Tulips, dotcoms can teach us about Bitcoin bubble's imminent bursting

Tulips, dotcoms can teach us about Bitcoin bubble's imminent bursting
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As we all learned as kids, bubbles soon burst. The same is true in the adult world, as centuries of economic experience have taught – dotcoms, housing prices, tulipmania in 1637, to name just a few.

There can be no doubt that a Bitcoin bubble exists. There is no rational explanation for the rapid run-up in the Bitcoin price in recent weeks or the price volatility it has exhibited. 

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That volatility is itself a warning that the bubble may soon burst.

 

With a market capitalization today approaching $200 billion, Bitcoin accounts for over half of the market capitalization of all cyber currencies, as reported at www.coinmarketcap.com.

The same price action has occurred with other cyber currencies, such as Ethereum, Ripple, and Bitcoin Cash. 

Worse, this cyber currency speculation is a global phenomenon.  Today’s New York Times, for example, reported on the growth of such speculation in Korea, which has led individuals of modest means to make cyber currency bets.

Like all previous speculative bubbles, the cyber currency bubble will end badly, with substantial paper and real losses to potentially millions of people – it is only a question of when the bubble will pop.

The fundamental weakness of most cyber currencies is that there is no “there” there.

With the exception of initial coin offerings (ICOs), cyber currencies have no substance or intrinsic value — they do not represent anything tangible, such as gold or silver, nor do they have a legally enforceable claim on other assets, such as a mortgage on a house or dividends paid on a company’s stock. 

Worse, cyber currencies are not immune to hacking, which further impairs their value. Cyber currencies also have failed as a medium for transacting business, such as paying for goods or services, because of their price volatility. 

Merchants are understandably leery of quoting prices in Bitcoin or another cyber currency because of the great uncertainty as to what that price will translate into in terms of dollars or euros or pounds when the sale is finally executed and money changes hands.

The current price of a cyber currency is based solely on the expectation that it will increase in value. Absent that expectation, most cyber currencies are worthless.

Inevitably, the cyber currency bubble will burst, just as all other bubbles have burst. The great unknowns are when, how fast and where will cyber currency prices bottom out. 

Some cyber currencies may simply disappear, just as stocks in defunct companies cease to exist; others will trade at a small fraction of their peak price.

The huge question today is what will be the consequences of the inevitable cyber currency price collapse. There may even be negative macroeconomic effects, such as on interest rates, stocks and other asset classes

For some cyber currency “investors” — those who got in early and have ridden the price bubble as it inflated — they will merely suffer paper losses, as did early investors in tulip bulbs and dotcom stocks.

More recent investors, though, who probably own most of the cyber currencies now in existence, will suffer real losses — the market value of their cyber currency investment will be far less than the cash they invested. They will be poorer as a result, in real terms.

Because opportunities to hedge cyber currency investments, such as shorting, are quite limited today, those tools will provide little loss protection to those who bet that the Bitcoin bubble would never burst.

Worse off will be those investors who borrowed to invest in cyber currencies; i.e., those who have made leveraged bets that Bitcoin and its ilk will continue to go up and up.

There is no data as to how extensive such leveraging is, but horror stories about Bitcoin investors going broke because they borrowed heavily to make their bets will certainly emerge after the bubble pops.

There will be the inevitable political fallout when the bubble bursts, reinforcing existing cries that cyber currencies must be regulated in some fashion, especially to limit their use for money-laundering. How to regulate the ethereal, though, is highly speculative and certainly untested.

Regulations most likely will be applied to ICOs since such offerings essentially are securities and arguably should be subject to the same disclosure requirements as traditional securities offerings paid for with dollars or other real currencies.

The laws against fraud may also play a role in curbing cyber currency excesses, but perhaps the best cure will be drawing parallels with past burst bubbles where there was no “there” there either, or at least little of substance. After all, one could plant the tulip bulbs that underpinned tulipmania. Not so for Bitcoin and the like.

Time will soon tell how the cyber currency bubble fares. It will be interesting to watch from the sidelines.

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking and thrift industries, monetary policy, the payments system and the growing federalization of credit risk.