Two underlying factors in the bubble cycle

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Steve Sokolowski
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Two underlying factors in the bubble cycle

Postby Steve Sokolowski » Fri Aug 10, 2018 9:50 am

Good afternoon! Now that we have time to relax after releasing charity mining, I thought that it was worth straightening out two misconceptions that seem get posted over and over again across the Internet. These ideas appear to come from people who don't actually work in the cryptocurrency industry or who don't actually spend any coins to buy anything.

There are two constant market forces unrelated to traders and purchasers that act in opposition to each other, and understanding them explains a lot about why markets act the way they do. I'll show that they can explain the existence and behavior of the bubble cycles that are especially pronounced in cryptocurrencies.


1. Mining sell pressure increases as prices fall

One of the most common refrains I see posted is that miners are supposedly more likely to save coins during the downcycle of bubbles, because they want to accumulate as many as possible so that they will be worth more when the next bubble starts. This is a sound investment strategy, but it doesn't work when you're running a business.

For example, our expenses are currently fixed at $1,574/day. This amount is what it costs for electricity, server maintenance, Internet connectivity, salaries, health insurance, reviewing 1099-MISC and W8-BEN forms, legal advice, taxes, and so on. Ideally, we would be investing more, but the massive labor shortage makes it impossible to hire anyone in this economy. Our revenues have been remarkably stable at about 11 bitcoins per day - down from about $230,000 per day in December to around $06,000 now. At the targeted 5% revenue, we earned around $11,500/day back then, and about $3,000/day now before expenses.

Of the $11,500 per day that was being earned back in December, about 15% was being spent or exchanged to dollars for business expenses and necessities like Purse purchases. Now, with $3,300 per day being earned, about 50% of coins are being spent or exchanged to dollars to pay business expenses and necessities. The rest accumulates and remains in the business's paper wallets for the part of this cycle when things get really bad - but there were more bitcoins going into the wallets in December. If the bitcoin price declines towards my earlier predicted capitulation low of $980, we will not only spend all of the coins we earn, but will also start drawing down the paper wallets to pay 200% of what we are earning to survive until the cycle reverses.

This is why the theory that miners will hold more coins because they think that the price will rise is incorrect. Expenses are fixed. We saved more money, in both dollar value and number of coins, when the value of coins was high. We are not able to hold as many coins now because more are being spent to pay fixed expenses. When prices fall even more, we'll actually start spending more than the coins we mine.

I strongly believe that the next bubble will see many coins (especially ETC, which is significantly undervalued because the ETH network is overloaded) rising to 20x multiples of what they are worth now. I also dislike wasting money on useless stuff like expensive cars and big houses and would rather save it. But that doesn't mean we're saving more money than when the coins were worth more. We still have to spend $45,000 per month. Before, that meant spending four blocks of litecoins; now, it means spending twenty.

Throughout the years, I've always wondered why coins seem to be so much more susceptible to bubbles than stocks are. Some try to write off the volatility as being due to the low market capitalization of coins, but bitcoin has a larger market capitalization than most companies, and it is still more volatile. I suspect the true reason is that stocks are not mined. The selling pressure from miners increases as the value of coins declines, because they have to unload more and more of them to stay solvent. The bubbles become like self-fulfilling prophecies. As prices decline, miners have no choice but to unload more coins onto the market. Once prices begin to rise, fewer and fewer coins are spent by miners, amplifying the cycle in the opposite direction.


2. Changing coins to dollars is difficult

People seem to miss is that even if it were possible to predict that a bubble has peaked with 100% accuracy, it's still extremely difficult to convert coins to dollars.

The first reason for this trouble is that there are a lot of costs involved. First, there are exchange fees and transaction fees associated with moving money to exchanges, which in December cost $40. Then, there is the rule that long-term gains are taxed as a lower rate than short-term gains. These taxes are, of course, applied on top of your income, so they are in the highest bracket. In our case, selling coins means setting aside about 26% to pay long-term capital gains taxes to all the tax agencies - but when coins are re-bought, short-term capital gains taxes are now applied. The short-term capital gains rate is about 45%.

Therefore, even if I were 100% certain that bitcoins would fall from $20,000 to $16,200, it still doesn't make sense to sell. Assume that I have one bitcoin that was bought for close to zero. Selling it at $20,000 would mean that I owe 26%, or $5200 in taxes. I have perfect timing and buy back 0.913 bitcoins with my remaining $14,800 at a cost of $16,200. This sounds like a great deal - I lost 9% of my bitcoins to pay 26% owed in taxes!

But when the price of bitcoins rises back to $20,000, I now owe 45% "short term gains" on the $4800 increase. My 0.913 bitcoins sold for $18,200, I owe $2,200 in taxes at 45%, and therefore I am left with $16,000. With perfect market timing, I somehow lost $200. Plus, if you need to re-read this calculation to make sense of it, then that should give you an idea of how much of an opportunity cost there is in time trying to sort this stuff out.

But there's a more important reason many people hold coins instead of dollars. It may not be illegal to sell coins, but everyone will treat you like it is.

In an earlier post, I talked about how Chris has already had two bank accounts closed (see viewtopic.php?f=11&p=18825), despite the accounts being used for no other purpose than to pay taxes. My theory is that banks have some sort of automatic trigger, where large transactions cause some sort of internal audit. Banks treat customers like criminals until proven otherwise. This internal audit seems to be much stricter than whatever paperwork they are required to file with government agencies.

Avoiding the use of banks isn't about avoiding illegal activity, since we don't have anything to hide. It's about avoiding unnecessary attention. Even when you're not doing anything wrong, you still have to spend time and sometimes money constantly proving that.

My impression when dealing with the government and banks is that, for whatever reason, they are laser-focused and see everything in terms of dollars. Dollars are worth something, and when you convert things into dollars, you have money and are rich. They view coins as something that isn't real, in that you aren't rich until you have a bank account with a lot of dollars in it. The reason is probably because most of the financial crime seems to go through banks - i.e., Paul Manafort thinking that transferring $11m through wire transfers would somehow be hidden from taxation.

This attitude extends to everyday people, too. To this day, there are still people who say things like "well, the business earns you coins, but how to you turn that into money?" I have four times as many coins as everything else I own combined, and yet to them my net worth is a portfolio of stocks, my old Prius, an electric bike that is worth just as much as the Prius, and a few other things. To them, the coins are just something else I happen to have "invested in" that isn't real money.

You can use this socially and legally to your advantage. The IRS allows people to hold as many coins as they want, and as long as they aren't spent, they can sit in paper wallets forever without owing a dime in taxes. There aren't any documentation requirements for declaring how many coins one owns, and unlike cash stored under a mattress, a split key can't be stolen or lost in a fire. A bag of cash being carried across the country is automatically suspected as being drug-related, while a paper with a private key is overlooked. Banks have no right to decide that they don't like your coins and freeze accounts pending investigation. And it seems like the average person doesn't consider coins as a form of "real money," so most people don't see you as rich with all the problems that come along with that.

Finally, even if I wanted to convert all these coins to dollars, I would have to send them to an exchange. Chris had his Coinbase account suspended "pending account review" for three months before their incompetent customer service finally was able to get around to his ticket and resolve the issue. We closed a Bitflyer account, because they won't connect brokerage accounts from "intermediate" clearing banks where the name of the account at the intermediate bank is the bank's name. Again, all of this is because of this idea that as soon as coins are converted to dollars, they suddenly become "real money" or something. To see how the concept of dollars being special is true, all one has to do is to trade on Coinbase's BCH/BTC market and discover how the trades execute instantly and you'll never have an account frozen for any amount of trading.

Not converting coins to dollars results in the least amount of trouble, and that's why I don't spend dollars anymore. You can buy anything, or a gift card to buy anything, at Purse.io. When buying something, I don't check how much the coins are worth.

You don't have to be doing anything wrong, and you can even have strict policies like our 1099 form noncompliance and zero-tolerance no drug discussion rule and still encounter problems like frozen accounts. There is a lot of money in coins that is being left there because, like me, the owners fear that they will be accused of wrongdoing and have to deal with months of customer service or civil law issues if they ever converted it to legacy currencies due to the misconceptions of many people. If the value of coins drops 90%, then they'll still have more money than the zero they would otherwise have, since there is no legitimate way to sell change large amounts of money to dollars. Note that the much smaller group of criminals who actually are involved in drugs also can't sell, contributing to this floor - money in ransomware wallets, for example, is unspendable because any transaction would lead to an immediate arrest.

This is also why the trite saying "it could all go to zero" is 100% incorrect. Coin prices have exactly zero probability of going to zero across the board. In fact, the idea that "only a few coins will survive" is also demonstrably false. Historically, only about 10% of the 793 coins we have ever offered for payouts have been delisted from all exchanges in the past five years.


Conclusion

How do these two forces work together? While traders buy and sell coins at various times, miners are probably the largest economic group that continually uses and exchanges in cryptocurrency. Mining accentuates the bubble cycle because the fixed costs result in more and more coins being sold as the bottom of each cycle approaches. At some point, however, a point is reached where the large number of people like me who have no other option of what to do with their coins provide a floor to prices. All the traders capitulate, but the group who has too much money to do anything else with it never sells. That reverses the cycle, and as soon as prices begin to rise, miners start selling fewer and fewer coins, accelerating the recovery.

It's impossible to fully understand the cycles without understanding that traders, while important, are only one group of people in a complex economy. The cycle is largely caused by miners, and the "coin-only" users provide a floor. Traders often panic that every drop is "the end," and discount that there is a floor because they lack understanding of the headaches associated with converting coins to dollars.

Finally, if you have doubt that coins will displace existing currencies some day, consider that banks are causing the transition themselves. Every day, more and more money gets caught up in coins because it is so difficult to exchange it in the old system. The floor of "can't sellers" grows higher and higher every day. Eventually, the number of people who have coins like this will grow so large that businesses will recognize the market to serve them is huge. The banks, far from trying to stop coins, are giving people no other option than to use them.
cc4506
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Re: Two underlying factors in the bubble cycle

Postby cc4506 » Fri Aug 10, 2018 11:40 am

This is very interesting Steve, I am glad you took the time to type this all out.

As a neophyte in this my observation seems to be that coins that are mined do better and are actually worth more than the ones that are not. Wouldn't it also be that once they can be mined that now others have an actual steak in them? I mean we have invested time and resources into them so while miners contribute to the ups and downs, I also see them adding value to them.

I would much prefer to use my coins to pay bills and use them in the real world. When that happens, you will see them appreciate in value but its got to be "wells fargo" easy. Non of this complicated crap. My gal pal said thanks but no thanks. She has a job, kids, no time for another complication in her life.

Instead of the coins trying to start all these new projects that, (from the outside), don't seem to advance their real world use, they should concentrate on the basics. I want to take my litecoin card to the store, and by shit with it. I want to be able to charge it and fund it easily. Pure and simple.
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Steve Sokolowski
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Re: Two underlying factors in the bubble cycle

Postby Steve Sokolowski » Fri Aug 10, 2018 12:50 pm

cc4506 wrote:This is very interesting Steve, I am glad you took the time to type this all out.

As a neophyte in this my observation seems to be that coins that are mined do better and are actually worth more than the ones that are not. Wouldn't it also be that once they can be mined that now others have an actual steak in them? I mean we have invested time and resources into them so while miners contribute to the ups and downs, I also see them adding value to them.

I would much prefer to use my coins to pay bills and use them in the real world. When that happens, you will see them appreciate in value but its got to be "wells fargo" easy. Non of this complicated crap. My gal pal said thanks but no thanks. She has a job, kids, no time for another complication in her life.

Instead of the coins trying to start all these new projects that, (from the outside), don't seem to advance their real world use, they should concentrate on the basics. I want to take my litecoin card to the store, and by shit with it. I want to be able to charge it and fund it easily. Pure and simple.


It's actually pretty amazing how much money people will lose because they don't want to learn new things. For example, even though my bank accounts are often closed, I still get those free "get $400 when you deposit $5000" offers in the mail. So I open an account, deposit some money, let it sit there for 3 months, and then close the account. Not bad for 30 minutes of work. Credit cards are like this too - I sign up for at least ten cards per year to get money for spending a certain amount of money, or for a limited time where a category is 5%, and then cancel the cards.

The only company that doesn't accept bitcoins that we deal with is Comcast, to whom we pay $4000/month. But they accept credit cards, so we constantly rotate cash back categories and never get a discount of less than 2% off this bill, which is a free $960/year.

But the most ridiculous thing is that I've told several people about purse.io, which is now getting orders filled at 23%. I saved about $2200 through Purse over the past few months - which is the money used to buy that expensive e-bike. People look at the bike and ask how I can afford such a thing. I tell them about Purse and they come up with all sorts of excuses like "it's too complicated" or "the price might fall during the five minutes I buy and then spend the coins," and so on.

This is great. I estimate that Chris and I are going to earn an extra $10,000 this year just by using Purse to buy stuff for us, and in the extra profit we'll get by buying business equipment there. And here's the thing - this is tax free money, because when you buy stuff with Purse, the purchase price of the goods is lowered. That means I would have to earn $20,400 more and pay about 52% in taxes if I wanted to increase my purchasing power the same amount without using Purse. You can always get more rich by saving money than by earning it because of taxes.

Unlike you, I dread the day that cryptocurrencies become more widely used. Someday, Amazon is going to accept bitcoin cash directly, at which time Purse will go out of business and all of this goes away. But until then, it's amazing how easy it is to profit off of people's unwillingness to learn. People are so set in their ways that they will give up thousands of dollars - dollars which mean a lot more to the average person than to someone who has more money than he needs like me.
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CSZiggy
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Re: Two underlying factors in the bubble cycle

Postby CSZiggy » Fri Aug 10, 2018 1:06 pm

Steve Sokolowski wrote:2. Changing coins to dollars is difficult

..... In our case, selling coins means setting aside about 26% to pay long-term capital gains taxes to all the tax agencies - but when coins are re-bought, short-term capital gains taxes are now applied. The short-term capital gains rate is about 45%.

....Assume that I have one bitcoin that was bought for close to zero. Selling it at $20,000 would mean that I owe 26%, or $5200 in taxes. I have perfect timing and buy back 0.913 bitcoins with my remaining $14,800 at a cost of $16,200. This sounds like a great deal - I lost 9% of my bitcoins to pay 26% owed in taxes!

But when the price of bitcoins rises back to $20,000, I now owe 45% "short term gains" on the $4800(THIS SHOULD ONLY BE $3800) increase. My 0.913 bitcoins sold for $18,200, I owe $2,200 in taxes at 45%, and therefore I am left with $16,000. With perfect market timing, I somehow lost $200. Plus, if you need to re-read this calculation to make sense of it, then that should give you an idea of how much of an opportunity cost there is in time trying to sort this stuff out.

Might want to check the maths, the profit was 3800 NOT 4800, so the taxes was 1700 NOT 2200, so you wouldn't lose $200, I think you end up making $300

I'm a bit confused on how/why you are using those numbers....26%? 45%? instead of 15% and 33%.
Bigger tax bracket or are you figuring in income tax or some other tax that isnt capital gains?
If you MINED the coin at $100, then you owe income tax on that $100. When you sell it for $300 then you owe capital gains on the (300-100) profit.

If you BOUGHT 1 bitcoin for "close to zero" then you would owe $0 income tax. TO BUY it you had to have had already cleared IRS taxed money that was already earned. BUYING the coin vs mining it means you are now an investor NOT a miner. MINERS create income out of thin air, so they need to be income taxed on the $ value of the coins they create. BUYERS have already had the money they are investing taxed so they need only pay capital gains on their profits. Or am I missing something?

Selling it at $20,000 would mean that I owe 15%, or $3000 in taxes. I have perfect timing and buy back 1.049 bitcoins with my remaining $17,000 at a cost of $16,200. Then when they hit back up to $20,000 I sell them again....(1.049 X 20,000)=20,980.
(20,980-16,200)=$4780 profit from the BOUGHT coin going up.
$4780 X 33% = $1577 capital gain short term taxes due.

So had I sold your bought coin at $20,000 and been done, I would have had $3000 in taxes and $17,000 in profit.
Selling, buying, and reselling it....$4577 in taxes and only $16,403 in profit.

If you are going to have to pay the 33% on capital gains, you need to buy the sold $20,000 bitcoin when it hits LOWER than 33% down.
$20,000 X .33 = 6600
20,000 - 6600 == $13,400
If you sell at $20,000 and then have to swap to 33%, you need to wait for the price to drop under $13,400 before you buy more or you won't recoup the lose from the taxes.

So yeah, as long as you know it's going to drop more than 33% for you to come out ahead then yes this is a good plan.
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CSZiggy
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Re: Two underlying factors in the bubble cycle

Postby CSZiggy » Fri Aug 10, 2018 1:32 pm

Steve Sokolowski wrote:Not converting coins to dollars results in the least amount of trouble, and that's why I don't spend dollars anymore. You can buy anything, or a gift card to buy anything, at Purse.io. When buying something, I don't check how much the coins are worth.


Looked up and saw Purse.io is based out of CA, USA and follows US laws.
Guessing any account doing over $600 a year would be reported to the IRS?

Or is purse.io a way to mine and spend bitcoins and never have to report them as income as it never converts to $ in a bank for them to notice?
I know trade/barter items are still taxed and you are supposed to report them. Purse just seems like a way to undercut taxes by not paying the capital gains or income.
Or is there something else to it?
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Steve Sokolowski
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Re: Two underlying factors in the bubble cycle

Postby Steve Sokolowski » Fri Aug 10, 2018 2:18 pm

CSZiggy wrote:
Steve Sokolowski wrote:Not converting coins to dollars results in the least amount of trouble, and that's why I don't spend dollars anymore. You can buy anything, or a gift card to buy anything, at Purse.io. When buying something, I don't check how much the coins are worth.


Looked up and saw Purse.io is based out of CA, USA and follows US laws.
Guessing any account doing over $600 a year would be reported to the IRS?

Or is purse.io a way to mine and spend bitcoins and never have to report them as income as it never converts to $ in a bank for them to notice?
I know trade/barter items are still taxed and you are supposed to report them. Purse just seems like a way to undercut taxes by not paying the capital gains or income.
Or is there something else to it?


In our case, the $600 limit is for payouts, because form 1099-MISC is for the amount paid to contractors. The amount earned is not relevant to the form, which is why tips and charitable contributions, which are not paid to the customer, are not included on the form. These forms don't necessarily require tax to be paid and they have nothing to do with income. In my case, which may not be the same with you, Coinbase and other companies send multiple forms for the same money that's just moving between them.

I don't know what Purse's responsibilities are with taxes; all I know is that I'm one of the 93 people who paid use tax on all purchases to Pennsylvania a few years ago and am in compliance with the tax laws.
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CSZiggy
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Re: Two underlying factors in the bubble cycle

Postby CSZiggy » Fri Aug 10, 2018 6:50 pm

Steve Sokolowski wrote:I don't know what Purse's responsibilities are with taxes; all I know is that I'm one of the 93 people who paid use tax on all purchases to Pennsylvania a few years ago and am in compliance with the tax laws.

Use tax is great, but are you recording and paying capital gains taxes on all the coins spent at purse is the question.

If you buy a coin for $100 and it goes up to $300, you owe capital gains tax on that $200 profit from the time you got it and exchanged it.
You can't just buy a coin for $100 and trade it in to purse for a $300 gift card to best buy and walk away not owing any tax money and spend the profits at a store without claiming the profits and paying taxes on them. Well, you can as long as you like to be illegal and don't mind risking prison.
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Re: Two underlying factors in the bubble cycle

Postby dragonbyte_llc » Sat Aug 11, 2018 10:16 am

Great article, Steve. Thanks!

If one doesn't change with the times, one gets left behind. And I agree: The banks are driving business away by not servicing the crypto-to-fiat (and back again) markets, while they think they are trying to kill their competition. They are not used to having any competition, and market forces are powerful things. Before their end, they will ramp up government power to try and kill it, which is why this libertarian movement needs to continue to be vigilant in political circles as well. Ultimately, it is only a matter of time. The genie is out of the bottle.

Cheers!

DB
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Re: Two underlying factors in the bubble cycle

Postby Steve Sokolowski » Sat Aug 11, 2018 11:04 am

CSZiggy wrote:
Steve Sokolowski wrote:I don't know what Purse's responsibilities are with taxes; all I know is that I'm one of the 93 people who paid use tax on all purchases to Pennsylvania a few years ago and am in compliance with the tax laws.

Use tax is great, but are you recording and paying capital gains taxes on all the coins spent at purse is the question.

If you buy a coin for $100 and it goes up to $300, you owe capital gains tax on that $200 profit from the time you got it and exchanged it.
You can't just buy a coin for $100 and trade it in to purse for a $300 gift card to best buy and walk away not owing any tax money and spend the profits at a store without claiming the profits and paying taxes on them. Well, you can as long as you like to be illegal and don't mind risking prison.


Of course we do. Off the top of my head, we've spent about 1 bitcoin and a few bitcoin cash on $10,000 of items and have a capital loss of $15,000 or so. We've never filed this before, so don't quote me on that, as when we actually read the laws carefully in January we may discover there is something that changes those numbers.

One of Chris's tasks is to buy accounting software that will automatically track this data more easily. Right now, it's pretty simple, as we just use a Google Drive spreadsheet that he created for the purpose.

I personally wonder what the people at the IRS do with this absurd amount of paperwork. Obviously, they did not consider that not defining coins as currencies would result in massive filings as coins became more widely used. The way they have these rules defined, we'll probably generate another 50 pages of transactions on top of the 150 pages of forms we filed last year, and that's just for me. If they ever conduct an audit, there is no way it will cost them less than $50,000 to go through the terabytes of data they would receive that we aren't required to file but need to keep on hand.

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