by Donald Gould
The crypto craze hit full bore in the fourth quarter, headlined by Bitcoin and several other digital currencies that boasted astounding returns in 2017 (Bitcoin returned a tidy 13,277% last year). The Bitcoin boom has all the hallmarks of a bubble. To wit:
A price chart in which the slope gets steadily steeper, ultimately approaching a vertical line
A situation where buyers are piling in for no other reason than that the price has been rising, coupled with an assumption that there will be other buyers at yet higher prices when it’s time to sell
A price that cannot in any way be connected to value
But what exactly is Bitcoin? In brief, it’s a digital currency that exists independent of the global banking system. Currencies like the dollar require a central bank (e.g., the Fed) to function. In contrast, cryptocurrencies rely on a decentralized and reportedly “incorruptible” ownership registry maintained through an innovative technology known as blockchain, supported by strong encryption to make it safe from theft or alterations. Transactions in Bitcoin are also untraceable, making it a favored currency for both privacy advocates and criminals alike.
The supply of Bitcoin is strictly capped. Bitcoin is “mined” by solving computational tasks that sequentially require ever more computer processing power. It is estimated that cryptocurrency mining now consumes more than one-half of one percent of all electricity worldwide. That’s a remarkable amount of resources to expend for…well, we’re not sure what.
So, why the craze? To which the crazed respond, why not? As with every craze, the cryptos are new, seemingly exotic, poorly understood, mostly exciting to novice investors, and the subject of endless headlines. Like the Kardashian family, which is famous for being famous, Bitcoin and its ilk have risen because they’ve risen.
It is true that one cannot confidently determine the value of Bitcoin. But that is not the same as saying we can apply any value we want, which seems to be the mindset of the crypto boosters. Working in Bitcoin’s favor is its name recognition and “first mover” advantage. On the minus side, there are no barriers to entering the crypto business, as we’ve seen with the recent introduction of many competitors. Picture Citcoin, Ditcoin, Eitcoin, Fitcoin, etc. Nor would we be surprised to see governments crack down or outlaw cryptocurrencies.
A cautionary note for those hoping to profit from a Bitcoin collapse… Simply knowing (or suspecting) an asset is in a bubble and will eventually find itself at a radically lower price is not sufficient for determining the proper investment move. Like a giant soap bubble, there’s no telling how big a financial bubble will get before it pops. Investors betting against Bitcoin (for example, through the newly introduced Bitcoin futures markets) could quickly go bankrupt. There’s nothing to stop Bitcoin from doubling, and doubling again ($60,000, anyone?) on its way back to $100. The economist John Maynard Keynes famously said “The market can remain irrational longer than you can remain solvent.”
Our advice: steer well clear of this mania.