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Bitcoin is the bubble that keeps on giving

There’s no question it is a bubble – like gold and much else in the financial world.
All money relies on the number of people using it as a key determinant of value. Image: Shutterstock

As the bitcoin price surged past $13 400 over the last week, an old debate has resurfaced: is it a bubble and will it burst?

Bitcoin was labelled a bubble from its earliest days. The bubble epithet appeared in 2013 when it was just $266, and has been repeated just about every year since then.

It seemed to defy conventional investment understanding. Share values are underpinned by earnings, and bonds by interest payments. Bitcoin, like gold, has no such underpinning. How, then, do we explain its extraordinary performance as an emerging new asset?

Two factors help explain this:

  1. Its wider adoption, including from large institutional investors; and
  2. Its relative scarcity (there will only ever be 21 million coins minted).

Fiat currencies such as the rand and the US dollar suffer all the frailties of centrally controlled currencies that have been recorded back to Roman and even Babylonian times. Rulers who control these currencies just can’t seem to help themselves – they eventually inflate their way into oblivion by printing more coinage, so violating the scarcity principle at the core of all sound money.

US fund manager and contrarian Peter Schiff, never a great fan of bitcoin, tweeted last week: “If you measure the size of asset bubbles based on the level of conviction buyers have in their trade, the bitcoin bubble is the biggest I’ve seen. Bitcoin [holders] are more confident they’re right and sure they can’t lose than were dotcom or house buyers during those bubbles.”

Is Schiff right about the bitcoin bubble?

It appears he may be, but not in the way he imagines.

Bubbles in perspective

“Since bitcoin’s inception, many intelligent investors have observed that it appears to be a bubble. They are more right than they know. If we define a bubble asset as one that is overvalued relative to intrinsic value, then we can think of all monetary assets as bubble assets,” writes Matt Huang in a recent research paper for Paradigm.

Nobel laureate Robert Shiller observed that gold is a bubble that’s lasted thousands of years. It has some industrial uses, but it’s value is underlying value is a matter of belief.

“We can think of money as a bubble that never pops (or that hasn’t popped yet) and the value of fiat currency, gold, or bitcoin as relying on collective belief,” writes Huang.

Blockchain company Etherbridge notes that since the beginning of 2019, the bitcoin network has almost doubled its number of active addresses from 550 000 to just shy of one million by August 2020. The users are coming and finding utility in the public payment system that is bitcoin. The confluence of growing usage, rising miner profitability and strong savings behaviour of investors is lining up bitcoin for another bull market.

Bitcoin price

Source: TradingView

“We can think of money as a competitive market like any other. Gold dominated for centuries not by accident but by possessing important features such as being scarce and unforgeable. Today, fiat currencies [those issued by central banks] dominate largely through local monopoly power, but all monetary assets still compete globally, with gold, US dollars, and euros favoured as reserve assets.”

All money relies on its ‘network effect’ – the number of people using it – as a key determinant of value. It must also be a store of value, easily transportable and fungible (every unit is the same as every other unit).

Bitcoin meets this all these criteria with the added advantage that it is almost infinitely divisible.

All bubbles follow a pattern

Huang says each bubble has a familiar pattern. High conviction investors start buying when bitcoin is boring and unloved. The resulting rise in bitcoin price attracts media attention, which then attracts investors (or speculators), many with lower conviction and shorter time horizons. This drives the price of bitcoin higher, which drives further attention and investor interest.

This cycle repeats until demand exhausts and the bubble crashes.

“Although painful for those involved, each bubble leads to broader awareness and motivates bitcoin’s underlying adoption, gradually expanding the base of long-term holders who believe in bitcoin’s potential as a future store of value,” according to Huang.

The future of bitcoin

Huang says bitcoin is unlikely to challenge the US dollar as the leading means of exchange and unit of account (at least anytime soon). Instead, it is likely to earn a place alongside gold as a sensible part of many investment portfolios.

“This has already begun with an early-adopter, tech-forward crowd, and we expect it to grow to include a broader set of investors and institutions over time.

“Eventually, central banks may come to view bitcoin as a complement to their existing gold holdings.”

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Bitcoin and gold in the same sentence. Gold is money. The only money.

In a bubble? Depends on whom you ask and what you value it in.

youtu.be/UU26H5iWbAo

”Nowadays to be intelligible is to be found out”

Oscar Wilde

Haha Ciaran – are you writing these types of articles to get publicly?

Economics 101 will tell you that gold is part of one of the asset classes.
Bitcoins are not part of any asset class – they are tokens.

”Perdedrolle is nie vye nie”

From the March 2020 lows

Gold is up 30%

Bitcoin is up 257%.

The wild swings in Bitcoin does not instill a lot of confidence in me to be honest and I don’t think it is anything like gold. Don’t think it does not do the same in the opposite direction. It does.

You can trade it but and investment?? Not for me. An asset should not behave like that.

reading this article and the comments make me realise that most of the world is still quite unaware of what bitcoin is.

gold was adopted as a store of value because it has certain properties: scarcity, fungible, recognisable, transportable, divisible, durable, etc..

bitcoin is designed to have all the above properties…but in orders of magnitude greater (eg gold still inflated at 1.5%-2.0% per year whereas bitcoin has a hard cap on supply ie 21 million coins).

bitcoin is simply the hardest form of money ever known in human history

You would have been right, except you cannot start printing dollars or mining gold at home, but anybody can start a cryptocurrency, and bitcoin is just one of the more popular ones. The more cryptocurrencies there are, the more obvious this becomes. These are fairground tokens. So far they have not proven any utility above existing forms of money apart from black market applications. Most of them (the unpegged cryptos) fail to hold a stable value, which is what most people expect when they think about money. Cash is expected to hold value day to day at the very least. Bitcoin attracts investors through volatility in value. That is the conundrum for me at least. I fully appreciate others may see this differently.

There are quite a few stablecoins. Although for saying that fiat is finished it is interesting that everything is still pegged to the reserve currency.

Do you think gold has value?

Great comment simbian. Nailed it precisely. Further to Bitcoins demise is the problem that when crypto’s become mainstream(and I believe they will), central banks will be forced to step in and regulate crypto, as well as issue their own crypto versions dollar/euro/rand etc. Government regulation will come to crypto, and when that happens the entire point of owning an unregulated, freely transferrable “asset” collapses, and will consign Bitcoin to the “novelty” section of history.

Paper money is just that…paper. Backed by an insolvent government that can’t meets its debts and obligations and which prints more of this paper on a daily basis.

So why in earth would you want to hold your wealth in paper?

You wouldn’t. Gold and Bitcoins can’t be printed. Crypto currencies have far more more utility than paper money (they’re programmable) and they can be used without permission.

Beats money hands down

I have one question ? In such a sophisticated, complex and highly regulated financial and capital market system we have today – how can bitcoin be a bubble and be a bubble worth $13000 or mkt cap of 250 billion dollars ???

Further I think bitcoin is currently worth more than most african countries and other emerging market countries’s – gdp

as they say – go figure

Too much hype.
Reminds me of Nieuwhoudt of Garies and the rotten milk scheme.
mass hysteria and lots of tears after.
Mining money in your own garage!
Get real.

I’m not too clued up about cryptocurrencies but when people get excited for the SINGLE reason that the price of the asset is continually rising, then that looks like a bubble to me. Their only motive is “I can’t miss out on this growth”. I’m with the tulip brigade on this one …

Well jblack

The Krugerrand coin I bought in the mid-seventies for< R 300 is now worth approximately R 30k – I would be inclined to say Yes – it has got value!

End of comments.

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