Bitcoin is a bubble, but let's see what it does post-crash
By Kim Cramer-Larsson
There has been a lot said regarding Bitcoin in recent months. Bitcoin is not alone among cyberspace currencies but it is the one which, pardon the pun, seems to be gaining currency. Indeed, that has developed to the point where experts are not only beginning to take the virtual monetary system seriously, but also to say that, among other things, it might potentially develop as a viable alternative to safe-haven commodities such as gold.
Sounds ridiculous? Well, Bitcoins this morning in Germany were retailing at USD 1,186.03 on www.bitcoin.de at 10:49 GMT, while gold this morning suffered its biggest fall for five months to 1,247 USD/oz. Go figure. What we can say with certainty is that, since Bitcoin's inception in 2008 set against the backdrop of the global financial collapse, it has been quietly and steadily building momentum before going ballistic in recent months. One Bitcoin was worth USD 70 in July. It hit USD 600 at the start of November and we've already mentioned the current price. Easy money indeed!
That's led to, for example, the likes of the German finance ministry recognising it as a "unit of account" and senior officials telling an American Senate committee this month that virtual currencies like Bitcoin have legitimate uses. (source: Economist). That's not to say it's all rosy in the Bitcoin garden. Online forum Silk Road, where illicit goods and services are traded for Bitcoin, was shut down in October by the US' Federal Bureau of Investigation before re-opening and Bitcoin theft has also reared its ugly head.
But returning to the massive spike in the Bitcoin price, it begs the obvious question as to whether Bitcoin is a bubble. A quick glance at some of the more infamous bubbles through the centuries might give us some insight as to the nature of Bitcoin's rise and its potential longevity.
Bitcoin's value has risen from USD 70 in July to USD 1,186.03 at 10:49 GMT today. Photo: Shutterstock.com
Some famous bubbles
Let's first look at a couple of the most famous bubbles and crashes. The Dow Jones collapse of 1929 was perhaps the most famous, plunging the globe into a decade of recession and helping to foment the seeds that ultimately led to the outbreak of World War Two a decade later.
Dow Jones Index 1923-1932
Source : CQG
We can also see a similar pattern emerge on the Nasdaq index at the turn of the century — the so-called dotcom crash — after the lemmings rush to invest in internet stocks plunged over the cliff and into the abyss.
Nasdaq Comp. (.com bubble) 1993-2006
Source: Saxo Bank
In both examples, one can see how the market went up almost vertically just before it crashed. The downturn was at least as fast — very often it will actually be even faster — than the upturn. That is how it usually is when a bubble bursts. Too many investors trying to sell at the same time and not many buyers around.
What does this tell us about Bitcoin? The daily chart for Bitcoin below covers the period from February to June. It was clearly a bubble and it also deflated as bubbles always do. It is just a question of time.
But then something interesting happened. It slowly started to move back up again forming the next bubble as the next chart shows. That small little bump or peak that can be seen in the beginning of the chart is actually the move as portrayed in the above chart!
Currently, the Bitcoin price is going vertically, a slope that we've seen before. Does anyone really believe that this can continue? I have added the volume to the chart as histograms. The biggest volume occurred during the first bubble in May and has not picked up much since. (Note that I cannot verify the veracity of the numbers).
This is obviously a massive bubble and it will collapse. But it is far less easy to predict when it will collapse and how high it will go. My gut feeling is that we are pretty close. What will happen, for example, when internet entrepreneurs the Winklevoss brothers starts to sell after they forked out USD 11 million on Bitcoins in April? Who will step into the breach they might potentially leave behind?
And what will happen when online shops that accepts Bitcoins as a mean of payment starts selling heavily and maybe even terminate payments in Bitcoin if (when) it drops rapidly? All these questions are valid, but we simply do not know how far-reaching the repercussions will be of a collapse which, as these things often do, might develop a momentum all of its own.
How far will it fall?
When the bubble bursts and prices collapse, I can easily see Bitcoin falling to somewhere within a USD 150-250 range. That's no random selection as this is the level of the first Bitcoin bubble. We call it a pre-peak. The price will usually drop to the level of a "pre-peak" once the bubble bursts. If we look back to the Nasdaq Comp., for example, we can see this pre-peak occurred in 1998 at about 1,500-2,000. That is exactly where the market dropped to in 2002.
The first Bitcoin bubble collapse saw price fall to about USD 100 from circa USD 250. There was, however, no pre-peak before the first bubble. But a price around USD 100 was the price just before it really took off and formed the bubble.
So, no, it really is not going to be different this time, but that will hardly surprise any seasoned market players among you. The real test for Bitcoin is how resilient it will prove to be post that inevitable crash, as an indication of its potential longevity.
— Edited by Martin O'Rourke