Is Bitcoin a Bubble?

By Matthew Turk

Using a cryptocurrency like Bitcoin is best described as a mysterious alternative to PayPal. That is partially one of the main reasons why so many criminals use Bitcoin to transfer money. But for the majority of investors who are not criminals, the entire concept of cryptocurrency can seem...cryptic. However, underneath the grandiose complexity of digital currency lies one of the most fascinating and innovative technologies that humanity has ever seen.

Unlike banks and online services, Bitcoin belongs to no sovereign nation and has no verification or overseeing of transactions. If a holder of Bitcoin decides to transfer money through cryptocurrency, there is no underlying intermediary that charges a fee. It is a truly direct transaction, just like handing someone physical money. After 2009, this seemingly odd and quirky idea caused investors to experiment in the financial world. As more investors tried to find their way in, it began to steadily rise, and last year, the value of a Bitcoin skyrocketed after established investors and companies collectively decided to venture into the wild west world of cryptocurrency as the world heads deeper into the Digital Revolution.

Alas, like all great things, cryptocurrency must someday end. Rise and fall is a simple fundamental idea of the Financial Instability Hypothesis by economist Hyman Minsky. That’s what classical economics predicts. Although Bitcoin has recently faltered in the wake of new governmental regulations, its overall rising price reflects how hard it is to get a Bitcoin from one of its existing holders, who are mostly avid believers in cryptocurrencies. Once an investing pattern in the price emerges, lenders and other financiers will realize they’ve over extended themselves with an investment leaving an absence of financing from external sources and a one-way ticket to financial collapse. Then the burden of the price drop becomes too steep to finance exclusively with the assets cash flows. It’s how the the free market works; it grows slowly, skyrockets, crashes, and recovers. It happens in companies, real estate, and it happened during the dotcom bubble burst in 1997. The Internet exploded because it seemed like the most promising new innovation. New companies emerged every day, totaling in 1,300 new ones during that period of time. Money flowed in from investors, and the media did not cease to rave, which brought the rest of the world onto the bandwagon, including many people who had no understanding of the Internet, but threw money in regardless. This yielded unbelievable numbers during the time. For example, Amazon’s stock price during the late ‘90s went from less than $2 to over $107 over three years. It wasn’t long before skeptics began to take a second glance at companies like Amazon and wonder if the new technology companies were overvalued. So one by one, investors tried to get their money back before a crash, and that’s exactly what happened. Eventually once the trend began to spread, the investing world went into panic, stocks became volatile, and larger and larger numbers of people began to pull out. By this time, Amazon’s stock was worth $7 and the company was on the brink of bankruptcy. Amazon and the other names we know today are the corporations that survived the crash and steadily rose in price as the Internet’s potential gained more credibility and solidarity.

Fortunately for Bitcoin, it is not exactly subject to the same dynamic as the dotcom bubble. It may not actually burst, and could just continue to expand for decades. While individuals may suffer catastrophic losses from ill-advised financing of Bitcoin purchases, since Bitcoin is not directly linked to the global economy (the financial system providing its funding), the ability for individual losses to generate the cascading effect that would lead to a Bitcoin bubble bursting are not a structural feature of the market for it. This is because the human race is nowhere near seeing the full capabilities of technology, and the potential of cryptocurrencies can only grow over the next few decades as the natural progression of scientific breakthroughs occurs.

This notion of ongoing development does not even take into account the larger technology that encompasses cryptocurrencies. Bitcoin is simply a consequence of the increasing demand for more digital interconnectivity in the professional world. On the fundamental level, Bitcoin is an innovation that stems from a concept from the 90s that was named “the blockchain” by a group of people who are collectively named Satoshi Nakamoto. The idea of the blockchain was to create a digital ledger, or record of every financial transaction and business interaction ever that keeps signatures and proof of the events and chains them together with cryptographic hash of the previous record. Each object on the timeline of the ledger is referred to as a block. By design, a blockchain is inherently resistant to modification of the data, making an excellent technology in today’s age. Once blockchain technology reaches its full potential, there will be new types of apps that keep track of and verify your education, work experience, medical records money, and more. This will be favored by users so much because it takes out skepticism and is usable by anyone. The sky's the limit for blockchain technology in the future, and Bitcoin along with it.

However, considering Bitcoin solely as an investment, its value cannot rise indefinitely either. At some point, in the next few decades, some investors will start selling and Bitcoin's price will fall or its value will plateau when it becomes a legal currency and steadily rise with the blockchain technologies. But the one issue with that financial trend is that experts are not sure whether Bitcoin is money or an investment. This goes hand in hand with Bitcoin’s status as a brand-new entity. So Bitcoin in summary is an asset in search of an equilibrium price. This price discovery process is unlikely to proceed without the market price getting excessive. It’s also quite possible that the ideal price of Bitcoin is higher than what it trades for today. But using history as our guide, it’s more likely that this process of price discovery will be volatile, and that the current price will deflate before a true pricing mechanism is established. Of course, this time could well be different. But history does tell us that it's dangerous not to take the past into account. Bitcoin is an asset that has jumped more than 1000% in the last year, so remain vigilant and understand the risks as time unravels the answer to the question.

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