It wouldn’t be long before I chimed in about Bitcoin and the collective insanity that currently surrounds it.
If I’m completely honest, I have not yet endured a market bubble whilst I’ve had skin in the game of the investing world. However the current situation of Bitcoin is obvious even to me.
Just like all the bubbles that appeared before it, Bitcoin has entered the stage where the most adamant of supporters are claiming ‘a new paradigm’. That us oldies can’t understand because we are dinosaurs from a time past.
I believe this will end spectacularly.
In truth, Bitcoin may represent the purest of academic bubbles that has ever existed. I say this because I have searched for a rational way to calculate the intrinsic value of a Bitcoin and everything I have comes up short.*
A Bitcoin produces no income and is extremely hard to value. Some even suggest it has a value of zero, which leads to the question…
Why are people buying it?
The answer is simple and yet it will raise plenty of objection.
It is pure speculation.
There is a relatively small number of people that really believe in the underlying technology and future of cryptocurrencies. I would also care to say that many of these people believe in the technology without really knowing much about the technology, i.e. Blockchain.
These are the first group of people buying up Bitcoins and other cryptocurrencies. They believe that these cryptocurrencies will have such great utility in the future, that the prices today are justified.
There is another group of people that have seen the astronomic rise in Bitcoin prices on the news and have come in to play their hand at the greater fool theory.
Both of these are positions of speculation.
I’ll admit, some speculation about the future value of assets is OK, as people try to judge the potential of an asset in the future. But here is the issue with Bitcoin. Too many are conflating the utility of the Blockchain with the utility of any one cryptocurrency.
Blockchain is extremely useful, with applications in fields such as finance, research and distributed computing. However the value of any individual cryptocurrency is much harder to judge, because they are highly replicable. Thousands of new cryptocurrencies are hitting the market precisely because any teenager with a rudimentary knowledge of coding can take the open source code for Bitcoin off of Github and create a new cryptocurrency with about a day’s worth of work.
So with many very similar competing ‘products’ and a very low barrier of entry to a competitor creating a new ‘product’, where does that leave the value of these things we call cryptocurrencies?
I believe we are left right back at the beginning. Bitcoin has the price that we give it. Which is just another way of saying Bitcoin’s price is based purely on the speculation of market participants.
Now that I have said this, let me add…I do believe you can make money from speculation. That is obvious from all of the bitcoin millionaires we are now hearing about.
I also believe there is a place for blockchain technology in the future.
I merely wish to comment on the speculative bubble that I am witnessing right now.
The anatomy of a speculative bubble
Below I am going to show you Jean-Paul Rodrigue‘s Stages of a Bubble chart, first developed in 2008 long before cryptocurrency existed, let alone had the attention it has today.
STAGES OF A BUBBLE
You can compare this graph to the real valuation graphs of any bubble in history and find uncanny similarities.
I will now show you a chart of the price of Bitcoin since the start of 2017.
It’s a fun game of try and spot the difference really.
As I take one step further and overlay the graphs below, the similarities become undeniable.
If this doesn’t scare the hell out of you, then I don’t know what will. In my opinion, this bubble has a ways to go before valuations reach a more reasonable level.
If you are in the group that is trying to jump on the money-making bandwagon, you’re likely motivated by the idea of making some quick cash, hoping you won’t end up being the greater fool. I just feel it is important to realise that is what you are doing. It is analogous to gambling.
If you are in the group that believes cryptocurrencies will eventually take over the world and the current valuation is justified, then nothing I have written here will change your mind.
The temptation to earn quick money is high, particularly when you have such an exciting goal such as financial independence to work towards. I say it is much better to avoid the trap of believing you can make some quick money. That is a strategy much like playing the lotto. A few people win and get massive media attention, but you never hear about the majority that lose. Even those that win often end up wasting it all because they never learned how to manage their money through the long tough slog of building wealth slowly.
Much better to work with the rock solid reliability of ETF investing, I say. Diversified, income-producing, intrinsically valuable organisations that will always see you increasing your wealth in the long term. They are a sure path to getting you to where you want to go and teaching you the lessons you need to learn to maintain that wealth when you get there. If property is more your game, I won’t begrudge you that opinion.
Pat the Shuffler
*It is true that there may be a way to calculate the fair value, but I believe if it is this hard for me to find it, then it is likely that it is just as hard for most of us to find the fair value of a Bitcoin. I say this not having any coding experience.