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Article / 29 November 2013 at 13:00 GMT

Bitcoin is a bubble, but let's see what it does post-crash

Technical Analyst / Saxo Bank
Denmark

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
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

Dow Jones 1929

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

Nasdaq comp

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. 

Bubbly Bitcoin

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.  

Bitcoin May13

Source: Bitcoincharts.com

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).

Bitcoin 2013

Source: Bitcoincharts.com

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

Link to this article

6y
Jim Earls Jim Earls
BitCon bubble metrics are a microcosm of the larger outstanding credit bubble that pervades the entire financial system.
6y
Mickette Mickette
Cyberwar and bye bye your Bitcoins!
6y
Kim Cramer Larsson Kim Cramer Larsson
Interesting development on the daily chart Thursday and Friday. It formed a Doji Evening star pattern. Major sell off Friday under heavy volume. Could this be the peak ?
Since it is not an official and regulated Exchange all information should of course be regarded with a bit of cautiousness.
6y
Kim Cramer Larsson Kim Cramer Larsson
Bitcoin bubble keeps deflating.
Source: Bitcoincharts.com
6y
Lasse Birk Olesen Lasse Birk Olesen
I remember back in 2011 when Bitcoin had just tripled from 0.3 to 1 dollar and most people said it was a bubble.

Kim, do you agree with the analysis in this video?

https://www.youtube.com/watch?v=qHUPPYzzZrI
6y
Kim Cramer Larsson Kim Cramer Larsson
No. I think he compares apples to oranges. An investment to a product or "functionality". On the other hand if he really wants to do the same analogy why doesn't he compare the tulip mania in 1637 with bitcoin ? Because it will not fit his story ! He assumes that an investment or the use of a product will flatten out in terms of value after a certain period of time which it will not. It will usually decline. Currently FB is loosing users !!! FB has to invent new ways to make money to keep or grow their value
It is the behaviour behind an investment that is interesting and the behaviour is still the same regardless of the instrument. What he try to do is to talk up the price or justify the price in the same way as people were trying to justify the calue of IT companies (many without any real product or servises) back in the 1990's dot com mania.
6y
Lasse Birk Olesen Lasse Birk Olesen
So Facebook may be reaching market saturation. What data do you have to back up that Bitcoin is reaching saturation?

In your original post above it seems you rely only on a technical analysis of "the Bitcoin price is going vertically". But you get the exact same picture if you looked at the Bitcoin price up to February 2011 hitting 1 dollar: http://bitcoincharts.com/charts/mtgoxUSD#rg60zczsg2010-01-01zeg2011-02-8ztgSzm1g10zm2g25zv

Would you also have predicted Bitcoin to be a bubble in February 2011?
6y
Kim Cramer Larsson Kim Cramer Larsson
However, I am not saying the bit coin price will collapse to 0 but the chart has distinctive bubble pattern and since I published my analysis the value of the bitcoin has dropped by 60%. And it went down to its pre-peak as an instrument always does.
If that was a stock market you would call it a crash - a major crash actually (1987 stock market crash caused a 40 % drop in Dow Jones). The value of the bitcoin can off course recover - and it has somewhat - and go to new highs and create an even bigger bubble which eventually will collapse. It has an enormous upside - and an enormous down side - like Gold, Tulip, Silver, dot com Co etc also has ...
6y
Lasse Birk Olesen Lasse Birk Olesen
" since I published my analysis the value of the bitcoin has dropped by 60%. And it went down to its pre-peak as an instrument always does.
...
The value of the bitcoin can off course recover - and it has somewhat - and go to new highs"

This is all in line with the S-curve analysis in the Youtube video I posted.
6y
Kim Cramer Larsson Kim Cramer Larsson
Yes you get the same picture. You also get the same picture if you back in time in a stock like Apple. Several times it has been a bubble and collapsed.
Below chart shows two bubbles in Apple but there has been a few more historically.
You can easily have several bubbles in the same instruments
6y
Lasse Birk Olesen Lasse Birk Olesen
So was your bubble prediction only for the short term? While long term you are not making any predictions here?
6y
Kim Cramer Larsson Kim Cramer Larsson
One has to understand that bubbles can occur intra day, over a few days , weeks and months. It is not a specific time period. It is a pattern that repeats itself.
A bubble has nothing to do with the price or value itself ie. not a certain price level nor has it any time period limitations. It is a characteristic pattern and it can occur in the same instrument over and over again.

Normally you see one or two so called pre-peaks before the peak. A pre-peak is characterised as major correction before the peak.
When the price starts to drop it usually drops down to a least the latest pre-peak which bitcoin now has done. Wether it then will pick up and create a new even bigger Bubble is too early to tell.
The pre-peak seems to have occured in November where the value dropped from 900 (high in pre-peak) to 500 (low in pre-peak) in a few days before resuming its bullish move to the peak in December.
6y
Kim Cramer Larsson Kim Cramer Larsson
That means that the price should drop to a least the highest level in teh pre-peak after peaking out but usually the price will drop to the lowest level in a pre-peak. And it did. It went from 1300 to 500 (lowest level in the pre-peak).

We saw the same pattern back in the spring. See chart. The pre-peak doesn't look of much now but in terms of percentage it was actually quite massive. Corrected from approx. 80 to 50 USD.
When the price has reached either the first or second pre-peak the bubble is over and done with. The price can still decline (to 0), stay flat for a long time, but it can also pick up again and create a new bubble. Then the latest peak and collapse can become the pre-peak for a new and even bigger bubble.

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