A textbook bubble in Bitcoin prices is developing right now.
And it has everything to do with Bitcoin's investors.
I'm probably not going to gain any friends
with this perspective. But there are inarguable factors that suggest
Bitcoin's own buyers are irrationally driving up prices. And their
exuberance is setting the market up for a crash.
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Let me clear one thing up about Bitcoin before I explain why I think prices are eventually headed for a crash...
As I argued before, Bitcoin is a legitimate form of money. But for the time being, it's being treated as a speculative investment.
Money is typically used in exchange. And while Bitcoin can
be used in exchange, it's largely not. Gary Schneider, Professor of
Accounting at California State University, says only about 10% of
Bitcoin is held by people who use it as currency. The large majority are
speculators hoping to sell at higher prices.
The fact that the market is dominated by
speculators is not necessarily the problem for Bitcoin. And here's where
I'm sure to piss some people off... The problem for Bitcoin is its
buyers.
Who are they?
Well, according to a recent survey, approximately 60% of Bitcoin owners are under 35 years old.
In short, most Bitcoin buyers are
millennials. And that's all we need to know about them to make an
inarguable point (told you I wouldn't be making any friends here).
The fact is this: A 35-year-old speculator
intrinsically has much less experience in risk management than a
60-year-old. And remember, most Bitcoin owners are mostly speculators,
as opposed to users of the product.
AND remember they're speculating on a currency, which is among the most volatile of financial instruments.
AND remember they're speculating on what essentially amounts to a new, experimental currency.
All this considered, Bitcoin looks to me as one of the (if not the) most speculative financial instruments available...
Expect for Bitcoin's derivatives, of course.
Yes, believe it or not, Bitcoin has a
futures market. And there are products that offer even more risk. On its
Perpetual Bitcoin/USD Swap Contracts, BitMEX offers up to 100x
leverage!
But to really understand why I think
Bitcoin is eventually headed for a crash, let's consider the most famous
market bubble in history...
Dutch Tulip Mania
In the 17th century, formal
futures markets developed in the Dutch Republic, providing the
infrastructure for a massive bubble in the price of tulip bulbs.
The tulip first became fashionable in
France, where early modern ladies of the aristocracy began sporting the
flower on their dresses. From there, the tulip became the flower to show
off social status and wealth. The demand for bulbs subsequently
skyrocketed, and prices immediately followed.
At the peak of Tulip Mania in 1637, a
single tulip bulb could cost as much as 10,000 gilders, the price of a
nice middle-class townhouse in Amsterdam. According to one author, 12
acres of land was once offered for one rare bulb. For a flower bulb!
The Semper Augustus was the most coveted of all Dutch tulips.
Of course, the bubble eventually burst. The
price of tulip bulbs collapsed, and fortunes in perceived value
disappeared over night.
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Here's what I really want you to take away from this story...
If we consider whom the people were who
took part in Dutch Tulip Mania and compare them to the majority of
Bitcoin owners, it seems both groups share the same shortcomings.
First, we know both groups are speculators
betting on the hot new product. But I think we can also make good
assumptions to compare the investment sophistication of the Dutch tulip
investors and today's Bitcoin buyers.
Because formal futures markets were only
recently developed, the Dutch tulip buyers were inherently
unsophisticated investors. All of them. They simply didn't have the
experience.
The majority of today's Bitcoin buyers are
generally younger, so they share the same inexperience. For many Bitcoin
buyers, I imagine it represents their first real investment. They
simply don't have experience in risk management. And I think that's
pretty clear considering some are buying products with 100x leverage!
Bitcoin could be the tulip of the 21st
century with the development of a textbook bubble. And I think could be
setting itself up for an eventual crash.
Now, even though I've been talking about a
crash in Bitcoin prices, there's an epilogue to the Dutch tulip story
that's often overlooked... and that actually provides a bullish outlook for the technology.
Truth is, the Dutch tulip bubble never
really ended... it evolved. The price of tulip bulbs collapsed in the
17th century. But the flower industry at large eventually recovered and
has never been bigger. Global floral production value is currently
estimated at $55 billion.
People still pay thousands for rare
flowers. In fact, an anonymous buyer paid over $200,000 for a rare
orchid in 2005. And that's not even considered the most expensive flower
in the world. Rose breeder David Austin spent 15 years and $5 million
to develop Juliet rose.
My point is, the tulip as an individual
product lost favor. But the collapse of the tulip market didn't
completely kill the flower market. In the same way, I don't expect a
collapse of Bitcoin prices to completely kill the blockchain-based
currency market.
Bitcoin is simply one product of many blockchain-based currencies. A crash in Bitcoin would throw a wrench in the blockchain-based revolution. But there is little doubt that blockchain technologies are the future.
As we speak, every major central bank and
large financial institution is researching how to implement blockchain
into its own systems. It has already been proven to eliminate
verification redundancies and improve security, and new applications are
being tested every day.
So while I think Bitcoin itself could
eventually be headed for a crash, the blockchain technologies that are
supporting all these digital currencies seem set for unprecedented
growth.
Until next time,
Luke Burgess
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