At the time of writing, Bitcoin is currently valued at $11,709.58 per …. no wait, $11,670.03 per Bitcoin. That’s down from the high of $19,343 on December 17, 2017. Since its high in December, Bitcoin’s value has taken a nosedive hitting a low of $10,772 on January 22nd of 2018 – losing almost half of its value in a little over a month. This has led investors, commentators, thought leaders, and crypto haters asking – Is Bitcoin in a bubble?
The value of Bitcoin is being fueled by a spike in global demand for cryptocurrency coupled with a limited supply. Bitcoin’s total supply is capped at 21 million coins – compare that with $1.56 trillion in Federal Reserve notes in circulation as of January 24th 2018. Limited supply and increasing demand means increased price according to economics 101. But is this price based on sound reasoning or speculative craze?
Proponents of Bitcoin and alternative coins (altcoins) claim that the value of cryptocurrency is not derived from the coin itself but from the underlying technology. Cryptocurrency allows investors to exchange currency seamlessly while reducing interactions from middlemen and intermediaries. No banks, financial institutions, governments, or other major players involved in transferring funds.
Comparing Bitcoin to Other Assets
One major reason why it’s so difficult to determine if Bitcoin is in a bubble is because there is no underlying value of Bitcoin. For example, the price of a bond can be determined by comparing the coupon rate of the bond to the current market interest rates. If interest rates increase then the price of the bond will decrease, and vice versa.
Bitcoin on the other hand doesn’t have yields, dividends, or other estimated earnings that create a predictable price. Therefore, the value of Bitcoin would be best described purely in the context of traditional supply and demand curves. But why is there such a high demand for Bitcoin?
Bitcoin as an Investment
Contrary to Bitcoin diehards, those flooding money into the cryptocurrency aren’t doing so because they believe in the decentralized nature of the blockchain technology supporting the digital currency – they are doing so because they want to make money.
The fear of missing out (FOMO) is fueling prices because early investors were able to become millionaires overnight. Even now, people are fueling speculation of Bitcoin rebounding and hitting $35,000 by the end of the year. Give it two are three years and you can potentially 10x your money.
What are these predictions based on? In short, nothing. There is no analytical justification for claiming Bitcoin will hit $35,000 at the end of the year nor is there justification that it will bottom out and be worthless by year-end. Why? Because the value of Bitcoin can be impacted by external factors that can drive up the price or make the price plummet.
For example, Asian countries are increasingly uneasy with the rise of Bitcoin and have passed laws to greatly restrict or completely ban the exchange of Bitcoin. This has led to massive losses in Bitcoin and other cryptocurrency. It’s ironic because Bitcoin proponents claim the value of the currency is derived from its decentralized nature. However, the rejection of this decentralized currency from centralized institutions sent the value plummeting.
Is Bitcoin in a Bubble?
It’s clear that the decentralized nature of Bitcoin is not driving the skyrocketing price alone. There are other cryptocurrencies or means of payments that eliminates financial intermediaries or solve the problem that Bitcoin is attempting to resolve.
When someone buys a Bitcoin they are not purchasing the rights to the underlying technology that is Bitcoin. They are not buying an asset that has utility besides a means of exchange. Lastly, they are not buying an asset that gives investors dividends, interest, or other forms of income. The best comparison one could make would be to gold.
However, gold itself has real world use and value beyond its use as a medium of exchange. Gold’s qualities make it one of the most coveted metals in the world. Not only can it be shaped and worn as jewelry, the metal conducts electricity and does not tarnish. These qualities, among others, make it the metal of choice for a wide variety of industries.
Lastly, Bitcoin itself as a medium of exchange is volatile to say the least. With the high transaction costs that the most common exchanges are charging, and unstable prices it would be cheaper and safer to transfer funds through traditional intermediaries.
Final thoughts – Bitcoin is in a bubble regardless if the price does in fact increase to $35,000 at the end of the year. Why? Because there is no scalability of a currency when it’s price can fluctuate hundreds of dollars while writing an article. But that shouldn’t stop anyone from gambling and trying their shot at becoming the next Bitcoin millionaire – or losing all their money in the process.
This article is for information purposes only and should not be relied upon as investing, tax, legal or other paid professional advice or service.