Bitcoin’s journey began in 2009 when it was initially valued at around one cent per coin. In 2010 it got to $1, and has since risen to as high as $64,000 in a journey that has been remarkable. The meteoric rise in its price has been accompanied by extraordinary volatility. The price surge, which is so dramatic that it is best viewed on logarithmic charts, has been punctuated by three deep bear markets: dropping 93% in 2010 and 2011, 83% in 2013 and 2014, and 82% in 2018 and 2019. Most recently bitcoin retreated about 50% from its highs.
Part of the reason for bitcoin’s volatility is its perfect inelasticity of supply. No matter where the price goes, the supply of bitcoin increases at about the same, pre-ordained pace (Figure 1).
Bitcoin’s latest tumble began at the end of April when prices peaked at around $64,000 per coin. Since then, prices have fallen to as low as $30,000 on an intraday basis. Were there any advance indications of its recent decline?
Here are three time series that are freely available on a website called blockchain.info/charts that cryptocurrency investors might find useful.
What happens with bitcoin has implications for the wider crypto asset universe, including ether, the currency of the Ethereum smart contract network. Ether is both highly correlated with bitcoin (Figure 5) and more volatile than bitcoin (Figure 6). To borrow the lingo of equity markets, this makes ether a high beta version of bitcoin. When bitcoin prices rise, ether prices tend to rise more. When bitcoin prices fall, ether prices tend to fall even further.
What’s curious is that ether supply isn’t limited in the same manner as bitcoin’s. With bitcoin, there will only be 21 million coins produced, of which about 18.7 million already exist. By contrast, there is no limit to the total number of ether coins that can ever be created, but only 18 million ether that can be created in any 12-month period. One might have imagined that ether’s greater supply flexibility might dampen its volatility, but the opposite appears to be the case.
The ratio of the annual creation of new ether to bitcoin appears to follow the ETHBTC exchange rate. When ether prices rise relative to bitcoin, as they did in 2017 and as they have recently, this appears to incentivize the creation of additional ether coins relative to the pre-ordained number of new bitcoin being created (Figure 7). What this suggests is that new ether supply isn’t so much driving the price of ether as it is responding to the price of ether relative to bitcoin.
This suggests that bitcoin retains a substantial first mover, incumbency advantage in the crypto currency world despite the fact that ether, as the currency of the Ethereum smart contract network, may have more practical applications than bitcoin, which is mainly used as a store of value. For many investors, bitcoin remains the first point of entry into the cryptocurrency universe and it retains a substantial role in price discovery for ether and other crypto assets.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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