Is Bitcoin A Bubble?

One key hallmark of Bitcoin’s price rise from the beginning of 2013 to now, where it has just crept above $240 a coin — up $100 a coin from the last time I wrote about Bitcoin — has been the oft-repeated mantra that Bitcoin is in a speculative bubble, and its price may be due to imminently collapse. This has spawned article after article after article after article — people were calling Bitcoin a bubble at $30 a coin, at $60 a coin — yet the price keeps climbing (and those who were discouraged from investing at lower prices missed out on spectacular gains). It is certain that at some stage the sellers will outnumber the bidders and the price will fall or crash. But when?

I ended my last article on Bitcoin joking that Bitcoin had a much better chance of being part of the monetary future than Groupon did being part of the future of commerce, and that I wouldn’t be surprised to see Bitcoin at some stage trading at Groupon’s record market cap — enough to price Bitcoin at $2,000 a coin. But this was a joke. Bitcoin and Groupon are fundamentally different investments; Bitcoin is an experimental deflationary crypto-currency instrument and anonymous payments system, while Groupon is the equity in an experimental company. That means Bitcoin is a whole new asset class. And not a fantasy asset class, but one that is rapidly permeating the spheres of human consciousness, an idea that is replicating and multiplying at a rate far beyond its original audience of crypto-anarchists, heterodox monetary theorists, and black marketeers.

I don’t really see Bitcoin (and its crypto-currency siblings) facilitating trade a great deal in the future (although, its deflationary-nature might make it attractive to merchants who wish to hoard it). During Bitcoin’s recent run (or more accurately, hyper-deflation) Bitcoin’s velocity has actually fallen sharply as its rising value has encouraged hoarding. Gresham’s Law implies that whenever possible Bitcoin’s deflationary nature will subordinate it to fiat currency for transactions. State-backed currencies tend to depreciate year-on-year, encouraging spending and discouraging saving. That is treated by central bankers as an imperative of monetary policy. Yet Bitcoin’s deflationary nature encourages the opposite, implying that Bitcoin is not a threat to state-backed fiat but a complementary currency, an intangible, anonymous, global and infinitely mobile counterpart to tangibles like gold.

Gold remains a part of the global financial system, a savings instrument alongside its tiny role as an industrial metal and its larger role as jewellery. Credit-Suisse estimated that total global financial assets in 2012 were $223 trillion, of which gold makes up 0.6%, translating to a $1.338 trillion market cap for gold as a financial asset, (although a larger amount of gold — around $8 trillion total at current prices — exists in other forms like jewellery).

There are no fundamental ways to estimate the value of assets like gold or bitcoin, and their values are entirely in the eye of the beholder. But we know Bitcoin is presently vastly outperforming gold as a speculative savings vehicle, and in spite of the fundamental differences (particularly that one is tangible, and one is not) this may drive more and more investors — including institutional investors and funds looking to diversify into something slightly futuristic — into Bitcoin. If Bitcoin’s market cap were to rise to equal that of gold’s as a percentage of global GDP today, that would imply a price of $160,650 per Bitcoin, far, far higher than any price target I have yet seen. Even if Bitcoin were only to rise to 10% of gold’s market cap, that would imply a Bitcoin price of $16,065, still far higher than any price target I have seen. Even at 1% of gold’s market cap, Bitcoin would still fetch $1607 per coin, an almost-sevenfold increase over today’s price.

And gold is by no means a widely-held asset in today’s global financial system. If Bitcoin grew to 1% of the global financial system today each each coin would reach $267,600 in price.

These are, of course, fantasy figures based on back-of-an-envelope calculations, and should not be taken seriously. But what they show is that if the idea of Bitcoin continues to flourish — and if fund managers, and institutional investors begin to hunger for a slice of yield — then there is more than enough liquidity out there today to drive Bitcoin far, far higher.

On the other hand, if Bitcoin is outlawed worldwide by governments (perhaps due to concerns over money laundering and tax evasion) then of course any chance of it beginning to attract any such levels of interest are nil.  But the current government approach to Bitcoin so far appears to be one of attempted regulation rather than outright warfare.

At some stage Bitcoin may be supplanted by competitor crypto-currencies, but so far it is by far the most widely-adopted, and cryptography experts agree that its cryptography is sound, so there is no reason to assume that this may occur anytime soon. But judging by the birthrate and deathrate of social networks in recent years, a fast birthrate and deathrate for crypto-currencies is by no means out of the question. Technology is a fast-paced world where yesterday’s prize-pig is today’s turkey, and already there exist currencies built on similar technology to Bitcoin trading at much lower levels — Litecoin, Namecoin, Freicoin, PPCoin, Novacoin, etc. Whether these act as supplements or competitors remains to be seen, but it may be helpful to remember that while social networking sites today remain hugely popular, the early leaders in that field like MySpace and Friendster are nowhere to be seen. Is it possible that Bitcoin is the MySpace of decentralised crypto-currencies, and that the Facebook and Twitter are just around the corner? Yes — perhaps a platform with a more consumer-friendly interface than Bitcoin will come to dominate the field, making up a sizeable chunk of global financial assets, and Bitcoin itself will dwindle.  Certainly, the source code is available to larger organisations (Facebook? Google? Amazon? Banks?) who may wish to experiment with their own decentralised crypto-currency systems.

It is really hard to say what ultimately will occur, but Bitcoin does demonstrate the principle that anonymous, deflationary crypto-currency can be an attractive complementary proposition in a world where inflationary state-backed fiat currency has become the norm. I would caution that holders of Bitcoins — particularly those sitting on large long-term profits — should seek to diversify both into real-world assets like real estate, productive assets like farmland and factories, and index funds, as well as into new crypto-currencies as they emerge, particularly ones built with more consumer-friendly interfaces that may come to dominate the market. Bitcoin could easily end the year below its current price, but as Bitcoin grows in the public awareness this is decreasingly likely. In the long-term, a market cap target of 1% of gold’s market cap (currently, that would yield a price of $1607 per coin) seems viable, especially if larger players including institutions begin to experiment in the strange new world of crypto-currency.

53 thoughts on “Is Bitcoin A Bubble?

  1. Great post. Your potential target is not the highest I’ve seen though!

    Here is another worth a read that I came across today:

    Balanced view, but points out the risk that a major crash could play out very quickly once started (hours not days) as there are no protocols in place to control the decline (although several mini-crashes in the current run up have not been able to stop Bitcoin from moving higher).

    I do understand that the number of people buying and hoarding Bitcoin is making it act deflationary at the moment, but the number of Bitcoins is constantly inflating so not sure I would refer to it as a “deflationary crypto-currency”.

    • Fundamentally, especially as we get out beyond 2017 and 2025 it’s highly deflationary because it is mathematically limited and over 90% of potential Bitcoins will have already been mined. Its current price trend (up) is deflationary because it encourages hoarding. Gresham’s Law is powerful, and we’re beginning to get empirical data that this is the case (although Bitcoin can still mediate exchange under some limited circumstances).

      When sellers exceed buyers prices could fall significantly. But a 50% fall would take us back to $120. I still think it’s possible we could go back as low as $30, but the wider interest is huge, and growing. This is capturing people’s imaginations. Lots of people are buying one or two just out of curiosity.

      • ” Lots of people are buying one or two just out of curiosity.”

        This is the key to its success. It is like an Art Auction. It just takes people’s fancy to bid the price up.

        • yeah a few of my firends bought 1-2 BTCs last week just to check it out
          perhaps when this slaughter is well over, I buy a few too just to play with it…

      • To me, it doesn’t seem like BC could be in a bubble because there would be an infinite demand to protect one’s wages from confiscation. It will be interesting to see if BC becomes so ubiquitous that one can find workers who will accept them. Also, there needs to be some way to earn interest on them, i.e.. investment uses.

      • Nice post John.

        Two armchair observations:

        1) A minor quibble on your numbers, as they seem to imply that there are currently around 8.3m bitcoins in circulation. According to this chart, it’s more like 11m. Still, the general point stands. (You may also be using some kind of average from 2012…)

        2) Based on this and the fact that one BTC is divisible up to eight decimal places, it would seem that Bitcoin could conceptually expand to 5 percent of the current global financial system before it’s smallest possible unit exceeds the value of 1 U.S. cent.[*]

        I wonder if this says something about the creator’s (creators’?) ambitions for infiltration into the monetary system?
        [*] Yes, I realise that this is a static calculation.

  2. I had thought that bitcoin was in a bubble and it would crash… now I’m not so sure. I think a lot of money has entered the system in the past month. Could it even get below $50 now? Are people buying btc will the anticipation of using them in a year, no matter the fluctuations? I’ll just stop making predictions and leave that to the smart guys..

  3. By the way, Aziz, 1% of gold’s market cap would make the btc market cap about $100B, a very high number. Maybe you mean 10% of one oz of gold per btc?

      • Aziz, I think the players of btc need it to be around $200/btc for what they wish to do; which is transferring amounts of $100,000 without affecting the price much. When that is reached and stabilized (I imagine it will hit $300 at some point), I think the players might be keeping their eyes open for a secondary cryptocurrency. Not just for its new bubble potential, but as a way to diversify from government meddling. (If Mt. Gox is raided, many users will no longer be anonymous.)

        Most of the alternatives (children really) aren’t terribly innovative from a user’s standpoint; although PPCoin looks very interesting because it seeks to replace mining with generation via interest on savings. This saves a lot of computer power which is wasted by other “mined” coins. Even so, it is still version 1 of cryptocurrencies. When version 2 cryptocurrencies come out, it will be a new family with new features.

        I think bitcoin will be dethroned eventually, and will perhaps be relegated to a niche role, but it will take a challenger with better features. This seems to be a true anarchic free-market of currencies, and in such a scene we should expect lots of innovation and turnover. I think one should keep an eye out for new currencies with new features, especially enhanced anonymity. When you see one like that pop up, I would suggest you take it seriously as a new player.

  4. Great commentary as always John. Being merely a low-end technophile, I am likely to miss this party. I’ve been nearly assaulted for making the ‘bubble’ assessment on other blogs. BTC owners are more impassioned than goldbugs.

    I do not chase value when price is escalating at breakneck speeds. That method of investing/trading has allowed me to miss plenty of great plays… but saved me from ten times as many disasters that would have been far greater in losses than the big wins.

    I genuinely hope it goes to everyone’s desired expectations… assuming they actually have one. I fear for those ‘speculators’ they are only buying small amounts, 1, 5, 10… just to be involved and putting a small or negligible amount of their net worth in a ‘gamble’, but I suspect they do not have an exit strategy, much like that bearded fellow in the Eccles Building. For them the time to exit may pass them by and they will be the ones holding the proverbial bag. I can tell stories about many souls that ‘took a shot’ on ZYX and XYZ dot-com stocks and were displeased as they saw them delisted.

    I will enjoy witnessing the mania from the sidelines and stick with my favorite investing/trading mantra: “Trade what you see or know.” Best of luck to those involved.

  5. How does one invest in ” Litecoin, Namecoin, Freicoin, PPCoin, Novacoin”

    I think Bitcoin is a little stretched in valuation. I don’ like pin point graphs, they tend to pop things.

  6. EVERYTHING is in a bubble, including BC’s. Until the system re-sets, you will not know the “real” price of anything. Afterwards, people will look at this entire era and have a good laugh.

    • The real price of things are what people will pay for them, same as ever. There may be more distortions now than ever, but that’s life.

      Personally, I buy things more for use-value than speculation, so price bubbles don’t really worry me.

      • Perhaps you should speak to the millions of people who bought real estate around the world , over the past decade and ask them what the real price of their homes are, were, will be.

        “What you pay is what an item is worth,” only works over large samples and time. Otherwise, your on your own. People get ripped-off all the time. And, as a matter of observation, it’s pretty much business as usual in this era.

        • Hey if I had bought a house in 2006 and it was a really nice house that I had bought for its use-value and not for financial speculation I wouldn’t be complaining. (I did the opposite — I sold real estate in 2006 because I knew we were in a bubble, but that’s another story).

          I don’t think that the price you pay for something is “what it’s worth” (I think that conflates financial value with use-value). But if that price was the result of a competitive market, then that’s the real price at that moment. Price bubbles are part of the human condition and have been happening since a very long time ago.

        • “But if that price was the result of a competitive market, then that’s the real price at that moment.”

          And, as you well know, the MAIN problem with financial tampering is that it distorts pricing which then leads to all kinds of mal-investment based of on fictitious valuation, the resultant bubbles and crashes.

          Reaching a true market price is like any other ideal, but there are times when you can approach such. Unfortunately, there are also times [such as the ones we presently enjoy] where pricing is severely distorted, almost always to the advantage of those holding the paper [until the very end].

          What, were you ten years old when you were selling property? 🙂

  7. Trying to find better money is like try to find a better religion. They’re all corrupted because they are abstractions of what is real.

    Just as pure spirituality can not be accessed intellectually, real value can not be accessed through money, and is therefore subject to ALL the distortions and corruptions that define all things knowable.

    John, it would be like trying to know you through this blog. Yes, we can get an idea of who you might be [perhaps], but we can not know you unless we understand your essence, only accessible directly.

  8. Bitcoin is man made. Fallible. Gold is God made. Infallible.

    I will stick with Gold. A violent gangster will spare my life, maybe, if I offer a golden ring in exchange for freedom.

    He’ll slap me down harder if I offer a Bitcoin.

    This is an extraordinary exciting time to see Bitcoin attract greater fools.

    • Bitcoin is man made. Fallible. Gold is God made. Infallible.

      Gold is a configuration of atoms. Bitcoin is a configuration of atoms. That’s what God (or nature) made.

      The purchasing power in both is manmade.

      • “Gold is a configuration of atoms. Bitcoin is a configuration of atoms.”

        Actually, Bitcoins have no material substance, but, in a sense you are correct that they one and the same. Gold only exists in its present state as a function of time and temperature, whereas Bitcoins similarly exists via the same constructs, except the atoms are not AU but instead, mostly C.

        In other words, all things truly are all things, understanding the relative/absolute nature of existence.

        Just the same, you can have your gold and your Bitcoins; I’ll take my labor-power and eek out an existence on my own.

      • Whilst we as humans are a natural by-product of the heavens, may I point out the Book of Ezekiel.

        Interesting reading. If we were given a message, we better heed it.

        BTW I enjoyed reading the Reddit link. People at the start of a Ponzi, always do well. Ponzi’s rely on hope first, then greed.

        The secret to a Ponzi is finding hopeful people first, this gives the base for the greedy ones to come along, then the late adopters, the shy, the curious the skeptical are finally fleeced.

  9. Re “perhaps a platform with a more consumer-friendly interface than Bitcoin will come to dominate the field, making up a sizeable chunk of global financial assets, and Bitcoin itself will dwindle.”

    Bitcoin is primarily a protocol. People can and do build many interfaces on top of that protocol, and indeed much more work on that angle needs to happen before Bitcoin is widely accepted. But the bitcoin protocol itself doesn’t dictate any particular interface; any innovation in that area can be applied as much to Bitcoin as to any other crypto-currency.

    • This is true. But I’m increasingly concerned that corporations (I’m especially looking at Amazon) trying to build a consumer-friendly front-end may want to build other features into it specifically escrow and some kind of insurance features.

      I hope the open-source community can come up with better interfaces for Bitcoin.

      • “Amazon”
        Amazon recently reached agreements with several state governments in US to collect and forward transaction sales taxes. (previously Amazon vendors were not required to collect sales tax if shipping to a different State) Purchasers names, State of residence and payment type information are now made available to government tax collectors. It will be interesting to see how this plays out during the evolution of crypto-currency.

  10. As Minsky said, anyone can create money, but the difficulty is getting it accepted. So given a perfectly well organised and viable form of money (dollars in the US, Yen in Japan, etc) there must be some motive for holding Bitcoins. And the motive is that transactions are easier to hide from the authorities than transactions done with dollars, pounds Sterling, etc.

    That apart, Bitcoins are INCONVENIENT in that they gyrate in value.

    So the market for Bitcoins will be limited by the number of people who are seriously concerned to avoid being noticed by the authorities. Lest that’s my theory.

    • As Minsky said, anyone can create money, but the difficulty is getting it accepted.

      Good quote.

      Personally, I think Bitcoin’s deflationary nature will also prove attractive to some too (markets should eventually become more liquid and architecturally sound, because quite a lot of the panic surrounding this recent crash over the last 2 days appears to have been a result of poor architecture on the main trading site MT Gox). Obviously not as a medium to denominate debt, but certainly as a medium to denominate savings.

      • Bitcoins also seem to be useful to those doing entirely honest international transactions. But the big drawback of Bitcoins is the fact that they gyrate in value.

        So there is a killing to be made by anyone who sets up a Bitcoin system without the latter drawback. And that is easily done: just make the new coins purchasable with any currency, and make the basis of their value equal to that of a basket of currencies. E.g. on coin equals one US Dollar, plus one Euro, plus on UK Pound.

        Of course the coin issuer would have to be trusted by everyone: a TBTF bank would do. That’s never going to go bust.


    Thanks for the link Aziz. This is a great way for the early adopters to get a tax free capital gain, thanks to the US taxpayers. I feel sorry for the young hopefuls who wanted to get rich quick. I feel their pain as I geared up as a student to buy into the tech boom, luckily there was work then to pay off the debt, but the benefit was also that it was only an unsecured loan. These guys who borrowed student loans to buy into the Bitcoin bubble will be in debt to the government for life. Sad.

    Does the Government forgive the debt?

  12. Because Bitcoin can be bought in small parcels, with no broker fees, watch the price skyrocket, once market players build momentum. Like all trading patterns, it will be pushed past its high and propelled by hot money..

    If you look at the graph last year it was parabolic. Then it crashed, stabilised and shot up again. I think we will see this occur again. The beauty of this is the Bitcoin (Stock) has no losses or earnings announcements, is not diluted by fresh capital raisings (Deflationary) . So its a pure example of human “How high can it go” hope.

    I am going to wait for it to stabilise in price, because people with a lot of money are playing this. They used the Cyprus crisis to play with the value. When another domino falls over, watch Bitcoin go parabolic again. Its devisability will allow smaller and smaller purchases, so even the poor will be able to buy a unit.

    There is nearly 7 billion on this planet very soon, with total access to computers. It is illegalised gambling.

    Not enough people have been burnt yet to make this a political issue. Yet.

  13. Mt Gox terms and conditions:

    “Mt. Gox will request identification information (such as an identity card, invoices, Government issued photographic identification, utility bill, residential certificate, signed certification of cohabitation, or similar, banking information) depending on the amounts deposited on the Accounts or the presence of suspicious activity which may indicate money-laundering or other illegal activity. Identification of the bank account from which funds are transferred to the Account may also be requested. In certain cases notarization of certain documents (including apostille) may be requested. Transactions may be frozen until the identity check has been considered satisfactory by Mt. Gox as required by applicable money laundering laws. Mt. Gox may request additional identification information at any time at the request of any competent authority or by application of any applicable law or regulation.

    Accounts may be used strictly for the purposes defined in these Terms.”

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  16. When purchasing a bit coin/s Mt Gox can be paid by bank transfer which costs $24 in Australia, and then they get charged 1000 yen their side, so they warn that small transactions may result in insufficient funds hitting Mt Gox account to finalise your purchase of Bitcoins. This calculation complexity makes it too cumbersome for most users to adopt:

    I honestly think this system won’t work for everyday users as too expensive in transaction fees, but there will be huge fees for MtGox and Banks in sending money via SWIFT.

    I still think it is a good system for moving cash fast, provided one say has exchanged gold for Bitcoins with a early adopter ( Has lots of bitcoins and will trade your asset) and then the recipient trades his bitcoin for the gold on the other side.

    Anti Money Laundering will catch up, but the window of opportunity for these transactions is closing.

  17. When purchasing a bit coin/s Mt Gox can be paid by bank transfer which costs $24 in Australia, and then they get charged 1000 yen their side –

    So about $35 AUD per transaction. At $1000 its 3.5% so you’ll need to trade over $2500 to make it economic (Assuming Merchant gets charged 1.5% Mastercard fees)

    Thus there is an incentive to purchase thousands of dollars of bitcoins to get the scale needed for merchants to adopt discounting for Bitcoins.

    Perhaps when bitcoins stabilise in price it will work for big end purchases.

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  19. I believe its a good and interesting game u play and play and get richer and richer. A virtual satisfaction but there is no exit. A man can physically buy only when the Bitcoin is exchanged with real time currency like USD, Euro etc. What use piling Bitcoin in Safe with no exit.

  20. Pingback: Bitcoin: el debate continúa | Níntil

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