Why the Bitcoin Price Is Stuck in a Rut for Now

There's no sugarcoating it: The Bitcoin price has plunged nearly 29% over the past two months.

The CoinDesk Bitcoin Price Index, which averages the Bitcoin prices across several major Bitcoin exchanges, dropped from $647.34 on July 2 to as low as $460.67 on Aug. 18.

Bitcoin priceThe Bitcoin price did manage to climb over $500 shortly afterward, but lately has slumped back into the $470s.

While few in the Bitcoin community are panicking over this decline, many are puzzled. Despite the lack of any unusually bad news, the price keeps trending down.

It's actually not as perplexing as it appears. At this point in Bitcoin's evolution, the market forces pulling the Bitcoin price down are stronger than those pushing it up.

A recent analysis by Citigroup Inc. (NYSE: C) identified what's been going on, pointing to Bitcoin miners and merchants as the main cause for the slump.

Citi might have a bit of an interest in discouraging Bitcoin adoption, but its analysis here makes sense...

Why the Bitcoin Price Fell

We know the Bitcoin miners have been in an "arms race" for a long time. Better equipment means more bitcoins and more profits, so many miners have been investing heavily in costly mining rigs. These rigs also consume an enormous amount of electricity, adding to the miners' costs.

That means the miners need to sell many of their newly created bitcoins to pay their electric bills as well as pay off debt incurred with the purchase of the rigs.

"Last year miners were selling a much lower percentage of new Bitcoin mined. Nowadays it's estimated that they're selling 70% to 90% of their Bitcoin," Mark Lamb, chief executive at Coinfloor, a London-based Bitcoin exchange, told CoinDesk.

With Bitcoin mining as popular as ever, that translates to a rising tide of new bitcoins getting sold on the exchanges.

"If the miners are a steady source of supply and there is no increase in final demand, we have this overhang of Bitcoin being sold in the market. In consequence, we have downward price pressures," the Citi report concluded.

And then there's the impact of the merchants, which many had assumed would be a positive for Bitcoin prices.

The Bitcoin Price Is Getting Hit with a Double Whammy

The past year has seen a steady rise in the number of merchants accepting Bitcoin, with the current total somewhere north of 60,000. That's generally been taken as good for Bitcoin - proof that mass adoption is well underway.

But while many merchants want the extra business (not to mention the cachet) of offering the Bitcoin option, few trust the digital currency enough to hang on to it themselves. That's mostly because of the extreme volatility in the Bitcoin price over the past year. Most merchants don't want to risk losing value if prices fall significantly.

So nearly all merchants that accept Bitcoin convert it immediately to fiat currency (that is, U.S. dollars), typically via Bitcoin payment processors like BitPay and CoinBase.

And it's yet another constant source of Bitcoin selling on the exchanges. Customer buying of bitcoins to spend is at best a wash; at least some of the bitcoins going to the merchants must have been sitting in Bitcoin wallets for a while.

The combination of selling pressure from the miners and the merchants means the Bitcoin price will struggle to rise from its current levels, and could even fall a bit further over the next few months.

But in the long term, Bitcoin prices will start going back up.

Why the Bitcoin Price Must Rise

The sell-side pressures from the merchants are a symptom of a still very young Bitcoin economy.

Eventually merchants will get more comfortable holding some Bitcoin, and more consumers will start using it, increasing demand for the digital currency.

The problem of the miners selling most of their Bitcoin can only be solved by increased buying demand, and that, too, is just a matter of time.

Demand for Bitcoin will rise as more people start using it, and more people will start using it when they realize that the true Bitcoin value lies in the blockchain - the underlying infrastructure that verifies every transaction.

The blockchain, you see, can be used in non-financial ways; supplemental data can be embedded in the transactions.

Just a few of the ideas for blockchain applications include decentralized stock exchanges where securities could be traded peer to peer, mortgages, "smart" contracts that could fulfill their function without outside intervention, voting, trademarks, and proof of authorship.

It's this potential that's luring an increasing amount of venture capital to Bitcoin - more than $171 million just in 2014 alone.

Remember, Bitcoin still hasn't moved much beyond the early adopters. When it reaches the majority of consumers in the next couple of years, the spike in demand will force the Bitcoin price up. 

How high it might go is speculative. But estimates range from $2,000 (which could happen within the next year) to as high as $1 million (a decade from now).

Michael Terpin, the co-founder of BitAngels, an angel investor group for digital currency startups, extrapolated a future Bitcoin price of $50,000 in a July Barron's column.

"Even in these early days [Bitcoin] has the potential to disrupt large sectors of the financial, banking, e-commerce, and securities markets in ways that could create wealth across its various components in excess of $1 trillion," Terpin wrote. "Despite the (increasingly unlikely) prospect of it going to zero, the upside makes it an important portfolio driver in the high-risk portion of a balanced portfolio for those who are savvy enough to take on the learning curve."

For more Bitcoin news and insights, follow me on Twitter @DavidGZeiler.

UP NEXT: One man who can't wait to use Bitcoin technology to disrupt the financial system is Overstock.com CEO Patrick Byrne. He wants to use the blockchain to create a decentralized, purely digital stock trading system that would "wipe out" Wall Street. Here's how it would work...

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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