James McKay research has taken an in-depth look at the fundamentals and technicals of the 2014-2016 bear market to tease out the similarities and differences to see what can be learnt about the ongoing bear market.

Cryptocurrencies have been on somewhat of a rollercoaster ride since December’s huge sell-off sent prices of bitcoin and major altcoins tumbling between 60-80% by February, followed by a sharp rally in April before settling into a trading range between $7,000 – $10,000. With bond yields flat and the stock market stuck in a corrective phase since January, it hasn’t taken long for attention to return to the crypto space, and many are now asking how long the latest bear market will last.

Predicting price action in a fledgling asset class still undergoing a series of volatile price discovery corrections is undoubtedly challenging, but performing retrospective fundamental and technical analyses of the factors surrounding the previous bear cycle in 2014 to 2016 can provide clues as to what we can expect going forward.

A Technical Look at Bitcoin’s 2014 and 2018 Bear Markets

The major support zone around $6,000 was established in November that initially served as the foundation for the parabolic move up to just shy of $20,000. This support was re-tested in February, over three months later. This zone was again tested again in April before prices climbed to the $10,000 level, which suggests that the $6,000 zone is terra firma for now.

However, if the lower end of the zone gives way at $5,750, the market will find itself in trouble with next support another 33% further south at $4,000 which would create issues around mining profitability.

In terms of resistance, the chart shows bitcoin’s recent bullish spike that for the first time broke the downtrend line established at the inception of the bear market in December and the SMA50 (yellow). With prices testing the $10,000 level in May all eyes are on whether it will continue its bullish momentum to push up towards the longer-term resistance zone around $12,000, which has already been tested multiple times since January.

But what can we take from 2014 trends to provide clues as to whether bitcoin will successfully break through this critical resistance level to confirm a trend reversal, or languish in a trading range for an extended period?

The chart for 2014 shows a somewhat similar technical picture, with bitcoin finding a range between $400-$600 after cratering over 80% from $1,200 in late 2013. Similar to 2018, the price recovered to unsuccessfully retest a key resistance zone at $680 twice over a three-month period, which sealed its fate to remain in a bear market for a further two years. This direct comparison with 2014 again would seem to suggest that another test of the $12,000 level may prove decisive to the medium, or even long-term price trend, given that the failure to make higher highs at a similar juncture proved extremely negative in 2014.

Naturally, the two situations are not comparable in every respect, and one significant difference in the aftermath of the two crashes is volume. As shown in the chart, the on balance volume (OBV) shows how trading volumes all but flatlined after the crash in 2014, which points to the fact of just how comparatively thin trading was for bitcoin relative to 2018. However, it also reflects the extent to which certain exchanges had come to dominate the trading landscape–often through questionable means–and here technical analysis alone cannot give a complete enough picture of these and other forces at work involved in moving the price of bitcoin.

Fundamentals:Manipulation, Regulation, Futures

Manipulation & Hacking

The key event precipitating the 2013-14 crash was the infamous Mt. Gox scandal which was a primarily the result of incompetence from the Founder of Mt.Gox, Markus Karpeles. To date the largest bitcoin heist ever, 600,000 bitcoins were stolen, worth an estimated $188 million.These bitcoins reportedly moved the market by as much as 4% on days where the stolen bitcoins were actively traded, according to a new research paper.

The manipulation to the upside prior to the crash itself was traced to two bots, aptly named ‘Willy’ and ‘Markus’. They appeared to be engaged in legitimate trades, but were in fact trading with nonexistent bitcoins, pushing prices to $1,000 before the bubble burst. It was subsequently found that trades executed by Willy bot made 10-20 bitcoin transactions every five minutes, totalling $112 million being spent on over 250,000 bitcoins in November alone. This injected a huge amount of fake volume into the markets and offers an insight into why volume fell off a cliff when Mt. Gox finally closed its doors in February 2014.

Although the regulatory framework has improved considerably since the Mt. Gox implosion, instances of manipulation and theft from cryptocurrency exchanges still occur. In January 2018 for example, the Japanese crypto exchange Coincheck was compromised, with hackers making off with over $500 million worth of the NEM currency. More importantly, rumours are awash that the crypto exchange Bitfinex, and its US dollar pegged cryptocurrency, Tether, have been helping to artificially prop up the value of bitcoin and other cryptocurrencies. Although no substantive proof yet exists, the fact that Bitfinex fired its auditor in February after being requested by a subpoena from the CFTC to provide the transaction records suggests that it could be 2018’s very own Mt. Gox, with huge potential to force the price down if any concrete proof were to appear.

Regulation

A distinction should be made between regulations designed to restrict or ban the use of cryptocurrencies vs. those designed to reduce market susceptibility to manipulation. While the former certainly would appear bearish whereas the latter could be considered bullish, the reality is that it’s difficult to correlate regulatory announcements with price direction. For example, in the wake of the 2014 crash, Benjamin Lawsky, New York’s top financial regulator, outlined plans to introduce bitcoin to safeguard against future bitcoin exchange manipulation.

“We simply want to make sure that we put in place guardrails that protect consumers and root out illicit activity, without stifling beneficial innovation.”

The news that these regulations had been formally implemented in June 2015 were not accompanied by any significant uptick in trading activity whatsoever and the bear market remained intact for another 18 months. Regulation designed to ensure the future health of cryptocurrency trading is a poor indicator of shorter-term price movements.

Conversely, the successive announcements made by France, South Korea, China, and other governments, to clamp down on the use of cryptocurrencies (i.e. fighting back against decentralisation) in early 2018 are widely perceived to have played a role in catalysing the negative sentiment around the cryptocurrency markets, and helping to cement the bearish trend from which they have yet to emerge. Interestingly, it appears the trend of cryptocurrencies reacting negatively to regulatory news, regardless of intent, is now very much entrenched, as evidence by bitcoin’s 9% drop over the news that the SEC’s plan to regulate exchanges in an attempt to root out fraudulent activity. Or, to take a different view, the fact that measures announced to weed out bad actors cause price dips, may indicate that said bad actors still have a substantial trading presence in cryptocurrency exchanges.

The Futures Market

As the futures market only debuted in December 2017 we do not have the benefit of a direct comparison for trading activity today vs. 2014, but what we can see is that the advent of bitcoin futures coincided perfectly with the start of the bear market, suggesting that the short position of bitcoin futures traders triggered the crash from $20,000. In line with this, the Federal Reserve Bank itself released a memo effectively attributing bitcoin’s sharp decline from the $20,000 peak to an increase in speculator activity driven by the launch of bitcoin the futures; a phenomenon that also has precedents in other asset classes. The Federal Reserve stated that:

“… The launch of Bitcoin futures allowed pessimists to enter the market, which contributed to the reversal of the Bitcoin price dynamics. It is consistent with trading behavior that typically accompanies the introduction of futures markets for an asset.”

In other words, the huge leg up in price was driven by an army of enthusiastic investors desperate to cash in on the mainstream bitcoin hype, only to have their parade rained on once the those looking to take the opposite side of the trade were given a regulated opportunity to do so.

Attributing the price plunge exclusively to the futures launch both oversimplifies and a downplays the manipulatory and regulatory impacts. However, the fact that the futures launch so neatly coincided with the end of the bullish momentum makes it difficult not to draw certain conclusions. One unlikely benefit of the futures market is that it allows for a faster price discovery and ultimately lower volatility as the market has a more equal distribution of bulls and bears, particularly with renewed institutional interest in the market.

Conclusions: Much More to Come for Cryptocurrencies

In conclusion, we can see that not only are the gut wrenching price swings of 50%+ part and parcel of the price discovery process of a young asset class evolving at unabated speed, but a closer look at the technical and fundamental specifics also reveals the substantial overlap between the current phase of the bitcoin market and the previous correction.

The coming months could prove decisive in terms of how the trend unfolds in the short to medium term, as any major revelations of exchange hacks or manipulation could dent confidence enough to keep bitcoin technically range-bound for an extended period, as was the case in the years 2014-16.

The bottom line is that bitcoin has always bounced back from its doldrums, and with cryptocurrencies increasingly a permanent fixture in the investment and business landscape, the long-term looks bullish for the ‘strong hands’ investors able to filter out the panic of temporary momentum shifts by remaining focused on the greater rewards to come.