Bitcoin: Everything is a bubble

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By US-China Investment News contributor Charlie Zien

Everyone seems to have an opinion on “the Bitcoin bubble,” many reputableand otherwise savvy investors having made a point of staying out of cryptocurrency altogether, envisioning a tulip mania-like scenario and the ensuing horrific losses.

The explosive and unprecedented growth in this new asset class seems a bit too good to be true. Adding to the mystique, crypto assets are completely intangible; it’s difficult to fathom that there could be so much money flying around over something that doesn’t really exist. Although, waxing philosophical, I suppose that depends on how you define existence. After all, the vast majority of the money supply exists only as entries in a ledger. But I digress.

I agree with the skeptics that that Bitcoin is in the midst of a bubble. However, I am more optimistic than most as to where we are in the timeline of that bubble and what will become of Bitcoin in the long term.


From currency to store of value

The term “currency” is something of a misnomer when it comes to Bitcoin, though that’s not to say it wasn’t an accurate descriptor at one point. Bitcoin was the first application of its kind. For the first time in human history, payments could be sent without relying on any central authority and not subject to control by any government.

The implications of this are tremendous, and decades from now we will look at this trustless payment system as the first instance of a transformative technology that will have disrupted too many industries to count, much in the same way that email was the internet’s first killer app.

In spite of the enormous significance of this advancement, adoption has been an uphill battle. In wealthy countries with strong institutions and robust banking infrastructure, the need for Bitcoin is not readily apparent, so the project did not catch on at first. But in 2011, Bitcoin found its niche in illegal markets on the Dark Web.

For that particular use case, Bitcoin’s main appeal was in its value as a transmission system and medium of exchange. Given the extreme volatility, most customers would use Bitcoin as an intermediary, buying as much as they needed on an exchange and spending it immediately.

As it turns out, demand for illegal goods is pretty high. As word got out that Bitcoin could be used to buy drugs safely and discreetly online, demand soared.

Only 21 million Bitcoins will ever be created. With a limited supply and increased demand from users of the markets, prices began to take off. And thus began Bitcoin’s transition from medium of exchange to store of value.


Rise of the altcoins

Soon, other cryptocurrencies, altcoins, began to emerge that improved on every aspect of Bitcoin. Litecoin and Dash decreased transaction times. Monero brought about superior privacy, with some illegal markets now dealing exclusively in the coin.

As of 2017, there are over 1000 altcoins and tokens. The technology behind Bitcoin is essentially obsolete. The network is exceedingly clunky, with transactions often taking over an hour and fees reaching exorbitant levels as strain on the network increases. Not to mention the inefficiency — I was stunned to learn that each Bitcoin transaction takes up to 77KWh of energy — enough to power an American home for a day!

Yet in spite of its obsolescence, Bitcoin continues to skyrocket in value. But why?

With some notable exceptions, the majority of cryptocurrencies are priced in Bitcoin. In this regard, Bitcoin acts as an entry point to the altcoin markets. While altcoins have encroached on Bitcoin’s market dominance, it doesn’t look like Bitcoin will be going away anytime soon:

By providing Rather than decreasing the value of Bitcoin, altcoins have actually reinforced that value!


Bitcoin is different

Bitcoin is often compared to the tech bubble, but the magnitude of the spike in price puts it and all other bubbles to shame:

Some people see this chart and reason that the bigger they come, the harder they fall, in which case we’re likely in store for a apocalyptic crash beyond comparison in the modern financial world.

However, I don’t believe Bitcoin is comparable to other bubbles. In fact, I see Bitcoin as having more in common with one of the oldest forms of money.


Gold 2.0

Considering Bitcoin’s level of sophistication, it may seem like quite a leap to compare it to something as low-tech as gold. But I find them to be comparable in many ways:

  1. Gold is obsolete. Like Bitcoin, it was once used extensively as a means of payment, but is now principally seen as a store of value, aside from some small-scale industrial applications.
  2. Gold is scarce. Although we don’t really know how much gold there is, we know there’s not a whole lot of it. Bitcoin relies heavily on this principle with its 21 million coin limit.
  3. Gold is forever. Part of the reason gold has such a good track record as a store of value is its longevity. The least reactive of all metals, gold doesn’t tarnish or degrade. Across civilizations, elite families have used it to pass down their wealth through generations. Bitcoin shares this permanence, without taking up any physical space.

Investopedia spells out eight reasons why people buy gold, many of which are strikingly similar to reasons people invest in Bitcoin.


Putting it into context

There is pretty much no doubt at this point that we are in the midst of a bubble the likes of which the world has never seen. But bubbles are a natural part of every market. Just as the price of gold has seen booms and busts, the price of bitcoin will fluctuate over time and I certainly wouldn’t be surprised if it were worth less a month from now.

That said, I see a lot of room for growth in the long run. As of this writing, the total market cap of all cryptocurrencies is approaching $300B, with Bitcoin currently accounting for around 50% of that value. That may sound like a lot, but in the grand scheme of things, crypto markets are a mere drop in the bucket of the global financial system.

In the dot com crash of 2002, it’s estimated the market lost around $5T in value. Given the global reach of blockchain technology, $300B is microscopic when compared to the total value of all stock exchanges, worth some $73 trillion, or the global derivatives market, which is estimated to be worth between $544T and $1.2 quadrillion.

While there is no way to know whether the crypto markets will ever reach such an astronomical value, I can see prices rising to $10k and beyond.

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