Bitcoin Balloons on Overheated Air

Ever since the dot-com and housing bubbles popped in 2000 and 2008, spotting bubbles has become a national obsession. Investors have spotted bubbles in bonds, credit, equities, gold — you name it — over the last several years.

I wouldn’t use the B-word to describe any of those investments — yet. In fact, I wouldn’t even nominate any of them for Most Likely to Bubble Over. I would give that distinction to a certain cryptocurrency that is quickly making its name and fortune: Bitcoin.

Bitcoin has all the attributes of a bubble in the making. First, it’s radically new. It’s a digital payment system that allows users anywhere in the world to transact directly without interference from intermediaries, governments, regulators or central banks — at least for now. Transactions are administered by a decentralized network of computers, much like the internet.

In his book about the 17th-century tulip bubble in Holland, “Tulipmania,” British journalist Mike Dash points out, “It is impossible to comprehend the tulip mania without understanding just how different tulips were from every other flower known to horticulturists in the 17th century.” The same could be said about the internet in the 1990s and about digital currency today.   

Second, Bitcoin is shrouded in secrecy. Buyers and sellers of Bitcoin can trade anonymously, which makes the digital currency a favorite of criminals and hackers demanding ransom. Its origins are shrouded in mystery. Its creator goes by the name of Satoshi Nakamoto, but it’s unclear who that person is or if it’s even one person. That, too, is reminiscent of another bubble. At the height of England’s South Sea Bubble in 1720, one company floated shares “”For carrying-on an undertaking of great advantage but no-one to know what it is.” Of course, that didn’t stop investors from throwing money at the company.

Riding the Wave

In 1720, share prices of the South Sea Company rose 400 percent in three months and then collapsed just as quickly

Source: ICF working paper, “New Evidence on the First Financial Bubble” by Rik Frehen, Will Goetzmann and Geert Rouwenhorst
Note: European date format.

Third, Bitcoin has no value other than what a buyer is willing to pay for it, which makes it susceptible to the argument that underlies all bubbles. Namely, that any price is appropriate. But there’s already reason to worry that Bitcoin’s price is excessive. An investment in Bitcoin has returned a breathtaking 351 percent annually since its inception in July 2010 through Tuesday. To put that in perspective, an investment of $100 in Bitcoin from the beginning would be worth close to $3 million today. It’s not easy to justify that kind of return for any investment.   

Digital Gold

The price of Bitcoin is up 3 million percent since July 2010

Source: Bloomberg

Bitcoin is similar to…

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