Bitcoin’s price is poised for “acute instability” due to an oversupply of coins from miners and large merchants, along with a weak growth in demand, according to a new research note from financial giant Citi.

The Citi analysis points to the increased sophistication and cost of mining as a major driver for growth in bitcoin supply.

As mining costs rise, miners come under pressure to sell their freshly unearthed bitcoin to recoup the costs of their investment in equipment. Citi notes that about 3,500 BTC are mined daily, against a backdrop of 60,000–10,000 BTC in daily trading volume in recent months. The research note says:

“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.”

Merchants add downwards pressure

Citi also arrives at a counter-intuitive conclusion about prominent merchants embracing bitcoin payments.

Moves by firms like Dell and Expedia to accept bitcoin for laptops or for hotel bookings are generally viewed with enthusiasm by the bitcoin faithful. However, Citi points out that the merchants are converting any bitcoin they receive from customers into fiat immediately, putting further selling pressure on the bitcoin price.

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Additionally, Citi points out that accounting rules may prevent large corporations from holding bitcoin even if they wanted to.

Under the generally accepted accounting principles (GAAP), corporations may not be able to count bitcoin holdings as a hedge against currency risk due to the volatile nature of the digital currency. They may instead have to count bitcoin assets as a speculative position, which would increase their risk profile.

In other words, large merchants can’t be relied on to drive bitcoin demand, nor are they long-term holders of the digital currency.

“For corporations to receive bitcoin and hold it would be an aberration,” the Citi note said.

Weak consumer demand

With bitcoin supply growing from miner and merchant sales, demand for the digital currency has to be taken up by consumers. Citi, however, doesn’t see this happening.

According to the bank, bitcoin’s potential to provide benefits to the man on the street hasn’t been realised yet. As a result, there are currently few incentives for end-users to use bitcoin instead of a credit card, for example.

Bitcoin demand is currently buoyed by users who spend the digital currency “for love, not money”, the note says. However, evidence from the market suggests that there isn’t enough love to keep the bitcoin price from declining:

“Consumers who do use bitcoin […] are doing it for love, not money. And the flat transactions profile suggests that love may not be enough.”

Other market observers have also concluded that the overhang of supply from miners and merchants could contribute to bitcoin’s price weakness. Mark Lamb, chief executive at Coinfloor, a London-based bitcoin exchange, said that sell-side pressures have intensified in recent months, with miners and merchants as the most likely traders.

“Last year miners were selling a much lower percentage of new bitcoin mined. Nowadays it’s estimated that they’re selling 70–90% of their bitcoin. Merchants coming in are also probably selling quite a bit of their bitcoin. So we’re having this constant sell-side demand,” he said.

Big funds aren’t helping

For bitcoin investors hoping for a rise in prices, the presence of a planned $200m hedge fund from Global Advisors, based in Jersey, and the $150m Pantera Capital fund is a sign that prices have to rise eventually. The Pantera fund, in particular, only takes long positions on bitcoin, signalling to some that the digital currency still has room to appreciate.

Citi’s Steven Englander, who wrote the report and is the bank’s global head of foreign exchange strategy for industrialised economies, doesn’t buy that argument.

In response to questions from CoinDesk, he said:

“Indications are that [merchant] transactions are flat to falling and investors who bought at higher prices may be cutting rather than adding positions.”

Featured image via Nic McPhee / Flickr