Bitcoin is all the rage in currency investments nowadays. Its recent sharp price increase (exchange rate with the US dollar) made it a hot topic for news and blogs. Many are now showing interest in “investing in Bitcoin” because of the tempting price increases. It came close to reaching the $20,000 level, about 250 times its price at one point in July 2010 or more than 6 million times its initial price with the now defunct BitcoinMarket.com.
Even those who don’t have any idea about blockchain technology or the secret behind Bitcoins are interested in getting involved with the Bitcoin hype. Well, it’s not really that necessary to understand the technicalities behind Bitcoin to take advantage of its value appreciation, but it always pays to be prudent. It’s worth noting that many are simply treating Bitcoins as a form of investment, with which they can make gains, as this cryptocurrency’s price continues to rise.
Many are already sounding alarm bells for a possible Bitcoin bubble burst. It only makes sense to be mindful of what can possibly happen. Those who have already obtained Bitcoins and those who are still planning to get a piece of the promising hype should be concerned.
What Is a Bubble?
If you are not familiar with the concept of a bubble, here’s a brief guide. A bubble is a term in economics that refers to an economic cycle characterized by the rapid increase of asset prices and immediately followed by a steep price decrease. Also known as an asset bubble, it’s basically just like how bubbles are formed. They appear quickly and disappear even more quickly as they burst.
A bubble burst usually happens because there are no more investors who are interested in buying an asset at the escalated price. As holders of the asset realize that they can no longer expect further price increases, they decide to sell or dump the asset. This dumping occurs en masse, leading to a bubble burst.
One well known example of an economic bubble is the 2005 real estate bubble in the United States, which led to the subprime mortgage crisis in 2006. As banks excessively extended home loans, demand for housing increased rapidly, so homebuilders built more and more properties. Many bought homes not to be used as their residence but as investments because of the constantly increasing home prices. Eventually, as supply caught up with the demand, prices went down, bursting the housing bubble.
Another example is the US stock market in 2013. In March, the Dow Jones Industrial Average closed at a record high 14,254.38. It eventually breached the 15,000 barrier in May and the 16,000 barrier in December. The stock market saw price gains that exceeded corporate gains. This was an unusual stock price increase considering that companies achieved increased earnings mostly due to cost cutting and not because of increased revenues. Also, the demand for consumer products back then was weak, unemployment was running high, and average income levels were low. All of these eventually resulted in a stock price crash.
The Bitcoin Situation
Bitcoin’s rapid price increase is unlike any other. It far exceeds the price appreciation of any bubble in history. In 2017 alone, its price increased by more than a thousand times before cooling down and decreasing by the end of the year. It’s easy to say that it is a bubble since it has many of the features seen in various economic bubbles over the years. In particular, the rush of Bitcoin buyers is rapidly driving the price higher. These investors expect Bitcoin’s price to go even higher.
However, it’s difficult to compare Bitcoin to the economic bubbles experienced in the past. This is because Bitcoin does not behave anything like them. It’s like gold in that it has no company involved and does not pay dividends but it’s difficult to establish its real value unlike in the case of gold. Things are likely to change though as governments and institutions slowly recognize Bitcoin. Japan’s Financial Services Agency already started recognizing Bitcoin as a legitimate payment method. Also, the US Commodity Futures Trading Commission has decided to designate Bitcoin as a commodity.
Bitcoin has already experienced at least one instance that can be compared to a bubble burst before. In 2011, for example, this cryptocurrency’s price reached a peak of $30 from a low of $1. However, it fell back to $2 within the same year.
Is Bitcoin a Bubble?
Valdis Dombrovskis, VP of the European Commission, in a Financial Times report, warned that Bitcoin was showing signs of being in a “pricing bubble”. He wrote to EU banks and markets urging them to go beyond mere warnings to customers when it comes to the risks of Bitcoin investment. He said that further work is needed to assess and improve the applicability of regulations to Bitcoin and other cryptocurrencies. The governor of the Bank of England shares the same opinion, saying that Bitcoin is a “big ol’ bubble and it’s going to burst”.
In the United States, former US politician Ron Paul calls Bitcoin the biggest bubble of them all. He believes cryptocurrencies have become assets that rival the bubble observed in stocks. University of Maryland professor Brent Goldfarb and MIT historian William Deringer, two prominent names in the study of the economics of bubbles, see the parallelism between what is happening with Bitcoin at present and the bubbles they have studied in the past.
Still, there are those who reject the idea of a Bitcoin bubble. There are those who keep faith in Bitcoin because it’s a new technology and is unlike anything that has previously gone through the bubble cycle. Glint co-founder Ben Davies claims that Bitcoin is not a bubble but asserts that other cryptocurrencies are. There are also columns asserting that Bitcoin has a different pattern, like the piece written by Brandon Green in Bitcoin Magazine, claiming that Bitcoin has an S-curve and that it’s just getting started.
Certainly, there are those who would say that it is a bubble, or that it isn’t. It’s difficult to say which side is right or wrong. What’s clear is that anyone interested in getting involved with Bitcoins should thoroughly understand it and be well-versed with how it works in both the micro and macro scales. Fortunately, fears of a Bitcoin bubble may not be something the global economy has to worry about, at least for now. If ever Bitcoin is indeed a bubble and it bursts, the impact likely wouldn’t be felt by the world’s economies, or only very slightly. Bitcoin is extremely concentrated at the moment, wherein only about a thousand people own 40% of all Bitcoins in circulation. Economic contagion of a possible bubble burst will be very minimal.