If you have any interest in buying bitcoins in order to cash in on its stratospheric rise this year……DON’T. It’s too late. Bitcoin (and cryptocurrency, in general) is now a bubble commodity whose value will fall precipitously. How can we be so sure? Because 14 days after we posted this article, Bitcoin prices have dropped by almost a third of its value in just five days, with the digital currency on track for its worst week since 2013. It’s going to drop even more in the coming weeks and here’s why:
The world’s most actively traded cryptocurrency has surged seventeen-fold in value so far this year. It started the year worth less than $1,000 but has soared above $17,000. As of December, its so-called market cap (i.e. its price multiplied by the number of bitcoins in circulation) rose to nearly $305 billion, according to Coinmarketcap, a trade website. By comparison, the market value of Wal-Mart Stores Inc is around $288 billion. Bitcoin is just one version of crytocurrencies. While bitcoin is the largest, with a market value of around $250 billion, and a nearly 1,900 percent increase in the past 12 months, there have been a wave of cryptocurrencies in recent years. Two other big ones, ethereum and litecoin, have seen even larger 12-month gains, 5,100 percent and 2,600 percent, respectively, according to a main digital currency platform CoinBase.
It is allegedly a currency, and yet online service companies have halted accepting it as payment. For example, Steam is one of the most popular gaming services in the world, with 67 million monthly active players, putting it head-to-head with Sony’s PlayStation Network. It began accepting bitcoin payments in April 2016 but last month announced that it would no longer accept this “cryptocurrency”. The alleged role of this market is it’s usefulness as a currency, as a medium of exchange. But a good currency will increase the money supply to match money demand better than Bitcoin and its progeny do. A volatile and, currently, exponentially appreciating asset that people buy like a penny stock fundamentally cannot serve as a currency alternative.
Note that Tether is now under investigation by regulators. In late January, Bloomberg reported that the US Commodity Futures Trading Commission had sent subpoenas to Tether to explore whether the site really had any kind of financial backing…..all signs are that it doesn’t. There are more than 100 exchanges where blockchain-based currencies are traded—places with names like Coinbase, Bittrex and Kraken. But many of these exchanges lost their ties to traditional banking partners or were unable to find new ones, making it harder for speculators to sell their cryptocurrency holdings for dollars or other fiat money.
So what is cryptocurrency? Perhaps in the future, it may be a currency market offering an alternative to country-backed currencies. But right now it is a speculative mess. This unregulated currency market — remember it was created in 2009 by an unknown person using the pseudonym Satoshi Nakamoto — has no oversight. It is black box trading by computers using complex algorithms. It became popular with criminals, corrupt officials trying to move money offshore and others who wanted to move money anonymously. Unfortunately, as of 2017, it’s been mom-and-pop investors who have been buying in in order to take advantage of the bubble. Many of these unsophisticated buyers are based in Japan and South Korea, where recent regulation changes have made it easier to trade bitcoin, according to experts.
Market bubbles are a well documented phenomena in which surges in asset prices to levels significantly above the fundamental value of that asset are fueled by unsophisticated speculators. Bubbles are often hard to detect in real time because there is disagreement over the fundamental value of the asset. The primary factors behind most all economic bubbles are twofold: a weak financial policy and excessive monetary liquidity in the financial system. When interest rates are artificially low (as they have been since 2008), investors tend to avoid putting their capital into savings accounts. Instead, they lever their capital by borrowing from banks and invest the leveraged capital in financial assets such as equities and real estate. This lays the foundation for economic bubbles.
UPDATE: One year later.
Bitcoin has dropped from over $15,000 to about $3300 in the last 12 months. Ouch! for those buyers who didn’t read this December 2017 post. Congrats to those who did.