 70 posts in this blog. If I write another one every year, the stock to flow ratio for my blog posts is the same as gold. That doesn’t make my blog worth 10 trillion dollars.

For any dead artist, the stock to flow ratio is infinite. They will never produce more art. But that doesn’t make their art infinitely valuable.

Assets are worth whatever someone is willing to pay for them. Bitcoin is only valuable to the point people are willing to pay a lot for it.

A bigger problem with the model is that the future predictions get impossibly large.

PlanB’s equation says that bitcoin’s price will go up 10 times, every 4 years.

After 2024, it predicts the price would go up to $500,000. Bitcoin would be worth as much as all the gold in the world.

In 2028, to 5 million.

In 2032, to 50 million. By then, it would be worth more than all the stocks and bonds and houses in the world.

We live in a finite world, exponential growth can’t go on forever. So, where’s it going to stop?

Bitcoin mining uses a lot of electricity, and that sets one limit

Every miner on the bitcoin network processes transactions in exchange for a possible mining reward.

The network processes one block every 10 minutes.

Every miner that processes that block tries to solve a cryptographic puzzle. The difficulty of the puzzle adjusts, over time — the more miners that are working, the harder the puzzles get. That keeps them from solving it too quickly, the difficulty gets adjusted so that it still takes about 10 minutes.

Each computer is basically trying random numbers to solve an equation, the computer that finds the right number gets rewarded with some bitcoin. There are millions of computers trying, so it’s very unlikely that any one will find the answer. Miners join together in mining pools that share the winnings.

Right now the reward is 6.25 bitcoins. That’s about $100,000 at today’s price, but with a higher price of bitcoin, the reward for mining goes up. At 2021’s peak it was $400,000.

In one year, about 50,000 blocks get processed. That sets the total revenue made by miners. If bitcoin costs $10,000, the miners bring in 3.2 billion dollars per year.

As the income goes up, more people are incentivized to start mining. If bitcoin goes up to $100,000, the miners now earn 32 billion dollars. Either, the miners all get richer, or more people join the mining business.

Think of it like pigs feeding at a trough. As the trough gets bigger, more pigs can show up and feed.

The trough can sometimes shrink, for a couple reasons. For one, there’s the halving: every 4 years, the reward that miners get is cut in half.

Beyond that, the bitcoin price crashes sometimes. During those times, the mining revenue goes down, miners struggle to pay their power bills, some of the miners quit, some hold on to their bitcoin earnings waiting for the next cycle.

But, as long as the price does keep going up, the trough gets bigger again. The number of computers that start mining keep going up with the price:

As more machines join, the puzzle difficulty adjusts to keep up:

So, the total compute power doesn’t really matter. The only things that matter are the price of bitcoin and the number of miners sharing the reward.

Mining puts one limit on how high the price could go. Here’s the total mining revenue, for a given price and a given year:

Like, bitcoin is definitely not worth 100 million dollars. If it was, the miners would earn 32 trillion every year. GDP in the US is only about 20 trillion dollars.

That doesn’t set a hard limit, though — bitcoin could go to a million dollars this year and the miners would only earn $320 billion. That’s large, but it’s not an impossible number. It would be less than 2% of the US economy. Apple makes about that much revenue in a year. US households save more than a trillion dollars a year. If people started putting lots of money into bitcoin, it could go to a million dollars.

A tighter limit comes from power consumption.

All those computers burn a huge amount of electricity to crunch numbers, and that goes up as more miners join the network:

Bitcoin uses about half a percent of the world’s electricity. It uses more than many countries:

We can make the same table, except now we’ll look at what percentage of world power consumption bitcoin would use, for a given price:

Now, 1 million dollars in 2022 looks impossible. The miners would use so much power that it would use 10% of the electricity in the world.

The world is already struggling to produce enough energy, with soaring prices for oil and gas. We’re facing a long struggle to replace fossil fuels with lower carbon equivalents.

It’s hard to put an exact limit here. A million dollar bitcoin price by 2030 could maybe be possible — that would make bitcoin twice as valuable as gold, and it would only use 2.5% of world power consumption (about 5 times as wasteful as bitcoin is today).

I’m going to guess that governments would try to pull the plug on bitcoin before it starts wasting 10% of the world’s electricity.

How could governments stop it?

Governments could just ban possession of bitcoin. It’s already illegal in some countries, partially restricted in others:

That wouldn’t really stop anyone from using it, you could still run the code, the government can’t block internet traffic. But it would limit the number of people who were interested in investing.

Making a mainstream website like Coinbase draws in unsophisticated investors. Forcing people to hide their transactions doesn’t draw in users. You need a lot of users to support a high price.

Governments could also ban mining.

China banned it in 2021 and mining dropped across the bitcoin network.

It’s hard to imagine the US banning it, because it would harm crypto billionaires, and regulators never want to hurt the rich.

But it would also harm US markets if too much money left the stock market and went to bitcoin and all the power went to mining. Other billionaires might complain and have more influence on the regulators.

Some miners in China started back up, after the ban. But it wouldn’t be that hard to enforce, with a bigger network. You couldn’t hide mining operations that used that much power.

You don’t need a huge network, to run bitcoin, but high prices usually encourage a large network. If governments cracked down on most mining and the price of bitcoin was still really high, then the miners that avoided the crackdown would be highly profitable. Mining might end up like trafficking drugs, where it’s high risk but highly profitable.

But you still need a lot of people that want to own crypto, and to pay high prices for it.

People might just lose interest, instead

After the FTX bankruptcy, thousands of users lost their crypto investment. After previous exchanges were hacked, bitcoin users had their money stolen.

Some people bought it in 2021 to get rich quick. Instead, they lost 75%.

Others bought it as a hedge against inflation. That didn’t work very well.

People could get jaded and disinterested, after repeated market crashes. It’s one thing if bitcoin is a niche market for 1% of people and some of them lost money. If 20% of the population has already tried crypto and lost money on it, that gives it a bad name.

If 50% of people get involved with crypto, and then there’s a crash, that’s closer to game over. The same thing happens with the stock market, of course. People get discouraged for years after a bear market. But the stock market eventually goes back up over time, as the economy grows.

Bitcoin only grows because more and more people get interested in it. There’s no underlying wealth, there’s no guarantee it’s worth something in 10 years, if people lose interest.

People could also lose interest because some better cryptocurrency takes the lead as a bigger market, a safer market, or a faster growing investment.

Or they could lose interest because they realize it only thrives from bringing in new investors.

The only value is in selling it to someone else

It’s a “store of value”, but its value fluctuates wildly.

It’s a “hedge against inflation”, but it just dropped 75% while inflation picked up.

It’s a “means of payment”, but it takes at least 10 minutes to transfer funds (really more like one hour if you want to avoid fraud).

Suppose everyone used it, instead of dollars. There are about 21 trillion dollars in the world. There are 21 million bitcoins. Each bitcoin becomes worth a million dollars. But, we also increased world power consumption by 10%.

Maybe the price stabilizes, now that everyone’s using it.

It wouldn’t rapidly appreciate, anymore. It doesn’t pay a dividend.

If it were used in place of the dollar, it would be the dollar. To grow your money, you’d want to invest in stocks, again.

What’s actually been gained? It’s anonymous. It’s decentralized. Maybe it’s easier to save money, because the government can’t print money and cause inflation.

For the most part, the biggest difference is that the people who invested in it early are a lot richer than the people who bought in late.

The main value in Bitcoin is that the early adopters get rich off the late adopters. Just like any ponzi scheme.

The only big question is whether there will be another bull market with new adopters.

A pew research poll in 2021 asked how many Americans had invested in crypto:

It’s getting close to 50%, for young men. So we might already be at a point where half of the main user base has been burned by a bitcoin crash.

There is still room for growth, if more people get interested.

Women are mostly not investing in crypto, and hardly anyone over 50 is.

Boomers still have half the wealth in the country, so there’s a huge opportunity there, if you could convince them it’s worth something, or that they should allocate a certain percentage to it.

Maybe if companies decide they need to hold some crypto on their balance sheets, that forces a lot of money into the market.

Maybe if billionaires all decide to own some, that forces more.

Maybe there’s some way to market crypto to women.

And there’s room for international growth.

Maybe the biggest question is what young men think about it. Are most of them frustrated with it, because they lost money in this bear market?

Or are they thinking about that rainbow chart, and how they’ll all get rich in the next 4 year cycle? Are they ready to throw more money at it, in the next bull market?

It’s hard to say, but I’d guess we haven’t seen the last bitcoin bubble.

Should you buy it?

That really depends where you are in life, how much money you have, and what your tolerance for risk is.

More than anything, it comes down to only one question:

“how afraid are you of missing out?”

A $20 investment in 2010 became a million dollars in 2021.

The returns aren’t going to be anything like that, going forward. But lots of people wish they’d gotten in earlier. And many might jump in again if the price starts rising.

There’s still some chance that a $10,000 investment during this bear market could become $100,000 in 3 years, or even a million dollars in 10 years.

Try to think about where you’ll be in 10 years. Suppose bitcoin survives and goes to $500,000 or 1 million. How would you feel about missing out on that? Suppose bitcoin goes to zero. How would you feel about losing $10,000?

Place your bets accordingly.