The Bitcoin Bubble: Can You Trust It?

Estimated read time: 5 minutes

Tulips and houses are two seemingly unrelated things. That is, until you consider that both have caused two of the worst economic calamities in history. In their respective times, each were the hottest investments around. We're talking foolproof money makers. Then their prices tanked, taking down whole economies with them.

Some wonder if Bitcoin is destined to suffer a similar fate. Tulips, as with the cryptocurrency Bitcoin, bloomed into an investment craze over a few short years in Holland. In the 1620s and 1630s, tulip prices soared in what became known as "tulip mania." It wasn't rare to see people even trading property for a handful of tulips. Eventually, prices got too high, and the Dutch cashed in, causing prices to crash. The tulip bubble had popped.

So, is Bitcoin a bubble ready to burst?

Bitcoin and Bubbles Defined

To determine if you can trust Bitcoin as an investment, it's helpful to first understand what Bitcoin is and what the term "bubble" really means.

Bitcoin is a form of digital currency that allows people to directly make transactions electronically. Unlike paper currency, the supply of Bitcoin is capped, which makes it particularly valuable. In 2017, for example, the price of Bitcoin skyrocketed from less than $2,000 to nearly $20,000. That's for just one Bitcoin. However, by January 2018, its value plummeted by almost half.

That is generally the hallmark of a bubble. A bubble is economic slang for when the price of an asset rises above what seems rational given all available economic data. Such events are typically characterized by irrational optimism by spectators and wild price swings that end in a crash.

Although Bitcoin is used by consumers around the world and accepted by many businesses, many people remain skeptical of its value. There are several good reasons why. For one, it was created only a decade ago, so it doesn't have a particularly long history. Again, Bitcoin's price is known to dramatically fluctuate. Further, the digital currency is still not as established and widely used as traditional paper currencies.

A Look at Bubbles in Recent History

For a better determination as to whether Bitcoin is a bubble, it helps to take a page from the past and look at some bubbles in recent history.

The dot-com bust

Gen X and those later in life might remember when the internet was just getting started in the 1990s. As if the wild west, startup companies were popping up all over the place trying to stake a claim in cyberspace. Seemingly every day a new company related to the internet was going public with insanely high stock prices. It didn't matter what the company did – if anything – as long as it had ".com" attached to its name.

For every Amazon and Google, there were hundreds of pets.com and eToys sites. Through 1999 and 2000, the dot-com era reached its peak and its inevitable fall as investor sensibility caught up to all the hysteria.

The 2008 housing crash

The financial crisis of 2008 is still fresh in many people's minds. The global economy and stock market may have since recovered, but the effects of the housing bust are still felt today.

In the early 2000s, banks were practically underwriting house loans to just about anyone. No matter their income or creditworthiness. Meanwhile, speculators were buying more and more properties expecting to easily flip and sell them. The thought was homes prices would just continue to go up. Eventually, many home buyers couldn't keep up with their mortgages, and speculators ran out of room to make a profit. The housing crash took down not only banks but also the global economy with it.

How is Bitcoin a Bubble?

Now that we've looked at a couple real-world examples of a bubble, let's consider how Bitcoin compares.

First and foremost, bubbles are characterized by an exponential rise and steep fall. As we discussed, the price of Bitcoin soared in 2017, eclipsing a value of $20,000. Fast forward to the end of 2018, and more than 80% of those gains were erased. In that sense, you can certainly argue Bitcoin is a bubble that has already popped.

Further, there is a lot of contention surrounding Bitcoin's true value and viability. Consider the digital currency had a previous period of a rapid ascent and abrupt fall in 2011. Although Bitcoin is often labeled the currency of the future, it isn't close to replacing paper currency or gold in investors' portfolios. There are dozens of Bitcoin exchanges, all unregulated. That raises concerns about the stability of Bitcoin, and ultimately, its future.

Will Bitcoin be remembered the same way tulips are remembered today?

Counterargument

No way, many Bitcoin enthusiasts would exclaim. They argue all the factors people point to as evidence for a bubble are typical growing pains for a new asset. And there is evidence that not only Bitcoin isn't going away anytime soon, it is in a good position for the future.

For one, its current price is still around three times higher than it was only a couple years ago. Assets take time to settle, and periods of extreme price volatility are normal. Investing is often about delayed gratification. Sell early and you can make a profit, but usually waiting results in a delicious reward. Right now, Bitcoin holders are eating well.

While some may see the lack of regulation as a concern, it can also be viewed as a positive. It means governments haven't had reason to crack down on the digital currency or its exchanges.

Lastly, the technological structure of Bitcoin, known as the blockchain, has continued to work well. As an open-source system, no egregious flaws or vulnerabilities have presented themselves.

If there's one takeaway from the Bitcoin bubble debate it's that you should never put all your eggs in one basket. Investing in anything comes with risk. In many respects, Bitcoin is still a young asset and has shown a tendency to experience some dramatic price swings. Bitcoin may have a long and healthy future, or it may fizzle out. Either way, one should proceed with caution.

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