Bitcoin on fire, falling from sky over city, illustrating demise of cryptocurrency

Is the Bitcoin Bubble Poised to Pop? Proceed with Caution


Written by John Rothans

Sep 20, 2017

Bitcoin has had a busy few weeks. The most popular digital currency in the world faced price drama, a new legal ban, and harsh words from big banks. Some say the cryptocurrency has bounced back stronger than ever. Others argue that Bitcoin is finally being exposed for the volatile fad that it is. While no one can say for sure, one thing is clear: proceed with caution.

Bitcoin emerged soon after the financial crisis of 2008 as a means of sidestepping banks and everyday payment processes and systems. It's a digital currency based on math puzzles and rules set up by an anonymous creator, alias Satoshi Nakamoto. Bitcoins can be bought or sold with traditional currencies, or earned by “miners” who solve complex puzzles.

Issues with supply, volatility & regulation

On the surface, Bitcoin seems to share some of the same advantages that physical gold offers: it operates outside of central banks and governments, gives holders control over their wealth, may help hedge against a weak dollar, and provides a certain level of anonymity. BUT—Bitcoin has a long way to go before it is (if ever) as widely accepted as gold.

For one, the supply of bitcoin isn't as finite as the supply of gold. Philip N. Diehl, president of U.S. Money Reserve and former director of the U.S. Mint, explains: “Buyers think the growth rate in the supply of bitcoins is strictly limited. What this ignores is that the supply of competing digital currencies is not limited, and those currencies are essentially substitutable. As a result, the potential supply of digital currencies is far greater than buyers realize.”

And gold? There are only about 57,000 tons left to mine, reports the U.S. Geological Survey. Pool this gold together and it would form a cube that stands about as tall as an adult giraffe.

But the differences don't end there. While gold and cryptocurrencies are often considered related in the financial markets because of their standings as alternatives to cash, the precious metal, which has been used in this way for ages, is typically more stable than Bitcoin, writes Bloomberg.

How much more stable is gold than Bitcoin? Consider this. According to the tech analysts at Swiss banking giant Credit Suisse, the value of Bitcoin “has been three times as volatile as the price of oil and 11 times more than the post-Brexit exchange rate between the dollar and the British pound.”

“These are highly speculative assets and extremely risky [financial] vehicles,” says Christian Catalini, an assistant professor at MIT. “Right now there is a very high level of enthusiasm about crypto tokens and blockchain, and this has resulted in unrealistic expectations about the value of some of these tokens.”

In the course of just three days last week the value of Bitcoin sunk by about 40 percent and then recovered more than 25 percent off the lows, notes BloombergView, illustrating Bitcoin’s potential for considerable price volatility.

Bitcoin prices have been known to fluctuate by hundreds of dollars in a matter of minutes. These huge, mostly unpredictable, price increases have created fears of a new bubble among seasoned market watchers.

Bizarre speculation levels making some anxious

“There are no fundamentals behind any of this—it's all based on public perception, so you can start to see some really strange phenomena,” says Rob Moffat of Balderton Capital.

This false facade has leaders like JPMorgan CEO Jamie Dimon sounding the alarm.

“It's not a real thing, eventually it will be closed,” warns Dimon. “It's worse than tulip bulbs. It won't end well…It will blow up.”

The tulip bulb mania that consumed Holland in the early 1600s is now held up as the first example of an economic bubble. Speculation drove the value of tulip bulbs to extremes. At the peak of the market, you could trade a single tulip for an entire estate and at the bottom, all you could get was an ordinary onion.

The prices were not an accurate reflection of the value of a tulip bulb. As soon as some people started selling to realize their profits, a domino effect set in, prices took a nosedive, and panic ensued. People had literally traded their homes for a piece of greenery, notes Investopedia. The Dutch government tried to step in but it was too late. The economy entered into a period of depression, all thanks to unbridled speculation around flowers.

The unprecedented speculative nature of Bitcoin has today’s government authorities worried, too. Norway, Thailand, Russia, India, Bolivia, Ecuador, Kyrgyzstan, Bangladesh, Vietnam, and Iceland have either banned the use of cryptocurrencies or instituted regulations around them.

On September 14, China joined these ranks. Beijing ordered cryptocurrency exchanges to stop trading and block new registrations. China accounts for almost a quarter of all Bitcoin trades and is home to many of the world's biggest Bitcoin “miners,” notes Nasdaq, so the final impact of this change could be huge.

By shutting off cryptocurrency exchanges, China is questioning the legitimacy of Bitcoin and its future, making it more difficult for the virtual currency to gain broad acceptance as a medium of exchange, as an asset, and as a different means of payment. Will the U.S. be next? The E.U.?

“So far governments have largely ignored digital currencies, in terms of exercising their regulatory authority,” says Philip N. Diehl. “Sooner than later, that will end. Probably sooner.”

Diehl goes on to explain that “digital currencies fill a need to execute financial transactions anonymously and easily—in particular illegal and unethical transactions. They also fill a seemingly eternal human need to try to get rich quick. These are two reasons governments are certain to intervene in the digital currency market.”

When they do, Bitcoin holders could lose it all. They may be holding on to something that's nothing but an illusion in the long run.

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Bitcoin: A dimming star, a bubble set to burst?

After eight years, Bitcoin still struggles to find mainstream acceptance. Like a slot machine, it can be fun to toy around with, but it's no substitute for a time-tested, strategically diversified portfolio. And it's hardly a match for physical gold.

Gold remains “useful insurance because we can be confident that if a government currency collapses the shiny metal will roughly hold its value…history holds plenty of examples of currencies losing all their value to hyperinflation while gold could still be bartered for food and shelter,” writes The Wall Street Journal. “Gold has thousands of years and a history of being used to back money to support its position.”

Bitcoin has little history, no precedent as a vehicle of wealth insurance, and a very uncertain future. Diehl, one of America's most influential luminaries, summed it up best.

“Bitcoin is a classic ‘greater fool' asset. You buy not because you understand its value but because you think someone else will pay more for it. The last buyer before the price collapse is the ‘greater fool.' Don't be the last buyer. Of course, no one thinks they will be the last buyer.”


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