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Dan Naumov
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I am an IT and design professional who has picked up investing as a major hobby when I have concluded that I no longer have faith in the long-term ability of the socialist governments of Europe to provide for the level of pension and retirement that people have come to expect. I was born and... More
  • Bitcoin Breaks 100$ 1 comment
    Apr 2, 2013 11:02 AM | about stocks: FXE

    Anyone who has been paying even the slightest bit of attention to alternative currencies has probably noticed that bitcoin:usd has been going bonkers as of late:

    BTC:USD - (click to enlarge)

    There are many reasons for bitcoin's rise, from the continuing currency debasement practiced by the central banks all around the world to the generally growing distrust of the population towards their governments and all-around skepticism around the future of the Euro (NYSEARCA:FXE) project.

    Unsurprisingly, the rocket-like rise of bitcoin has pundits already comparing the cryptocurrency to the infamous Tulip mania of the 17th century and to be fair, the longer term chart does bear a striking similarity in it's trajectory.

    BTC:USD - (click to enlarge)Tulip Mania - (click to enlarge)

    A quick look at the charts would imply that perhaps bitcoin is due for a massive and violent correction downward, but things might not be so simple.

    Causes of demand:

    At it's introduction to Europe somewhere around the late 16th century, the tulip was strikingly different from every other flower known to Europe at that time. Simultaneously, Netherlands was experiencing a rise of it's trade fortunes, as Amsterdam merchants were at the center of the lucrative East Indies trade.

    The new merchant class displayed it's success, primarily by erecting grand estates surrounded by flower gardens, and the exotic tulips were prominently on display. As a result, the flower rapidly became a coveted luxury item.

    The second leg of the tulip bubble was fed by speculation as the Dutch merchants and traders were renowned for their gambling and betting habits. The things fueling the bitcoin craze are very similar, but they came in the reverse order.

    First, there was speculation. When bitcoin was introduced in January 2009, there were very few ways to actually utilize the cryptocurrency. Many people would argue this is still the case, but it has to be said that today, 4 years later, there are vastly more avenues for spending the coins on products and services than there were at the time of their introduction.

    Enter Cyprus. If you look closer at the bitcoin:usd charts, you will notice that the biggest rise of bitcoin value coincides almost precisely with the expectations and eventual introduction of currency controls in Cyprus.

    (click to enlarge) (Source)

    It is not a given that most of the inflows are Cypriot money, but it can be reasonably deduced that with banks of other periphery countries admitting they are now seeing increased deposit outflows, the money has to go SOMEWHERE. With "truths" like the letter above, can you blame the depositors?

    Scarcity:

    It's becoming increasingly expensive to stay competitive in bitcoin mining.

    Bitcoin is designed from the ground up to be a scarce commodity. The algorithm responsible for introducing new bitcoins into circulation becomes slower as the total computational power of the bitcoin network increases.

    In the very early days, you could easily use a 100$ videocard in your PC for mining and make a handy profit after subtracting the electricity expenses. Later, you were forced to consider adding a second card to increase the computational power and joining a "pool" that shares resources, because mining a single coin on your own began taking several weeks.

    These days, FPGA and ASIC rigs rule supreme, cheapest ones starting at around 1500$, with anything less powerful mostly being a waste of your time and electricity. As the price of bitcoin rises, more and more people join the mining craze, increasing the total network power, which in turn makes mining more difficult for everyone involved.

    To top things off, the number of bitcoins in existence will never exceed 21 million by design and there is no way to replenish or restore coins lost due to hardware failures and lack of backups.

    Semper AugustusSingle bulbs were sold for twice the price of a house.

    There were several reasons for the scarcity of the sought-after tulips. One of them is the fact that regular tulips were not in demand - buyers specifically sought out the most intense-colored and exotic-looking ones. It is now known that the desired look of the bulbs was caused by them having been infected with a type of tulip-specific mosaic virus.

    The nature of the tulip lifecycle also certainly didn't help satisfy demand: It usually takes around 7-12 years to go from a seed to a flowering bulb and while the bulb can produce seeds and a few bud clones, the original bulb lasts only a few years. Properly cultivated bud clones will become flowing bulbs of their own within 2-3 years.

    Once infected by the virus, the exotic bulbs became an extremely limited commodity because the sought-after "breaking pattern" can only be obtained through clones, not seeds. In addition, the virus also weakened the plant and retarded the propagation of offsets, making cultivation of the most desired varieties even harder.

    Downfall:

    The collapse of the tulip bubble began when for the first time, there were no buyers at a routine bulb auction. It's quite possible that the lack of buyers was due to the fact that the auction was being held in Haarlem, which was suffering an outbreak of bubonic plague, however, within days panic had spread across the country.

    Despite the efforts of traders to prop up demand, the market for tulips evaporated with flowers that had commanded 5,000 guilders a few weeks before now fetching one-hundredth that amount.

    Even though I believe the current leg of the bitcoin rise to be fueled by genuine demand rather than speculation, I would not dare call the recently breached 100$ mark to be a "permanently high plateau".

    However, I would also not expect it's valuation to fall off a cliff in a matter of days. Rather, I assume the valuation will eventually top off (unless things get really ugly) and will then experience a prolonged and steady decline, as the situation in Europe improves.

    Buyers beware:

    "The four most dangerous words in investing are 'This time it's different.'" · Sir John Templeton

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I do not own any bitcoins. My USD, EUR and GBP accounts are all negative as I am leveraged up on equities.

    Themes: forex Stocks: FXE
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  • Maninder Batra
    , contributor
    Comments (572) | Send Message
     
    Good article .
    10 Apr 2013, 05:40 AM Reply Like
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