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The Bursting of the Bitcoin Bubble

15/12/2017 … Author:

During a trip to Holland last year I visited a Tulip Museum and purchased a large Amaryllis bulb for just eight euros.  Just under 400 years earlier, such a bulb would have cost considerably more in today’s terms.  In fact, at one point, at the height of what became an incredible, speculative bubble, single tulip bulbs were reportedly exchanging hands for more than 10 times the annual income of a skilled craftsworker and one particular variety was worth upwards of five times the cost of an average Dutch house at the time.

Tulip mania as it became known, remained the biggest, recorded speculative bubble in history – until now.  Unless you have been living in a bubble of your own, you can’t have failed to have heard of Bitcoin. It is a computer based currency known as a cryptocurrency of which there are now well over a thousand, with more being launched every week in one form or another.  Research from New York based, Convoy Investments released this week concluded that the Bitcoin Bubble has now surpassed that of Tulip mania as the biggest ever economic bubble, as shown in the chart below


Source: Elliot Wave International, Yale SOM, St. Louis FRED, GlobaFin and Convoy Investments

Bitcoin, introduced in 2009 was the first of the new online currencies and its value has seen spectacular volatility and growth.  Like everything else, Bitcoin is only worth what anyone else is prepared to pay for it and that price has largely been fueled by significant demand which, in itself, has been fueled by the significant rise in value.  

The initial Bitcoin Bubble was inflated in the early part of the decade.  From mid 2010 to the start of 2013 the price of Bitcoin varied widely but ultimately increased by more than 167,000%, from a low of $0.008 to over $13. Less than 11 months later it had increased by a further 7,000% to reach $979.   However, those that bought in at this point saw 75% of their investment wiped out over the next two and a half years.  Holding firm did however prove to be prudent as, by January this year the price had recovered to its 2013 high. And then it doubled, and then did so again, and again, and again. 

At the time of writing Bitcoin is trading at $17,070 and it is not inconceivable that the spectacular increase in value will continue to tempt new investors to join the frenzy which, will then see the price pushed up even further – before it collapses.  And it will collapse.  

Cryptocurrencies are currently as good as unregulated by any real sense and this won’t always be the case, for all of them at least.  Whilst Bitcoin has now entered the mainstream with related trading now occurring on major exchanges, there are many uncertainties about it and its kind. One certainty is that cryptocurrencies and trading around them will be rife with fraud and criminal activity.  A significant amount of Bitcoin transactions for goods and services historically took place on the ‘dark web’ where the transactions are, invariably, for ‘dark’ things of one type or another.  Every Bitcoin is numbered and as such, traceable but for a small fee you can break the trace through something called a crypto-tumbler.  Many Bitcoin market participants will be honest, law abiding citizens but you can be certain that the currency will be linked to a significant amount of criminal activity.  The dramatically increasing value will, in itself, lead to more.

Economic bubbles are fueled by false confidence or, ignorance and we strongly believe that this one will burst spectacularly.  Whether it arises as a result of the introduction of regulation, which, admittedly may be difficult to enforce or, as a result of major frauds in cryptocurrencies generally, or some other factor, the confidence will be shattered at some point.  By then, the smart money will have been converted into more mainstream currency and it is likely to be those that found themselves swept up by the mania who will lose the most. 

For every transaction there is a buyer and a seller and with something as volatile as Bitcoin that translates to a winner and a loser.  There may still be substantial gains to be made from the Bitcoin Bubble before it bursts but if you are thinking of investing, you have to ask yourself whether it will be you or the seller who will be the ultimate loser because, just like tulip bulbs in the 1700’s eventually, some people may find that their investment becomes close to worthless.

Cryptocurrencies are here to stay and with consortiums of banks and other major financial institutions aiming to introduce their own, better regulated alternatives, they will become more mainstream.  In the meantime, take a moment to contemplate the fact that we are witnessing one of the biggest asset bubbles in history.  The estimated total value of all cryptocurrencies in circulation is now on a par with the market capitalization of the oil giant Royal Dutch Shell.  Which would you rather own?

Incidentally, the Amaryllis flowered beautifully - twice and is currently in storage pending its rebirth next year – for eight euros it certainly was a good investment!

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