Bitcoin is perhaps the hottest investing topic of the decade, and with its meteoric rise, talks of bubbles have been abound. A cursory review of just the work published on Seeking Alpha recently on the topic includes the term bubble in more than a handful of articles on the topic. We may very well be in a bubble, and major names in the industry warn that investors should be prepared to lose everything.
At the same time, we may just be starting to inflate the blimp, even after the amazing 2017 run we have been in. No one knows for sure, but in this article, we will discuss several historic bubbles, as well as detail general problems for bitcoin as we move forward in a world seeing new cryptocurrencies being created daily. We also contend that cryptocurrencies are here to stay, but you should carefully consider which technology is superior in conjunction with the present bubble before investing.
You may be seeing a lot of people comparing the action in bitcoin to so-called “tulip mania.” But just what are people referring to here? This is one of the oldest bubbles on record. Back in the 1600’s, there was a massive speculative bubble in tulip bulbs from 1634 to 1637. As prices began to rise speculators poured in, driving prices up even higher. In fact, prices rose so high that a tulip bulb was priced at tens of thousands of present day dollars. Speculators became wealthy in a matter of months, but alas, the bubble came crashing down eventually, and bankrupted thousands. Here is a look at the chart:
Keep an eye on the pattern, as it is a common theme to all bubbles, and a pattern that we will be watching for in bitcoin.
The South Sea Company
A huge bubble formed in the South Sea Company from 1716-1720. The bubble formed because the South Sea company had apparently been granted special trading rights in the South American region of the world. As rumor spread of this potential monopoly, shares were driven to new heights. Like with all bubbles, when it became dinner conversation among the most common of people at the time, the bubble popped drastically, and led to an economic crisis. Take a look at the historic chart:
Notice the similarities between the pattern here and that of tulip bulbs.
The Mississippi Bubble Built on The Back Of Paper Money
Interestingly at nearly the same time as the South Sea Company bubble, economist John Law created a national bank that would accept silver and gold deposits in return for paper notes. Now, perhaps this was a lesson in fractional reserve banking, or somewhat of an inflationary experience, but the bank issued far more paper notes than was backed by precious metals, which drove the price (exchange rate) much higher. It wasn’t long before economics caught up and the bubble popped (albeit a bit more slowly than other bubbles), taking the value of the notes down with it. Take a look at the chart:
Source: Brittanica (linked above)
The key here is the meteoric rise in the short time span.
Railway stock bubble of the 1840s.
One of the largest bubbles of the 1800’s was in railroad stocks. During the mid-1800’s railroad stocks were soaring because this new technology was paramount to transporting goods and services across long distances. Stocks in companies dealing in this sector rose astronomically. However, railroad companies, in an effort to demonstrate their reach, overbuilt throughout Europe. When the bubble eventually popped, many railroad companies went out of business and thousands of investors were bankrupted. Have a look at the chart:
Source: Liberty Street Economics
Take note of the sharp one year rise from 1844 to 1845.
The Nikkei Bubble of the 1980’s
Fast forwarding a century, a few more bubbles cropped up here and there but this was the first one that modern investors likely remember. In the late 1980’s the Nikkei surged, capping off a strong three decade run that began after World War II. Factoring in normal correction-like behavior, global economic turbulence, and Japanese real estate market selling, the Nikkei bubble popped from hits peak of almost 40,000 down to 15,000, where it meandered for decades. Take a look at the chart:
Source: The Market Oracle
Most notably, have a close look at the two year-run before the peak of the bubble.
The Dotcom bubble of the late 1990s
When people talk about bitcoin as a potential bubble, many speak to the dotcom bubble. Tech stocks simply rose too far, too fast. While speculation drove prices higher, over exuberance led to tech stocks being discussed at many dinner tables, similar to the old South Sea bubble and today’s possible bitcoin bubble as it is now dinner conversation. Then, at the turn of the century, the bobble popped, and bankrupted countless investors, with the NASDAQ plunging almost 80% in a year and a half. We remember those days. Take a look at the chart:
By now, you hopefully can see a pattern.
Bitcoin As a Bubble
As we mentioned in the opening, bitcoin has been associated with the word bubble across countless articles. However, this piece indicates why. The patterns are extremely similar. Take a look at the current chart of bitcoin:
Source: World Coin Index
Look familiar? In particular, take note of that meteoric rise in a short period of time. It should certainly make anyone considering an investment nervous. It certainly has the makings of a possible bubble that is set to burst. From a chart only, technical aspect, it certainly raises a massive red flag. Can we all agree, that bitcoin is most certainly a bubble?
Just because its a bubble doesn’t mean it will pop, at least not yet. How much higher can it go remains a paramount question. That said, we will tell you bitcoin has bubbled and popped several times already, back in 2011, and twice in 2013. We were going to document this and present an analysis, however our colleague Lynn Sebastian Purcell published an article documenting just this very fact while the present column was being developed. As such, we strongly recommend that you read that article to understand where and how bitcoin has already seen crashes. That said, it seems that we are setting up for a bigger one.
What could cause a pop? To us, it is a longer-term question. What could get the ball rolling? Hints of regulation may be a start. Tax policy could be another. Restrictions on ICOs could further lead to pressure. Continued hacking of exchanges could also be a negative catalyst. For us however, we believe negative pressure will be fundamentally based in the longer-term.
The key questions for bitcoin are long-term. It comes down to this: “is cryptocurrency going to continue to be adopted worldwide? And if so, and assuming a lack of regulation in the short-term, is bitcoin the most useful of the cryptocurrencies?”
Why Bitcoin Will Pop
We believe the answer to the first part of this critical two-part question is a resounding “yes.” We believe cryptocurrencies are most certainly here to stay longer-term. However, just like the dotcom bubble which fundamentally was a belief that our entire economic structure would change in the future (and it did!), those types of macroeconomic changes take time. Cryptocurrency is still in its infancy. So why is bitcoin surging?
Well first it is not just bitcoin which is surging. Most other cryptos are rising at meteoric paces as well. We believe bitcoin is doing the best because it was first on the scene, giving it advantages over the “me too” cryptos. Being first on the scene builds brand recognition. It builds investor confidence. We believe that bitcoin will continue to enjoy its position in the near-term, but we fundamentally believe that bitcoin is absolutely ill-suited as a cryptocurrency which can be utilized for real world transactions in the future. This is the reason bitcoin will pop.
The reason for this is because while bitcoin is built on blockchain technology, similar to many others, bitcoin is slow. In addition, the fees are high. While this is true for many cryptos using the blockchain technology, there are a few technologies that standout above bitcoin. One such example is litecoin. Litecoin is our top choice for alternative blockchain technology. There are some key differences between litecoin and bitcoin, despite many similarities.
First, litecoin is capped at 84 million coins, four times as high as the cap of bitcoins. More supply can help ease demand. However, it is in the technology that there are superior aspects for litecoin. Here we are talking about the time it takes for transactions to go through. Block generation take is 1/4th that of bitcoin, coming in at about 2.5 minutes. This means transactions are conducted about 4 times faster than bitcoin. That is a key advantage. This makes litecoin far more suitable for smaller transactions, as the fees will be lower and the time will be faster.
That said, litecoin still relies on blockchain technology, and in our opinion while this technology is amazing, it is subpar when compared to that of another cryptocurrency, IOTA, which uses the Tangle ledger. We have already documented why we believe this technology is superior, however we want to remind of you three key advantages. First, there are zero fees. None. Second, when considering a crypto on a global scale, IOTA can scale to infinity, while bitcoin, and litecoin, will be hampered by its scaling limits. Finally, IOTA is being designed as its own ecosystem, unlike bitcoin which is in our opinion, still a means of barter for larger exchanges person-to-person. While of course there are no guarantees with this technology, and much is riding on both regulation and continued adoption, from a fundamental standpoint, bitcoin is at a major disadvantage relative to just these two cryptos alone when it comes to real world applications. We are confident that in the comments section following publication our readers will provide a litany of other examples.
Bitcoin is definitely a bubble. There is little to dispute here. That said, it certainly appears from the charts that it is setting up for another substantial pullback, but it is a question of when. The ultimate question for bitcoin longer-term is its adoption on a more global scale as well as its utility compared to other cryptos. We believe the technology benefits by being first on the scene and having big name recognition, however its technology is inferior to others. Bitcoin cannot be practically implemented at a global scale, so we think it is prone to a significant pullback when it is realized by the common investor. With bitcoin now becoming dinner conversation even among the most casual investors, we are extremely cautious near-term. That said, we do believe cryptocurrencies are here to stay, and recommend a small portion of your portfolio be exposed to the technology.
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