Bitcoin Fans should Recall that bubbles always burst

Sam Sivarajan is senior vice-president of riches alternatives at Great-West Life.

In the immortal words of Yogi Berra, “It is déjà vu all over again.” Throughout human history, there have been bubbles in markets.

“Tulipmania” in the Netherlands in the 1600s saw, at its summit, one tulip bulb selling for 10 times the yearly wage of a skilled craftsman.

The South Sea bubble in England in the early 1700s was created after the British authorities gave out the rights to trade with South America to a single company. Frenzied trading of shares in the business, despite insignificant gains, resulted in a bubble that eventually burst and destroyed many. Even Sir Isaac Newton, arguably among the most brilliant minds the world has seen, lost cash in the bubble and ruefully commented, “I can calculate the motion of heavenly bodies, but not the madness of people.”

The dot-com bubble in the late 1990s and early 2000s climbed from new internet ventures being floated on the stock market with no earnings or prospect of earnings that frequently doubled in price in the first trading days. 1 example is Garden.com, an internet gardening merchandise retailer which went public in September, 1999, . From November, 2000,

Today, we might be seeing another bubble in the making — bitcoin. The digital currency was made in 2009 by an unidentified individual using the pseudonym Satoshi Nakamoto. Among the benefits claimed for bitcoin are that it is:

  • Digital, so no actual transfer of money is required;
  • Decentralized, because bitcoins aren’t issued by a central bank and so insulated from the macroeconomic risks that affect traditional monies;
  • Verified, despite not being controlled by conventional banking systems. Any commercial transaction involving parties requires a contract, or a neutral party to offer the assurance to both parties that the trade will occur as considered — as banking systems do for monies. Perhaps the most persuasive part of the bitcoin narrative is that the verification is managed with blockchain technology, a complicated mathematical protocol which ensures the security, legitimacy and transparency of the market.

Bitcoin costs have surged from less than $1,000 at the end of 2016 to over $12,000 per week — an increase of over 1,100 per cent. To put this in perspective, at the height of the dot-com bubble, the tech-heavy Nasdaq index had a trailing price-to-earnings (P/E) ratio of 175; .

Why would this be a bubble?

Currencies, unlike gold, aren’t a store of value. But even gold isn’t an investment per se — there are no returns related to gold, and there certainly is not with holding bitcoins. Broadly, stocks provide dividends, bonds offer interest, rental properties offer rental income. The only return that holders of gold, or bitcoins, can reach is if they could sell it for a higher price than they bought it for.

Selling bitcoins in a higher cost relies, to a large extent, on the scarcity element. Apparently, the source of bitcoins is closely controlled. However, for such a high valuation to be sustainable there can not be any close substitutes.

So, by way of instance, Uber commanded a substantial premium as the first entrant from the ride-sharing marketplace; however as Lyft and other competitors gain market share, Uber can only preserve its valuation if the entire market grows at exactly the same rate or if it gains market share. For bitcoin to have the ability to keep up its valuation, the market must keep on growing (and finally squeeze out traditional monies) and bitcoin must outcompete possible digital competitors. The question might well be: When does the Swiss National Bank, the U.S. Federal Reserve or the Bank of Canada decide they want a piece of the action and issue their own digital currencies? And if this happens, what does it do to bitcoin’s cost?

Can there be a bandwagon effect happening in the market? In all previous bubbles, the summit was marked with the average man in the street talking about the investment and everybody piling up for the fear of falling out.

Are we there yet? Consider that Coinbase, Based on Nobel prize-winning economist John Bogle, the founder of Vanguard, , “Bitcoin may well go to $20,000 but that will not prove I am incorrect. If it gets back to $100, we’ll talk.”

To be clear, blockchain technology is proving to be very promising an down the road, there might well be successful companies which exploit that technology. But there’s a lot to learn from the dot-com encounter: The early hype price retail investors lots of money; however when rationality returned into the current market, the natives built their companies and now we’ve got the Amazons of the world. The underlying technology (net or blockchain) may well be revolutionary; it does not follow that the very first companies to exploit them will be winners in the long term.

George Santayana, the philosopher, said that “those who can’t remember the past are condemned to repeat it.” Regrettably, many bitcoin investors may not bear in mind that bubbles always burst.

Courtesy: The Globe And Mail

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