I have been seeing many articles the last few days asserting that bitcoin is in a bubble and will burst soon. On the plus side a handful of journalists writing for mainstream outlets are finally starting to use facts in stead of just making things up (a topic I want to write about soon). On the other hand these articles about a bubble tend not to rely on facts, instead basing the idea purely on price movement. Bitcoin has gone from X to Y, and only bubbles create this kind of price movement, right? Maybe not.
Bitcoin is incredibly volatile. Last I wrote about it, the price swung between 1800 and 4000! Not as many people were paying attention way back then (July and August 2017), but had they been the press would certainly have published many articles titled "Bitcoin is Dead" or similar on the down swings.
The problem with ignorant journalists is that they are making stuff up AND PEOPLE BELIEVE THEM! They have no idea why the price is moving like this. The inevitable comparison is the tulip bubble, which like Hitler always seems to show no matter how absurd the comparison. Its an easy (and lazy) way to write an "engaging" article. I bet if I published an article titled "AltcoinX, The Hitler Of Crypto Currencies," it would get a fair number of clicks.
And people listen to this sort of nonsense. I used to as well, however a lesson or two when I was younger taught me to never believe anything, ever, no matter how reputable the source (when it comes to investing). Maybe I will get the chance to write about that in the future.
Before declaring a bubble, or believing one, take a look at market volume during 2017. See anything different, maybe starting in May? How about again in December? Is this volume exuberant and irrational? Or have people been predicting this for years? Is it a coincidence that if bitcoin was worth one million dollars, its smallest unit, the satoshi, would be worth one cent?
The thing is, even people who are normally investing geniuses don't understand bitcoin. In case you don't click on that link, it is Carl Icahn saying both that he doesn't understand bitcoin and that it is in a bubble. How can he possibly make any assessment of bitcoin if he doesn't know anything about it? It is like investing in Microsoft and not knowing what a computer does. And yet his word carries weight even though he readily admits ignorance. People like Icahn see a certain price movement and think the only possible cause is a bubble.
Unlike any other asset I know, Bitcoin is strictly finite. The maximum to be created is 21 million, about 17 million of which already exist. Compare that to stocks. XOM, to pick a stock with a market cap similar to but higher than bitcoin, has over 4 BILLION shares outstanding. Another, INTC, also has well over 4 billion shares. More are printed all the time. So many shares are printed that stock buybacks are commonplace to prevent too much dilution. Stocks are printed to raise money, to pay executives, or if the price goes high enough (if the company believes the stock is overvalued they may print more because it is basically free money). Not every company abuses this, and I am not trying to make a case that the above two issue too many shares. The point is that the number of outstanding shares is not only vast, but theoretically infinite.
But there are no extra bitcoins. No one can print more to capitalize on a price increase or to raise more money. New entrants to the market must purchase from a diminishing supply. And many early adopters, who bought some for reasons other than price appreciation or speculation, don't want to sell. The supply of available bitcoins is extremely limited compared to the availability of most assets. This by itself does not dismiss the idea of a bubble. But as I wrote last time, we are seeing the effects of institutional investors entering the markets. Markets that used to move when $10k entered are now rocketing to unimaginable heights as billions of dollars chase a diminishing supply of coins.
So how do we know if it is a bubble? How do we know what the price should be? It pays no dividend, has no earnings, and no way to easily determine value. It is actually simple. Is it in any way useful, and do people want to own it?
Utility is a monumental topic beyond the scope of this article. Some say there is none but I suspect they don't have any idea what bitcoin is. But it is a totally new innovation offering utility that has never before been seen in an asset.
Do people want to own it? Clearly they do. If every household in the USA wanted a bitcoin, they would not be able to get one. But this isn't a stock that may or may not attract foreign investors. This is a global currency that can not be seized, controlled, or devalued by a corrupt government (which is why most governments don't like it). Most people living in relatively stable nations do not understand the significance of this innovation. This isn't the next pet rock, it is a real game changer. In places where the economy is in a state of collapse it is not unusual to see the price of bitcoin double compared to exchanges as locals scramble to offload their nation's worthless money.
If every household in the world, not just the USA wanted to own some, then the price would far exceed anything we have seen. If every household in just the ten largest nations wanted bitcoin today, and we assume that all 21 million have been created (they won't be until 2140 or so), then each household would get .018 of a coin. But this does not include people living in certain places like hotels and camps, who may also want some bitcoins. In addition there is the fact that many bitcoins have been lost. I just read a heartbreaking article about an early adopter who lost 7500 bitcoins by accidentally throwing away his old hard drive. Estimates are as high as 4 million lost coins. Subtract that from the nearly 17 million currently mined, and each household can only get .011. This may be an oversimplified estimation since not every coin is for sale, not every household wants one, and not every household would spend the same money to buy some. None the less it illustrates the scarcity of bitcoins.
A bubble can not be declared by looking at the price movement. Price alone is completely irrelevant. What needs to be determined is whether the price is reasonable and what direction it will go in the future. Predicting future price is not easy: it requires a deep understanding of the asset. Is bitcoin going up in price because it is achieving wide spread adoption, or is it going up because it is in a bubble? I have not yet found specific data regarding bitcoin, but the most important element of a bubble is usually leverage. I still know almost no one who owns bitcoins, and the leverage used to buy, if any, is likely nothing compared to the leverage used to buy other assets like stocks or houses. Debt levels are not something I want to get in to here, but they are very high and the stock market has achieved valuation levels only seen twice before. For me the question is whether this is the new normal caused by decades of interest rate manipulation, or if we are fast headed towards another crash. Either way the stock market looks more like a bubble than bitcoin. What we are seeing with bitcoin is a result of many more people (and dollars) entering the markets.
Even just a few months ago barely anybody owned bitcoins. But now that the wall street stamp of approval has been granted, everyone is paying attention. Now many people want to buy and they are competing with wall street institutions to get some.
Basically I do not believe bitcoin is in a bubble because more people want some every day.
All of this being said, bitcoin is still very new. Anything can happen. Governments could regulate it out of existence. Newer and better alternatives could replace it. Just because it is revolutionary does not mean it is a good investment. While I believe it is here to stay and price will increase in the long run, it is currently a dangerous and incredibly volatile investment. No one should bet the farm on any investment, especially one with so much uncertainty. Only buy what you are willing to lose.
But if there is no bubble, shouldn't it be safe to buy a ton of it? No. Not at all.
I suspect there is a bubble, just not in bitcoins. The recent torrent of ICO's has me worried. There have been alt coins as long as I have owned bitcoin, and the vast majority of them have failed. But they never got the influx of capital that they enjoy today. ICO's are being regulated or outright banned in many countries. But governments need not worry: when enough people lose enough money, the ICO's will collapse under their own weight. I need to research more, but I suspect that ICO's will collapse in a year or two and bring bitcoin down as they die. Eventually this would only bolster bitcoin as a safe and stable crypto, but in the process many will lose fortunes.
So why does anyone but these ICO's and alt coins? Because they think that bitcoin is too expensive at its current price, whatever it may be, and they want to enjoy the same rewards that early adopters attained. But expectations must be reasonable. Would anyone buy stock in Amazon and expect to cash in like early investors did? Even if bitcoin is adopted by the world it is too late in the game to expect exceptional rewards. Then again, if someone told me a year ago that bitcoin would reach its current price, I would have assumed they were delusional. I expected these prices eventually as the world increasingly adopted the new technology, I just didn't expect to see it so soon. I am certain of only one thing: whatever happens it will be an exciting ride.
UPDATE: As I was revising this to post it, bitcoin went from 17-19k, all the way down to 12k. This illustrates the extreme volatility that needs to be understood before buying. Perhaps a dollar cost averaging strategy is best, but caution is advised. This is not a burst bubble, it is normal fluctuations for bitcoin. I am still in disbelief that the price is as high as this, I was not expecting it for years. In any case the price of bitcoin can and does change very fast. Perhaps it is because only a small number of the total coins are available to be bought and sold, amplifying movements.
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