By Chuck Jones

Stefan Hofrichter, Allianz’s Head of Global Economics & Strategy has developed 8 criteria to determine if an asset is in a price bubble. According to his evaluation “As a currency and asset class, bitcoin has potentially fatal flaws – which is why we believe it’s a matter of when, not if, the bitcoin bubble will pop. Yet the blockchain technology that powers cryptocurrencies could bring significant benefits to investors.”

[Ed note: Investing in cryptocoins or tokens is highly speculative and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.]

Asset bubble criteria

Of Hofrichter’s 8 criteria, I don’t think all of them apply to every asset bubble, but some definitely do for Bitcoin.

The first is “New-era” Thinking. The phrase “It’s different this time” has led many assets to become overvalued and then have a sharp correction . If digital currencies aren’t “New-era” and “bleeding edge” nothing is. This is similar to the Tech Bubble in 2000 to 2001 when any company that had an i in its name or utilized the Internet seemed to go up in price no matter what business it was in.

Another criterion is Overtrading. Bitcoin volumes have increased almost five times in the last five years. I would extend this to a rapid rise in an asset’s price. It seems a bubble is typically formed (but only visible in hindsight) when there is a swift upward price movement. The upward trend gets investors to pile in and the “greater fool theory” comes into play. Unfortunately, when there is a rush for the exits the price can drop like an elevator.

One criterion Hofrichter has is Significant Overvaluation, but I’m not sure how to apply it in this case. While this makes sense, a “concern” I have about using this regarding Bitcoin is what benchmark to value it. It doesn’t generate any revenue or profits, so traditional methods don’t work.

It does have a cost to create it, but that can vary significantly by what location is used to mine it. Most other assets have some valuation metric, but Bitcoin doesn’t seem to have one. Therefore it is hard to say it is overvalued.

Hofrichter added, “So is this the end of the hype about bitcoin as the future of global currencies? Probably not yet, since speculation in bitcoin and similar instruments appears set to continue for some time. Yet from our perspective, bitcoin has serious flaws: its trajectory resembles a textbook case of a financial-market bubble, and it is lacking several key qualities that would qualify it as a currency.”

Comparing Bitcoin to other bubbles

Hofrichter has compiled pricing for Bitcoin and 14 assets that have seen significant price appreciation followed by declines. They include various stock market and real estate timeframes along with Oil between 1975 and 1985, Gold between 1975 and 1982 and Tulip Mania from 1636-1637.

He has used five years before the asset’s peaked in value to five years after, and graphed them on a logarithmic scale. As you can see on the chart, Bitcoin has far exceeded any of the other bubbles . This makes Bitcoin riskier than the other asset bubbles, since it has a much higher price compared to what the other ones attained.

15 historical asset bubbles AllianzGI; Datastream; Peter Garber (1990), “Famous First Bubbles”; Federal Reserve Economic Data; Robert J. Shiller (2000), Irrational Exuberance; Earl Thompson (2007), “The Tulipmania: Fact or Artifact?” Data as at January 2018

Asset bubbles

Intrinsic value is zero

Hofrichter believes that Bitcoin’s intrinsic value is $0 because “a bitcoin is a claim on nobody – in contrast to, for instance, sovereign bonds, equities or paper money – and it does not generate any income stream.” This is very similar to Warren Buffett’s thinking on Bitcoin.

He also doesn’t believe that Bitcoin is a currency or store of value. Its volatility and high transaction costs (which I believe could come down over time faster than its volatility) keep it fitting into either of those categories. I do believe that if it can solve these issues, along with a few others, that it could be one of the digital currencies that survives.

Hofrichter doesn’t believe that a Bitcoin meltdown will impact stocks and bonds since their “size” is still small, which is similar to my thoughts. And he believes that Blockchain technology has merits due to its ability to significantly reduce the costs of verifying transactions.

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