The recent growth in bitcoin prices has been absolutely astounding. During the month of December 2016, the value of a unit of the cryptocurrency increased by $211.79 (€202.45) rising from $758.38 (€724.92) on December 1 to $970.17 on December 31 970.17 (€927.37) according to data provided by Coinbase.
By January 2, 2017, the price of a bitcoin had risen to $1,029.98 (€984.54), Coinbase reported. The payment processor also estimated that the price of bitcoin had grown by the $560.56 (€535.83) in just a year. Back on January 3, 2016, a bitcoin was selling for just $432.51 (€413.43) apiece.
Even the mainstream media began to notice the bitcoin price increased by 125% during 2016, Reuters reported. So what is behind this boom; is it mindless speculation like that which drove the last bitcoin bubble in 2013 or is this organic growth?
The current bitcoin growth appears to be driven by a combination of macroeconomic trends and popular fears about recent political and financial events. Understanding these trends and fears can show us where bitcoin and the economy are going and what steps investors can take to cash in on them.
The Trends and Events Driving Bitcoin’s Astounding Growth
Some of the trends and factors driving bitcoin’s astronomic growth include:
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The strong United States dollar. The greenback has risen to a 14-year high because of the Federal Reserve’s latest interest rate hike. That hurts other currencies such as the yuan which lost 7% of its value in 2016. Investors dump those currencies to buy dollars driving their prices farther down. This drives bitcoin’s price because many investors associate the cryptocurrency with the dollar. Buying bitcoin is a cheap and easy way to buy dollars and protect investments from their rise.
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Hedging. Bitcoin is a cheap and very means of hedging savings and investments against macroeconomic changes such as the strong dollar and inflation, South African entrepreneur Vinny Lingham recently pointed out. Buying bitcoin gives average people all over the world the ability to hedge their funds at the press of an app. One reason why people use bitcoin to hedge is that it increases their buying power.
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Higher interest rates. Higher interest rates generate inflation and drive down currency values by making it more expensive for corporations and governments to conduct business. They end up spending more of their money to buy less which pulls cash out of the economy and further depresses the currency. This hits countries lots of debt and those dependent on natural resource exports hard.
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Hyperinflation. The rate of inflation in Venezuela reached 131% on December 11, 2016, the Cato Institute reported. This is driving demand for bitcoin in Venezuela, and undermining faith in currencies in other countries. Riots and the antics of the nation’s buffoonish president; Nicholas Maduro, generate news coverage of mess in Venezuela which drives fears in other countries and interest in hedging mechanisms like bitcoin.
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Inflation. Inflation has been increasing in a number of countries including Mexico where the consumer price index rose to 3.48% by mid-December because of a weaker peso, The Wall Street Journal reported. Inflation was also at a two year high of 1.3% in the United Kingdom in early December because of higher clothing prices, the BBC reported.
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Fears of inflation. Even worse than inflation itself, is the fear of it. Fears of inflation encourage investors to dump cash or equities in favor of vehicles seen as more stable such as gold or bonds. Others seek more liquid alternatives such as foreign currencies (the dollar) or bitcoin. In recent months there has been a great deal of hysteria about inflation, including predictions that the election of Donald J. Trump as president will lead to inflation in the USA.
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The low price of gold. One reason for the interest in bitcoin is the low rate of return on gold lately. The price of an ounce of the precious metal only increased by $73.90 (€70.64) over the course of 2016, rising from $1,078.40 (€1,030.83) on January 4, 2016 to $1,152.30 (€1,101.47) on January 2, 2017. The lack of movement for gold prices is driving some investors to look for alternatives like bitcoin.
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The low price of oil. Low oil prices are the root cause of Venezuela’s hyperinflation, but they’re also wreaking havoc in other countries dependent on oil exports such as Saudi Arabia and Russia. Saudi Arabia has already had to raise taxes and cut government spending to cope with lower prices. Russia is straddled with a weak ruble and a 7.39% rate of inflation. Higher inflation drives the urge to hedge and to move money out of oil-based economies which helps bitcoin.
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Demonetization. The sudden declaration of currency as worthless is a black swan event that can drive sudden increases in bitcoin values. 2016 saw one of the world’s most massive and sudden demonetizations when Indian Prime Minister Narendra Modi declared the 100 and 500 rupee bills; which made up 86% of the nation’s currency, no longer legal tender on November 8. Not be outdone Venezuela’s Maduro triggered rioting in December by declaring the 100 bolivar note demonetized, then reversing his decision. Such actions drive interest in bitcoin by undermining or destroying faith in currency and giving everybody a strong incentive to dump the national currency as fast as possible.
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Currency controls. Around 95% of the world’s bitcoin trading takes place in China which has strict rules on currency transactions that are getting tighter. Under current regulations Chinese nationals can only exchange $50,000 (€47,794.30) a year, a restriction that can easily be circumvented with bitcoin. Starting in January 2017, transfers of more than 50,000 yuan ($7,201 or €6,883.33) will have to be reported to the People’s Bank of China. Nor is it just China, Spain now limits cash transactions to €1,000 (€1,046.15). Currency controls undermine faith in the national currency, by convincing citizens that something must be wrong with it.
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Brexit and fears about the Euro. The successful Brexit vote in the UK, raised fears about the demise of the Eurozone and the return of worthless inflation-plagued national currencies such as the Italian lira. Britain itself has been plagued by fears of the pound’s collapse, inflation and Scottish independence. The uncertainty is increased by events like the recent Italian referendum and the rise of nationalist political parties in France and Germany.
Disturbingly this is just a short list of the trends driving bitcoin’s rise. The popularity of the cryptocurrency shows just how quickly the world’s economy is changing. One trend is certain the volatility will continue and with it a desire for alternatives to the traditional financial system. That might drive bitcoin; or some other cryptocurrency, to even greater heights and totally disrupt the market.
