A closer look at the latest record Bitcoin collapse

Bitcoin (BTC) prices, which had spiked as high as $1200 (£730) a week ago, fell back to Earth sharply yesterday as news came from China that government banks had begun blocking BTC transactions.

This has put the currency’s Chinese future in danger in what had become its largest market. With prices slumping sharply downwards, the usual dog pile has emerged, with some pundits decrying this as proof that cryptocurrencies are intrinsically overvalued, and others arguing that this is a momentary slump, with BTC values predicted to rebound just as sharply.

I think it’s important to put this move in a regulatory context. Many banks in the UK, US and other countries are leery of BTC transactions. Critics charge that this is because the financial industry believes BTC could replace it, but I think the truth is more prosaic.

If you’re a bank in a modern Western nation, the last thing you want to do is encourage financial transactions that take place in a regulatory grey area, and ones that could be used for highly nefarious purposes. Yes, it’s absolutely true that banks across the world have done business with everyone from the Mafia to Latin America drug cartels, but those accounts and transactions are typically shielded behind regulations and carefully crafted walls of deliberate obfuscation to maintain plausible deniability.

Bitcoin is an unknown. That makes it intrinsically more dangerous to play with; no bank wants to expose itself to the dangers of sudden, sweeping federal oversight. The difference between what’s happening in China and the way this has played out to date in the West is that US regulators haven’t banned Bitcoin altogether or levied special disclosure rules or other decisions against the currency. The SEC ordered Mt. Gox to follow the rules for a money service business (MSB).

China, on the other hand, has banned new third-party deposits altogether. It hasn’t banned the currency as such, but absent any new supply of coins from third-party systems, there’s no way for anyone to bring new BTC into the system. Customers are still able to purchase BTC with exchange-deposited funds, and can withdraw cash from exchanges to transfer back to their original bank accounts.

What happens next is still unclear. We could see further bubbles emerge in BTC prices if the currency catches on in other large markets. The rampant speculation that drove prices to $1200 (£730) last week was an enormous opportunity for a certain class of investor, and those types of buyers will be looking for ways to tap the market again.

One interesting fact regarding the price spike is that while $1200 (£730) is insanely deflationary for any currency that opened the year with a two-digit value, the price of BTC hasn’t kept pace with the difficulty of mining – not by half (the graph above shows the Bitcoin market’s hash rate and difficulty over the past nine months). Returning to May’s profitability rates would require a BTC price of something like $25,000 (£15,000) per coin.

At the current price of around $600 (£360) per BTC, a 25 gigahashes-per-second ASIC miner from Butterfly Labs will earn you a meagre $8.30 (£5) per day – not counting the cost of power. The company is promising 28nm ASICs that can hash at 600GH/s per card, but such hardware is still some way from completion, and will face even stiffer competition from expanded pools.