The Bitcoin Bubble Boils

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About: Winklevoss Bitcoin Trust ETF (COIN), Includes: AYT, BTC-USD, BZF, CEW, CNY, CROC, CYB, DBV, DRR, ERO, EUFX, EUO, FXA, FXB, FXC, FXCH, FXE, FXF, FXS, FXSG, FXY, GBB, ICI, INR, JEM, JYN, PGD, UDN, ULE, URR, USDU, UUP, YCL, YCS
by: Andrew Hecht
Summary

A long history of bubbles.

Tulip mania and Bitcoin.

Is almost $2800 the high for Bitcoin?

Blockchain validates the cryptocurrency and vice versa.

The financial drone that flies beneath the radar has tremendous appeal that is growing- Watch for a split that could boost prices.

Just last week, the price of Bitcoin reached a level that no one thought possible just a few short months ago. In 2010, Bitcoin was trading at around the 6 cents level. At the end of 2016, the price had risen to the lofty level of $960.47. At that point, many people were calling the explosion of value a bubble market in the cryptocurrency.

We are now not even at the halfway point of 2017, and the price of Bitcoin has more than doubled from the level it was trading at on the last day of December 2016. Demand for Bitcoin is growing as the price of the asset is only controlled by bids and offers in the market. If Bitcoin is a bubble market, it could be one of the biggest bubbles in history. $100 invested in Bitcoin in 2010 has grown in value to over $4.5 million at the recent highs. If that is not a bubble, I do not know what could constitute one. In fact, it is now a certainty that Bitcoin will find its way into the history books as either the best performing asset in history or, the biggest bubble ever known to humankind. Right now, the Bitcoin bubble is boiling.

A long history of bubbles

" An asset bubble occurs when the price of a financial asset or commodity rises to levels that are well above either historical norms or its intrinsic value, or both." This definition from Investopedia sums up the current situation in Bitcoin. One of the cautionary signs of a bubble is when market participants suspend disbelief and increasing signals that the price of an asset is irrational. There have been so many bubbles throughout history, but three of the biggest have occurred since the 1980's.

In the early 1980's the Japanese yen surged by 50% which caused a brutal recession in the Asian nation. The central bank and government reacted with a program of monetary and fiscal stimulus that caused stock prices and land values to triple from 1985-1989. The bubble bust in the early 1990's leading to a lost decade for the country in the 1990's and 2000's as the economy tanked.

In the late 1990's in the United States shares in technology companies soared leading to a dot-com bubble. The NASDAQ index climbed from 500 at the beginning of 1990 to highs of over 5000 by March 2000 resulting in a crash where the index lost 80% of its value by October 2002 triggering a recession in the U.S. It took 15 years for the index to climb back and make a new high.

The last major bubble occurred in 2008 when U.S. housing prices jumped to irrational levels leading to the Great Recession in the United States. The economic contraction caused the central bank in the U.S., and others around the world, to stimulate economies via programs of historically low interest rates and quantitative easing or repurchasing of debt by the central bank.

Perhaps the most famous bubble in history occurred in the 1600's in the Netherlands.

Tulip mania and Bitcoin

Bitcoin is an asset like no other. In fact, central banks and regulators around the world are having a hard time classifying the cryptocurrency. The Commodities Futures Trading Commission is looking at Bitcoin as a commodity, perhaps because of its penchant for extreme price volatility. Bitcoin is certainly a means of exchange. The regulators and governments are the reasons for its existence. Many people around the world wish to use an asset that is not under the control of any government or regulatory body. Bitcoin is not like the stocks, bonds, or real estate that caused the bubbles since 1980 it is different. Therefore, we need to go back in history almost four centuries to find another market that is analogous.

Tulip-mania gripped the Netherlands in the 1630 and is one of the earliest recorded instances of an irrational asset bubble. Tulip prices soared twentyfold from November 1636 and February 1637. The prices then plunged 99% by May 1637. During the bubble, some rare tulip bulbs were worth more than luxury homes. Bitcoin was 6 cents in 2010. In May 2017, it traded at almost $2800.

Is almost $2800 the high for Bitcoin?

There is a fixed amount of Bitcoin available to the market. There are only 16,367,375 Bitcoins in circulation. At 6 cents, the market cap of the entire market was just under $1 million. On Friday, June 2, 2017, the market cap was $40.22 billion at a price of $2450.85. In less than ten years the appreciation has been nothing short of astonishing, and on the face of it, Bitcoin looks like the biggest bubble in history. However, it lacks several characteristics of a bubble market. While lots of people are talking about Bitcoin around the world, few are buying and selling the cryptocurrency. However, the beauty of Bitcoin is that it is a market where the price is solely determined by supply and demand as bids and offers in the market cause the price to move without any governmental or regulatory influence. Bitcoin is a lot like gold; the only difference is that central banks are the world's largest holders of the yellow metal and can affect the price by their buying and selling activity. When it comes to Bitcoin, the central banks, monetary authorities and supranational institutions like the International Monetary Fund and World Bank have been observers rather than participants.

When I was a young trader at one of the world's leading commodities trading houses in the 1980's one of my bosses told me that the only reasons that markets go up or down is when there are more buyers than sellers or more sellers than buyers. When it comes to Bitcoin, that lesson rings especially true.

One of the aspects of the cryptocurrency that has gained widespread appeal is the operations system of recording that tracks ownership of Bitcoin.

Blockchain validates the cryptocurrency and vice versa

Blockchain or distributed ledger technology will change the world of operations in financial markets, banking, and other business disciplines. The computer-based record keeping allows for an instantaneous flow of ownership and will make formerly tedious operations and settlement procedures more efficient. Blockchain will save Wall Street and many other areas of the international economy lots of money and time in the years ahead. Most recently, the CFTC has set up a lab to encourage and spread the technology throughout the commodities futures markets.

In many ways, Bitcoin has validated the existence of Blockchain and vice versa. The growing acceptance of Blockchain or DLT as the norm of the future has confirmed Bitcoin as an asset.

The financial drone that flies beneath the radar has tremendous appeal that is growing- Watch for a split that could boost prices

The appeal of Bitcoin is that it is a financial drone that flies beneath the radar of governments and regulators. In China, Russia, and other nations that do not have freely convertible currencies Bitcoin is a method of electronically moving wealth abroad to regions of the world where the rules allow for money to move more quickly. While there are many nefarious applications for Bitcoin in the world of narcotics, arms, computer hacking, kidnapping ransom and other illegal activities, in Japan Bitcoin is accepted by most merchants for payment and its acceptance in Europe is growing.

Bitcoin is held in a computer wallet by holders and is transferred from sellers to buyers via blockchain operations. No one controls the market. It would make sense, given the current price level for a split of the number of Bitcoins in circulation at this point. A 100 to 1 split would put the price at around the $24 level which would make the market more attractive to a greater addressable market. However, one of the many answers I do not have about the cryptocurrency which is an enigma wrapped in a riddle, is who would arrange for such a split?

When it comes to bubbles, it is almost impossible to identify a top from which the asset comes crashing down. Bitcoin currently as many of the characteristics of a bubble, perhaps the greatest asset bubble in history but where it pops is anyone's guess at this point. The Bitcoin bubble was boiling at $500, $1000, $2000, and most recently $2800. With a market cap of around $40 billion, the total stock of Bitcoin has a current value of just over half of Warren Buffett's net worth these days. As a means of exchange that transcends borders, it is likely that this bubble is not close to inflated yet. The Mount Gox scandal a few years ago slowed the ascent of the cryptocurrency, but now it seems to be full steam ahead for an asset that was born less than eight years ago.

Many people believe that Bitcoin is a Ponzi-scheme. However, it is looking more like a tulip bulb to me these days. That bulb could keep appreciating for a long time before it hits the history books and by that time it could be the biggest bubble in history, and the price after the fall may even be higher than its current level.

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Disclosure: I/we 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.