This is one of the questions I am asked most frequently. Is Bitcoin a bubble? When will it burst? How high can it go? Without a Magic 8 ball, I am going to attempt to answer these questions pragmatically (a term that usually gets thrown in to the wind when people get caught in the hysteria of cryptocurrencies). As opinions on Bitcoin are often binary, I welcome an open discussion and any challenges to my views.
Is Bitcoin A Bubble?
I have shared my opinion on the trading of cryptos and how to prepare for less volatile prices before, but avoided taking sides on the debate regarding whether Bitcoin is actually a bubble? I have been buying Bitcoin (and still hold some) and Ethereum since the start of 2017, but in my view, the answer is yes. To expand on this, let’s look through the phases that typically comprise a market bubble.
1) Displacement: A displacement occurs when investors get enamored by a new paradigm, such as an innovative new technology (Blockchain).
There is no doubt that blockchain is an ingenious invention, with applications across many industries by allowing for peer-to-peer transactions without an intermediary. People have piled money in to the potential of the blockchain by buying Bitcoin, the cryptocurrency that utilizes the technology. Blockchain may have huge potential, but this potential has not yet been realised so it is difficult to justify the current price moves beyond pure speculation.
Little attention is paid as to what would happen if a cryptocurrency significantly superior to Bitcoin were be released, rendering the currency obsolete? There are now over 1100 cryptocurrencies in existence (some with names as ridiculous as ‘DogeCoin & Trumpcoin’). Only the best could in theory be widely adopted and survive and therefore, by default, the value of all others should eventually become negligible.
2. Boom: Prices rise slowly at first, following a displacement, but then gain momentum as more and more participants enter the market, setting the stage for the boom phase. During this phase, the asset in question attracts widespread media coverage.
Fear of missing out on what could be an once-in-a-lifetime opportunity spurs more speculation, drawing an increasing number of participants into the fold. This boom has particularly big, both in magnitude and length, as it has never before been easier for the novice investor to purchase a cryptocurrency, and brokers and ‘gurus’ advertise them wildly. Bitcoin has probably featured in every mainstream media outlet, is widely posted about on social media and the average Joe can make hedge-fund scale returns overnight with just the click of a button.
3. Euphoria: During this phase, caution is thrown to the wind, as asset prices skyrocket.
This needs no explaining, just look at the price of Bitcoin! Who is actually buying Bitcoin to spend it? Realistically, for many it is a pure speculation play. Even if the TECHNOLOGY (blockchain) is good, doesn’t mean the value of the CURRENCY should increase so rapidly. How can something who’s value can rise or drop 50% within a week be adopted by mainstream corporations, who then need to exchange this back in to their operating currency to pay tax to governments? The exchange risk for them is too great.
I believe we are encroaching the end of this euphoria phase, as this is undoubtedly the most crowded trade in the world right now. If the rate of growth Bitcoin has experienced in 2017 were to continue, in 2020 it would cost $2million for a single coin…
4. Profit Taking: By this time, the smart money – heeding the warning signs – is generally selling out positions and taking profits.
Estimating the exact time when a bubble is due to collapse can be a difficult exercise. However, I believe we are in the final push higher as this market is becoming increasingly difficult to invest in for the average retail investor. Whereas in January $1000 would buy you a Bitcoin to yourself, and give you a decent risk to reward, you would now get around 0.15 Bitcoins for the same amount of money, and with a lower potential return. People who bought in early will begin taking their profit and anyone who bought late will be left holding the bag.
5. Panic: In the panic stage, asset prices reverse course and descend as rapidly as they had ascended.
Investors and speculators, faced with margin calls and plunging values of their holdings, now want to liquidate them at any price. As supply overwhelms demand, asset prices slide sharply. Unlike with other assets the supply of Bitcoin can only increase so when the demand starts to reduce, the price will drop rapidly. When Oil falls, the Saudi’s can turn off the taps, when copper is getting cheap, they can slow down the mines in Chile, when Bitcoin falls? People can stop mining but the existing Bitcoins in circulation can not be destroyed – this supply remains.
When Will It Burst?
This is a difficult question to answer. It is impossible to confirm a bubble is a bubble until it is too late – otherwise they wouldn’t happen. Markets can stay irrational for a very long time and ironically it is usually the first people who ‘spot a bubble’ that end up going bust (Think Christian Bale in the Big Short, who nearly lost it all by seeing things too early).
People have been calling this market a bubble for a long time – I am in no way leading the way here. The people who thought they were cleverer than the market and went against Bitcoin when it passed $1000, $2000, $3000… $7000… made no money. They missed out on a hell of a ride and a lot of money in the process.
Just because you believe it is a bubble does not mean you can’t profit on the way up – it’s all about getting out at the right time. They have been my most profitable trades this year, and they may equally be just as profitable on the way down. If I’m wrong and it’s not a bubble? I’ll keep buying.
The important lesson to any investor is to be cautious and flexible. Bitcoin may well rise to $10,000, even $20,000 (It is trading at $7400 at the time of writing), but if it does turn out to be an over-inflated market then it will certainly not stay there. And unfortunately it is the most vulnerable and naive investors who enter late that will pay the price for this.
How High Can It Go?
This could well be history’s biggest ever bubble – Bitcoin is up 93750% since 2011 – and it could easily keep going.
Why? Well, in comparison to previous bubbles cryptocurrencies are unbelievably easy to buy. In the 1990’s, you had to pick up the phone and call your broker to buy tech stocks. In the 2000’s it was easy to buy a house and flip it, but it required time and effort. Now anyone can open a brokerage account and buy a Bitcoin at 3am from their sofa. This makes it particularly dangerous as the market has access to an almost infinite number of novice investors who don’t want to miss out.
I have twice had my brother ask me to buy Bitcoins for him. Why? Because he saw they had gone up. That’s it. No reasoning, no thought as to the actual value, just blind herd mentality. And he’s not alone. I get asked on a daily basis if people think they should ‘buy Bitcoin now or wait for a dip’. Never have I been asked ‘Is Bitcoin fairly priced? Is Bitcoin expensive?’
In summary, I believe it would be naive for anyone to look at Bitcoin and completely rule out the possibility that it is a ticking time-bomb, long overdue a significant price drop. It is too easy to obtain tunnel vision, particularly for those who are most closely involved in cryptocurrencies and blockchain technology, and avoid the early warning signs. Stay alert and remember no technology in invincible, particularly in today’s disruptive environment.
The Two Traders