Ripple Effect and Price irrationality of Bitcoin

Irrationality in prices

Behavioral economists have tried to correlate and predict price movements in markets with behaviors of traders. Since most such analyzed markets were in stable economies that were efficient and usually upheld the rule of law, irrationality was quickly absorbed by markets. Irrational exuberance, as in the times of the dot-com boom quickly devolved and disappeared. All this was good, as long as the markets were local (geographically) and as long as traders were local firms that were under the purview of the law of the land.

With Bitcoin, things have changed.

With a 24X7 market and a globally available(distributable) asset, these behavioral inconsistencies can potentially last for a long long time. Off late, this irrationality and exuberance have meant arbitrage opportunities for other asset classes in nations where political and economic instability have taken place.

Such instability has had a tremendous spillover effect on the price of Bitcoin. Over the past 3 days, since the regime was toppled in Zimbabwe, citizens have Рattempted to move their assets into Bitcoin. Exchanges for the local currency saw brisk trades giving it a rise of over 200%.

Ripple Effect

However, these prices are mostly local and do not spiral out to global markets, on account of low demand for such expensive assets. For example, the markets in Zimbabwe have had less than monthly transaction volume of USD 1 Million. Compare this with an average daily transaction volume of greater than 1.4 Billion USD for Bitcoin globally.

This clearly shows that though local markets can, at times, in the face of sudden economic uncertainty exhibit irrationality in prices; global markets will not be affected unless volumes are large.

You can consider this as similar to a ripple effect on a large pond of water. Unless and until the stone thrown into the pond is large enough the ripples will not reach the edge of the pond. In Physics and Economics, this is modeled as a Ripple Effect.

Question: How much of a volume is needed to move the price up irrationally for Bitcoin in a global market?

Forks – Bitcoin vs. Ethereum

Bitcoin’s forking problem

Today’s fork created Bitcoin Gold. A couple of month’s back there was a fork that led to the creation of Bitcoin Cash. Again in November, there is going to be another fork to Segwit2x. Many more forks can happen down the road -each claiming to have a new variation of the Bitcoin blockchain. Afterall, bitcoin’s source code is open source, and so is the blockchain accessible to all participants. If a group of people decides¬†to host nodes with a particular version of the BTC code software with a particular change in the code (or logic) and start mining their own blocks a new chain is created.

The largest challenge for participants(traders, nodes, exchanges, miners) in the crypto-ecosystem is to identify that one of the forks is the original Bitcoin. Recently a couple of early adopters (Bitcoin millionaires) started claiming that Bitcoin Cash was the original Bitcoin and that they would fight for the rebranding.

Needless to say, this looks like the wild west in finance, where many versions of the same chain can exist independently, without anyone to control or coordinate these changes. (Time series Price correlations between Bitcoin Cash and Bitcoin has been < 0.6 since the birth of Bitcoin Cash).

Every exchange that supports Bitcoin will at the time of the fork have to decide at the  time of the fork to either support or to not support the fork. This is tedious work, to ensure that wallets of all users now access the corresponding keys on different blockchains to reflect the right balances. For exchanges will millions of users like CoinBase, Kraken, etc. this is a huge software update challenge.

Ethereum’s Fork (No! Problem)

Compared to Bitcoin’s forking problem, Ethereum’s hard fork to the Byzantium release did not create either a new chain or a new token variant of Ethereum. The Ethereum ecosystem, though, closely resembling Bitcoin’s ecosystem rallies around Vitalik and the Ethereum Foundation’s proposed changes. This is a wonderful model for large scalable open source systems, and, is slowly but surely leading to a self-regulated environment wherein a core team decides the roadmap for scaling (or other features) to be rolled out. The entire community of nodes, miners, and developers rally behind the fork and adopt the fork almost instantaneously.

Scaling the network, for all participants i.e. nodes, exchanges, transaction endpoints such as payment nodes, etc. become significantly simpler with Ethereum’s fork.

Cryptocurrency and the cost of holding an asset

One of the most neglected portions of “transaction costs” is that of the cost of holding an¬†asset.

Examples of holding costs

If one holds fiat currency (i.e. in the form of currency notes or coins), the fiat currency runs risks of official demonetization, devaluation or of theft.  Similarly, just holding currency at 0% interest in a bank account, will lead to a gradual loss on account of inflation. Periodically, since the beginning of the existence of fiat money, governments all over the world have retired old currency notes in favor of new ones Рsometimes at a jiffy in mass exercises such as demonetization. Occasionally, governments and international monetary systems have devalued existing currencies suddenly. Eg. in Venezuala

If one were to store gold in a bank locker there is a cost to rent the bank locker. Similarly, there is a cost to purifying the gold once it has to be sold after holding it for many years, and so on.If one were to hold other forms of assets e.g. vintage Cars, real-estate, etc. the cost of holding the asset at least equals the cost of insuring the asset and the governmental tax rates prevalent.

In all these cases though significantly smaller than the value of the asset, the cost of owning the asset and holding it proportionally increases with the value of the asset.

Cost of holding is almost Zero with Cryptocurrency

With cryptocurrencies, the cost of holding an asset can tend toward Zero, irrespective of the size of the asset. With cryptocurrencies, while the general thought is that one needs at least own a mobile device or a computer or an online wallet to store the asset, this is not a pre-requisite. If one were to write down ones private keys on a piece of paper, that would suffice to access one’s holdings and to later either transfer or exchange it for fiat currency.

Similarly, if one were to have access to hardware wallets like ledger or software wallets like exodus.io, a series of strings (words in the English language) would be sufficient to access one’s assets anywhere globally.

One could with memory training also significantly remember the passcode or the 12 words needed to recover the wallet. The incremental costs of holding cryptocurrency is also zero, on account of the same mode (wallet address) capable fo holding any incremental value..

Centralization and volatility

Market concentration

Similar to the distribution functions (extreme value) of money in any of its manifestations (M0-M5, i.e. currency notes, bonds, assets, gold or other stores of value), Cryptocurrency markets are also concentrated.

The market share of the top 5 currencies (almost 90%), the network mining hashpower (total Megahashes per second) controlled by the top 5 mining pools (almost 85%) and the top 5 Crypto-exchanges (80% share of volume of trade) all garner the lion’s share of the market.

Similarly, the ownership distribution for cryptocurrencies is highly concentrated. At least, for Bitcoin, the top holders listed here own significant value in these markets.

Signaling and Regulation

While Satoshi Nakomoto remains unknown, though he holds about  $4 billion (at 4000 USD/BTC), several influential holders actively make public predictions of a 10000% growth in value in a short time. To add to this milieu of information is the fact that many amateur analysts contribute to publicly available information about price movements. Compare these signals to that of publicly traded firms.

Publicly traded firms release price movement predictions through a properly audited statement filed with SEC every quarter.  However, public companies do announce product release plans, etc. ahead of time Рbut would never release statements about the valuations of their stocks prior to the result announcements. Additionally, SEC rules prevent insiders (or their relatives) from trading on the corresponding stock for a certain time window close to the announcement of quarterly results. This arrangement prevents many ills such insider trading, or, leaks of information that would have otherwise made markets more inefficient wherein individuals with more information can either go long or short on a particular stock.

Informationally inefficient

¬† Similar regulations cannot be affected in the cryptocurrency market by SEC. Trade in Cryptocurrencies happen¬†globally, and news of events affecting cryptomarkets affect prices across geographic and economic boundaries. Each online wallet creator such as Coinbase,¬†Kraken, etc.. operates as a separate exchange (.e.g NASDAQ, NYSE, etc.), with minor price differences between exchanges. One of the key facets of market efficiency is that the price (at any given time) of an asset (or stock) traded in the market incorporates all information about that asset at that given time. Note that “time”¬† and “information” are of paramount importance in the previous statement.

If this information itself is not good, then volatility would continue to be a characteristic of this market. Informational inefficiency and the difficulty to regulate this market is just one of the other reasons why volatility would persist in these markets.

Problem to ponder

How can crypto-ecosystems regulate information that affects trade?

Can these markets ever become devoid of massive volatility?

Banning Initial Coin Offers

Initial Coin Offers Banned

The role of governments has since time immemorial been to protect its citizens, the assets of citizens, and, businesses by whatever means. Sometimes it was through force, and other times it was through the rule of law. Initial Coin offers were a new way of holding assets of citizens, without governmental control and oversight. This past weekend saw an exercise in such control in China.

ICO's banned
Initial Coin offerings Banned


In China, Initial Coin Offers were banned in total.

While an “outright” ban bought the fledgling market to a grounding halt. Reasons that were attributed to this ‘ban” are many: a significant mushrooming of ICOs (Imagine about 50 online businesses helping create ICOs to raise public money); the high cost to enforce regulations; the extreme bypassing of national banking systems causing capital flight, etc…. There are two sides to the regulation debate. On one side, some proponents of ICOs claimed that a total ban was bad. On the other side of this debate, is the fact that regulations remove bad actors that harm the ecosystem. There are always going to be instances where regulations can completely kill a new market for innovation, but, developed societies always manage to find a balance based on the convictions of experts. The New York hearing in my previous post was an example.

Ease of creating Complex Contracts – bypassing regulation

There have been plenty of businesses raising money from gullible investors bypassing all known capital regulations. The underlying platform in this case Ethereum Рper-se does not have a governance model for launching a new ICO. In fact, anyone can create an alt-coin- as documented here and here.  Ethereum is creating an easy to use graphical web-based interface to enable non-programmers to create tokens (as contracts). The platform can create, validate and transfer tokens across geographic boundaries, and, even financial-economic boundaries. To top it all, these tokens can be configured as a contract which can express complex functionality when it executes on the network. These complex functionalities could be as complex as either a second order derivative that can be traded on exchanges: an example would be Mortgage-Backed-Securities with a dividend option; or; as a simple security: one that holds value and increases as the business grows. These can be bought and sold on exchanges that support the alt-coin.

Hope for a Governance model for new ICOs

With such complex functionality supported, a few bad actors riding on speculative transactions can cause significant mistrust amongst citizens and the government’s ability to reign in bad financial actors. We wish that at some time in the future, either the Ethereum Enterprise Alliance or some other entity sets out a global order to govern new token (and ICOs) releases – so as to give them more legitimacy supporting the aspirations of nation states and their financial needs.

New York District financial services hearing about Bitcoin

This is an interesting video, although held 3 years back.

Amongst the topics discovered, a few interesting things are:
1) How will cryptocurrencies affect society?
2) What does the future hold for it in terms of legal bindings?
3) Do current legal frameworks from SEC, etc. suffice to prevent money laundering, etc.?

4) How does this affect money transmission?

Many of the things stated in this video have come to hold true. A few though like – the Winklevoss twins’ proposal for an SEC approved, ETF for cryptocurrencies have not yet been approved.

Interesting conversation – do you think Bitcoin is future proof?

Interesting Question

Last week, had an interesting conversation with an uber driver at New York, about Bitcoin. ¬†He posed a question to me quite casually – “what do you think – is Bitcoin future proof?” – and then he gives me his insight into why he thought it is entirely not future proof, and, why he has not considered investing in it.


New York Question

He told me that – though he’s in New York and a lot of people are Bitcoin users there (almost an ATM every 5 miles), he is skeptical about the technology because it may not be future proof. He told me that once quantum computing (i.e. a computer that can theoretically compute at very high speeds ) becomes a reality, Bitcoin wallets and other storage devices that store the private keys of users could be attacked using Brute force.

He asked me if bitcoin’s and the other¬†blockchains (such as the Ethereum chain) could withstand such attacks, if large computational and storage power became available, at low costs. ¬†This leads to an interesting problem – if at all answerable.

Computational Power

How much computational power would be needed to compromise the network effects built over years – if at all feasible, if there were infinite computing power and infinite storage suddenly available? Traditionally Moore’s law has been applied to both computing power, and, to storage – and will continue with semiconductors and storage. However, if there were a technological development over and beyond current semiconductor and storage based developments, such as a leap-frogging to quantum computing, this law may become irrelevant.

To Ponder

PS: Question – What would be the computational power needed to brute force the components of the Bitcoin subsystem i.e. wallets, nodes, multi-sig, etc..?


Bitcoin cash – post launch

Bitcoin forked into Bitcoin cash, increasing overall market valuations for all crypto-currencies. While some analysts compared¬†this to unlocking value, the valuation (price) of BCC showed how much the market had awaited a solution to problems (limited block size of 1 MB, that¬†led to large transaction lags¬†and delayed confirmations on the main chain, etc.) faced by BTC. While BCC’s initial blocks were still being mined, exchanges that supported both BTC and BCC started seeing large volatility (imagine a deviation of $400 in a single day) amidst large volumes.


Block monitoring

The following website ¬†-https://www.btcforkmonitor.info/ monitors newly mined blocks on both chains ie BTC and BCC. What’s important to note is that the difficulty level (or number) indicating the mining power needed to mine new blocks for BCC is much lower (and almost at 25% ) than that for BTC. ¬†Despite this fewer blocks are being mined for BCC. Technically, splitting one blockchain into two, at the level of mining has its challenges – since all nodes ¬†that supported BTC prior to August 1st will have to decide as to whether they need to update their code to the new version (BCC) and / or support both versions of the code.

While large market movers (i.e. individual miners, exchanges, traders and pools) expected BCC valuations to either fall or remain irrelevant, in reality, BCC reached a valuation of 1/3rd that of BTC and till date remains at close to 1/10th of the valuation of its parent i.e. BTC. This is probably an indicator of the demand for the technology promise of BCC I.e. Much faster transactions, -an 8 Mb block size, seamless scalability, etc…The market valued ¬†“the solution to problems” faced by the original Bitcoin significantly higher that the value expected by the large players in this ecosystem.

Issues with BCC online wallets

Both coincap.io and coinmarketcap.com show that BCC is a top 5 currency. This has led to a lot of legal, and service problems for exchanges (and online wallets) that promised to not support BCC. Everything from theft, to, possible invocation of “common property law” was decried upon by cloud-wallet users. Eventually, seeing the global support for BCC (despite its volatility) almost every large exchange has some sort of plan to either reimburse their customers in BCC or support BCC in full form (albeit a bit late). It has to be seen whether Bitcoin Cash will live up to user expectations of super fast transactions – that will challenge the dominance of BTC.

Of course, with Coinbase starting to support BCC on January 1st, 2018 almost 10% of the global BTC owners will now have access to an equivalent number of BCC, which will flood the markets at that time.


Also, read:

  1. BTC and BCC -http://notesnewtech.com/2017/07/31/btc-and-bcc/
  2. Technology maturity and stability –¬†http://notesnewtech.com/2017/07/23/technology-maturity-blockchains-stability/


This week, Bitcoin forks. About 99% of the network including the miners, exchanges, user nodes will continue to support the original BTC, which has agreed to roll in the Segwit2X patch for scaling. However, many of these exchanges have taken a stand that they will not support the BCC chain.

Bitcoin Cash

However, the rest will move onto BCC (Bitcoin Cash), an alternative currency supported by a few miners, and, developers. ( Read more about BCC at its website https://www.bitcoincash.org/. ) There are quite a few main exchanges like Kraken that are neutral to BCC.

This has happened earlier with Ethereum – wherein two coins were born i.e. ETH and ETC, after the DAO hack. ETC continues to trade on several exchanges such as on shapeshift.io, but major exchanges do not support ETC.

In equity markets, when a stock splits or additional shares are issued as a bonus, the value of the equity does go down to reflect this – so as to retain the market cap of the firm issuing shares. Usually, in the short term, this increases the market cap because of each new share, becomes more amenable to the buyer’s “willingness to pay”.

In Contrast, with respect to Bitcoin – this is very unlike a stock split (or a bonus declaration). This is the creation, of a brand new coin and blockchain off the original chain. Ideally, every BTC owner can- after August 1st access both his BTC and BCC balance. The futures market of BCC, already shows the price of BCC to be between 0.08 and 0.01 BTC.