Is the Bitcoin cryptocurrency just another Tulip Bubble?

The Dutch tulip bulb market bubble, or Tulip Mania, is one of the most famous market bubbles of all time, and the first to be recorded. It occurred in Holland in the early 17th century when speculation drove the value of tulip bulbs to extremes. At the height of the market, some tulip bulbs traded for as much as six times the average person's annual salary.

Tulip bulbs even began trading on the stock exchanges in Holland, encouraging all members of society to speculate in the markets. Many people traded or sold possessions, their life savings, including properties, to participate in the tulip market mania. As with all bubbles, it came to a crashing end in 1637 when prices dropped and panic selling began. It left many people in financial ruin. More history on it here: http://bit.ly/Tulip-Bubble

What is Bitcoin?

Bitcoin is a cryptocurrency, and one of the first to be launched. What's a cryptocurrency? A cryptocurrency is a decentralized digital currency, as the system works without a central bank or single administrator, as is the case with National/Sovereign currencies like the US Dollar. The network is peer-to-peer and transactions take place between users directly, without an intermediary. The transactions are verified/vouched by network nodes through the use of cryptography and recorded in a public distributed ledger called a blockchain.

The number of Bitcoins that can be created has been capped at 21 million, creating the necessary scarcity issue common in bubbles. Of these 21 million coins, there have been 80% put into circulation, therefore the total Bitcoin supply is approaching capacity.

A basic explanation of a Bitcoin is that it is a means of exchange of value. Just like US Dollars, where you exchange goods or services for dollars, you can do so with Bitcoin. What gives Bitcoin it's value, is the value other people are willing to exchange for it, in the market. Therefore, Bitcoin's value is determined by the marketplace and because the Government does not control the supply, as with US Dollars, they cannot manipulate it. This is one of the main attractions of Bitcoin.

There is a huge drawback to Bitcoin and its valuation. The valuation is subject to the confidence the market places in the system, and so long as it is seen as a useful store of value. It's not too farfetched to imagine the valuation crumbling due to confidence in the security of the system, or that demand diminishes as more competing cryptocurrencies come on the scene. The fundamental value of a Bitcoin is dependent on what someone is willing to exchange for it. Compare this to the US Dollar, where standing behind the Dollar is the US Government, which collects $3.5 trillion in taxes annually, oversees a $20 trillion economy, and has the most powerful military in the world. That's a pretty strong guarantor of the US Dollar currency!

Bitcoin is also susceptible to competition from other cryptocurrencies, such as Ethereum, or newer more efficient cryptocurrencies being developed. The maintenance of the Bitcoin blockchain takes up a huge amount of computer storage and processing power, requiring massive computer servers and energy demands. It is not very practical to use Bitcoin as an everyday currency, say to buy coffee, as it's estimated that only 100,000 vendors accept it. Therefore, the main holders of Bitcoin are not utilizing it as a means of exchange, but as a store of value, and more likely as a speculative bet. Perhaps Bitcoin could become the MySpace of cryptocurrency, where it was the pioneering innovator only to be overshadowed by a newer & better competing version. There are anecdotal stories of people mortgaging their homes and maxing their credit cards to draw down cash to buy more Bitcoin. A classic indication of mania.

Government Intervention

Another downside risk is Government intervention. While one of the core advantages to Bitcoin is that is decentralized and not subject to Government currency manipulation, there is the risk that the Government insists on some oversight or regulation. If that is not permitted by Bitcoin users, the Government could outlaw it. Bitcoin does not have a Sovereign National identity, and it can continue in existence worldwide even if outlawed within one particular national border. However, if it became outlawed within a major economy such as the US or Europe, then its valuation and utility will be damaged significantly. Government oversight may be introduced in the guise of preventing money laundering. Bitcoin does allow for a more anonymous exchange, and there is a worry that it could be used to launder money from illegal activities, such as drugs and arms dealing, and it is already being used by hackers for the payment of ransom on ransomware.

The IRS has ruled that Bitcoin and other cryptocurrencies are viewed as property and not currency for tax purposes. A U.S. District Court judge in California in December ordered Coinbase, a popular platform for buying and selling bitcoin and other cryptocurrencies, to turn over identifying information on accounts worth at least $20,000 during 2013 to 2015. The IRS took the case to expose non-reporting of Bitcoin sales by investors.

While the downside risk is huge, there is certainly a major role and future for cryptocurrencies. As a secure means of exchange, it's proven to be quite reliable, aside from some early hacking incidents which appear to have been resolved. It also offers people in volatile environments, such as a collapsing economy or overzealous government, a means to resort to another currency not controlled domestically. This was the case in Cyprus when there was a fear that the Government were going to heavily tax bank deposit accounts, which provoked a flood of Cypriots to buy Bitcoin.

Frothy Bubble Territory

Bitcoin first launched in 2009, by 2010 it was valued at $0.06, and stayed under $100 until mid 2013, and ended 2013 around $950. It continued to trade under $1,000 until early 2017 and then exploded to a high of $19,343 in December 2017. Today it sits around $10,000, but as you can see the pricing is extremely volatile. Proponents of Bitcoin are predicting pricing anywhere from $500,000 to $1 million in the next two years. Many people have called Bitcoin a speculative bubble. The former Fed Chairman, Alan Greenspan, being one, although he may lack some credibility at not having any foresight of the Tech Bubble in the early 2000's, and calling it a new normal! However, a more credible economist, Robert Shiller, who did call the Housing Bubble and the Tech Bubble, agrees with Greenspan, as does Warren Buffet and Charlie Munger of Berkshire Hathaway.

Skeptical people have called Bitcoin a Ponzi Scheme, or a Pyramid Scheme. It is neither, but what I believe it is, is an over-hyped mania. Just like the Tech Bubble when it crashed, the solid income producing Tech giants such as Microsoft and Intel were still standing strong, but their valuations came back down to earth. So, I believe the same will be true for Cryptocurrencies. They will still have a useful role, and an ever-increasing utility of exchange, however their current valuation will be tempered down.