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Bitcoin Boom and Bust Cycles. Is it a Ponzi Scheme?

Bitcoin had several boom and bust cycles in its short history but no significant boom after 2018. Becoming very rich from holding bitcoin is a thing of the past and trading this cryptocurrency nowadays is no different from trading high beta technology stocks although the risks are much extreme.

In January 2011, bitcoin 500-day rate-of-change rocketed to more than 11,500%! After a collapse, in December 2013, bitcoin 500-day rate-of-change surged to 14,500%! After the boom of 2013, a bust followed but in December 2017, bitcoin 500-day rate of change again increased to more than 3,300%. These boom and bust cycles are shown in the chart below.

The above chart shows both the rolling 120-day and 500-day rate-of-change. As of Saturday, January 2, 2021, 6:10 pm ET, the 500-day rate of change was 216% and the 120-day 205%. These returns are nowhere close to what was achieved in 2011, 2013 and even 2018. Good times are over and now traders and investors must fight for returns in a very competitive market driven by excessive speculation.

Tesla and Peloton stocks gained 743% and 434% in 2020, respectively, while bitcoin gained 303%. Speculation in this cryptocurrency is driven by unjustified expectations about a rise to 100K and even 1M, depending on who you follow. These investors and traders who believe bitcoin can reach those levels and returns can increase to 2011 highs or even higher maybe think that they will find counterparties to transact at those high prices. But those prices rule out retail and they will have to deal with professionals. And professionals do not like to lose.

Is bitcoin a Ponzi scheme? Maybe it is. It may also be a security offering since the inventors of the cryptocurrency pre-mined coins for own account. Therefore, one source of tail risk for bitcoin is a possibility of being labeled a security offering. Then, another risk is central banks: if they decide to issue digital currencies there may be interference from a digital currency they do not control and they may try to outlaw it or at least terminate its convertibility to other currencies.

No one knows what will happen and if any tail events will occur. However, it is highly likely that the times of huge returns in bitcoin are over and risk/reward is much higher as compared to 10 years ago.


Charting and backtesting program: Amibroker

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