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17 USC 102

The Bursting Bitcoin Bubble

January 9, 2018

 

There has been a significant amount of intrigue surrounding the cryptocurrency Bitcoin due to its recent surge in value. On December 17, 2017, Bitcoin recorded an all-time record high price of $19,843 per coin. While Bitcoin’s intrigue and rise have caused an increasing number of individuals to become interested in investing in Bitcoin, I am not one of these individuals. As I will detail below, there are a substantial amount of warning signs that indicate that Bitcoin is not only a risky investment, but a bubble waiting to burst.

 

First, the volatility of Bitcoin is highly concerning. While Bitcoin has demonstrated an ability to rapidly accelerate its growth, it has also displayed its potential to experience drastic short-term crashes. Bitcoin has experienced three such crashes in the last two months: most recently, the price of Bitcoin declined 22% over a four-day span, which came just after that price reached a record high. If any mutual fund or stock experienced a similar collapse in its value, shareholders would be enraged and demand that the company or portfolio manager take substantive steps to remedy its issues. Yet, due to the nature of Bitcoin, there is nobody to hold accountable and no means by which its flaws can be eliminated.

 

Second, as the amount of Bitcoin transactions continues to increase, transaction costs will continue to rise and the speed at which Bitcoin’s network will perform transactions will be slowed, because this network is flawed and unable to handle the current quantity of transactions. Thus, Bitcoin is progressively becoming less liquid, meaning that it will be harder to convert the cryptocurrency into “legitimate” currencies (the dollar, euro, yen, etc.) and make purchases. If this trend continues, Bitcoin will become worthless and its price will sharply decline.

 

Third, there is no inherent value in Bitcoin. Unlike any other currency, it has nothing backing it. While those optimistic of Bitcoin’s future would allege that the dollar faces a similar predicament, it is important to note that while the dollar is no longer backed by gold, it is backed by the faith and trust in the American government, meaning that you can use it to pay your taxes.

 

Fourth, Bitcoin is highly concentrated in the sense that only a few individuals hold a significant percentage of the currency. It is estimated that just 4% of Bitcoin holders control 95% of the currency. For example, the founder of Bitcoin, who goes by the pseudonym Satoshi Nakamoto, holds approximately 6% of Bitcoin. This characteristic of the current Bitcoin market makes investing in Bitcoin highly risky, as it reflects the potential for one or several investor(s) to spark a massive sell-off, and in turn “pop the bubble,” by offloading all their holdings at once.

 

Fifth, as Jamie Dimon, the CEO and Chairman of JP Morgan Chase, asserts, there is a high potential for governments to take steps that would effectively eliminate the existence of cryptocurrencies. There are several reasons for which governments around the world would want to reign in cryptocurrencies, and particularly Bitcoin: for example, as Jim Rickards, a leading economist who accurately predicted the Great Recession and the editor of Strategic Intelligence, speculates, the majority of individuals selling Bitcoins are not recording their gains on their tax returns. Another reason is that the design of Bitcoin makes it inherently traceless, thus it has been utilized by terrorist organizations, drug cartels, and money launderers. According to a survey conducted in 2015, those who hold a high quantity of Bitcoin are utilizing the currency for illegal purposes. An additional reason governments will want to stop Bitcoin from operating is because of its energy-intensive nature. It is estimated that the amount of electricity used to mine Bitcoin in 2017 exceeded that of 159 countries, and in the near future it will utilize as much energy as that of Japan, the world’s third largest economy in terms of GDP. Therefore, Bitcoin is unsustainable and produces significant environmental costs, increasing the incentive for governments to take substantive steps to eliminate the usage of cryptocurrencies and for the bubble to burst.

 

Lastly, if nothing else, there are a substantial degree of economists and leaders in the business community expressing their skepticism for the outlook of Bitcoin. Jamie Dimon in September called Bitcoin a fraud and has been adamant in his criticism of the cryptocurrency. Jim Rickards has expressed his skepticism regarding Bitcoin by deeming it the second largest bubble in the history of the global economy. Paul Krugman, a Nobel Prize-winning economist has assessed that the Bitcoin is a more obvious bubble than the housing bubble was. Such skepticism has also been expressed by institutions as well, such as major investment firms and hedge funds that have not invested in Bitcoin.

 

Unfortunately, if you have not already invested in Bitcoin, you already missed out on the most substantive benefits. While those who were early investors in Bitcoin could do so at a relatively low risk with the potential for high yields, those investing in Bitcoin today will experience high risk and a substantially lower yield. If you are currently holding Bitcoin, try to sell your holdings as soon as possible because the bubble is waiting to burst and selling while ahead is the preferable option to risking it all. Instead of investing in Bitcoin, invest in mutual funds and diversified portfolios that have performed significantly well in the last year and still offer high yield with low to medium risk.

 

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