Bitcoin and the Cryptocurrency Bubble

Bitcoin and the Cryptocurrency Bubble

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On a brisk October morning in 1929, Joseph Kennedy decided to get his shoes shined. He left his office and walked down a few blocks before finding a boy offering a shoeshine service. As he took a seat and propped up his feet, the shoe shiner asked Kennedy what he did for a living. Kennedy told the boy that he was an investor, among other things. The boy stopped shining Kennedy’s shoes and looked up. “An investor, eh?” said the precocious boy, “well, I’ve got a whole bunch of tips for you.”

Kennedy politely listened to the boy as he recited a shopping list of hot stock tips until his shoes were eventually shined. The 52-year-old stood up, brushed himself down, and paid the boy for his service (presumably for the
shining and not the investment advice). Soon after, Kennedy walked straight back to his office, put his coat on his
desk, and promptly sold his entire stock portfolio. “When a shoeshine boy has tips,” Kennedy later remarked, “the stock market is too popular for its own good.” Kennedy was proven right; a few weeks later on October 29th, the Wall Street Crash occurred, serving as the prelude to 1930 Great Depression, the worst ever economic crisis to hit the United States. And that anecdote, ladies and gentlemen, will be the segue into the subject of this article: Bitcoin, the world’s most popular cryptocurrency.

Bitcoin is the undisputed market leader in the cryptocurrency world; nearly one in every two users hold Bitcoin, and the second most popular currency, Ethereum, does not even come close, with a 20% market share. Today, it is hard to make it through the day without hearing at least a mention of Bitcoin. It is an unstoppable force and an immovable object all rolled into one. Or so they say. At the time of this article’s writing, Bitcoin’s price is $7,368 (£5,578) per coin. One year ago, it was $710 (£539) per coin. If you bought five Bitcoins for $3,550 in November 2016 and left it there for a year, a cool $36,840 would now be sitting in your bank account. Mazel tov.

But the chances are, most people did not buy Bitcoins in 2016. More probably, they are buying them now, and that is why there has been such an exponential price rise.Sounds familiar, doesn’t it? For those who can cast their minds back to the early 2000s, where George W. Bush controversially defeated Al Gore in the U.S. presidential election and Destiny’s Child released their third studio album to critical acclaim, there was also what soon became known as
the ‘dot-com crash’. Over the course of the 1990s, a spate of new technology firms emerged; in 1995, there were 1,000 technology firms but by 2000, there were 5,000. This dot-com boom created a hysteria in the media and wider public as share prices soared. One notable example was the telecommunications company Qualcomm, which saw a 2,619% increase in its share price. Everyone was raging about dot-com stocks. Even Alan Greenspan, Chair of the Federal Reserve, spoke favourably towards their high valuation.

And then in 2000, it all came crashing down, when tech companies lost nearly half of their value in the space of twelve months. Just in the same way that we were blindsided by the Great Recession of 2008 or the Tulip Crash
of the 17thC, we cannot seem to cage our inner Icarus. In 2000, excessive optimism once again outstripped rational
expectation, and this is likely the case for Bitcoin.

In 2015, behavioural economist Richard Thaler wrote an article for the Financial Times examining the financial crashes of the past one hundred years. In the article, Thaler refers to an excerpt from John Maynard Keynes’ The General Theory of Employment, Interest and Money, where Keynes finds that the share prices of ice companies rose
during the summer months because sales were higher. But in an efficient market, Keynes notes, these seasonal price rises should not occur. In fact, the share price of a company is supposed to reflect the long-run value of a company
and should not fluctuate on a season by- season basis. Keynes concluded that “the element of real knowledge in the
valuation of investments by those who own them… seriously declined.” In other words, people who knew about
the value of their companies no longer held a majority stake, just as with Bitcoin today. People swarm towards the Bitcoin honeypot because they see that the price keeps rising, and that is reason enough. It has become a case of speculating on speculation, and we do not even realise.

There has been a tendency in the Bitcoin debate to liken the cryptocurrency to other commodities. Jamie Dimon, JP Morgan’s CEO compared Bitcoin to the Dutch tulip mania of the 17thC which, in turn, led to a huge crash in the Dutch stock market.ut Bitcoin proponents do not make the same comparison. Rather, they posit that Bitcoin’s rise is more akin to gold, not tulips. Gold, like Bitcoin, experienced a similarly meteoric rise between 1999 and 2011, where its value increased from £6k per kilo to £33k per kilo. Gold has consistently remained at around that level since.

However, this comparison is deeply problematic because there are a scarcity of resources that gold possesses and Bitcoin does not. Although there is a finite number of Bitcoins in circulation (21 million), there are very few checks
and balances in place to prevent more coins from being produced or ‘mined’. The valuation of Bitcoin therefore cannot correspond to the fundamental laws of supply and demand. But there is one obstacle in the marshy swampland of the cryptocurrency world that looms larger than any other: government. It is often said that political power follows economic power, but in the case of Bitcoin, it is unclear where the economic power actually lies. Cryptocurrency poses a huge threat to the sovereignty of a government because it does not want to lose its
privilege as the monopoly issuer of a legitimate currency. As the economist Abba Lerner wrote: “The modern state
can make anything it chooses generally acceptable as money…It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty.”

As of yet, no country taxes Bitcoin (part of the coin’s appeal) and no state accepts it as legal tender. Indeed, Japan may have authorised Bitcoin exchange centres, but this move only improves its price transparency, not its valuation
We should not consider Bitcoin, or any cryptocurrency for that matter, as a negative force in society. A key driving
factor behind its rise is, in essence, a manifestation of the public distrust in government or banks. Through the use of Blockchain technology, Bitcoin users can exchange in a peer-to-peer network without interference from these third
parties, who can slow or disrupt the exchange process. Bitcoin has become immensely popular with immigrants, for
example. Now, remittances can be sent back to their families via Bitcoin without the huge transaction fees that banks
charge.

But in spite of these benefits, we cannot ignore the fact that Bitcoin is incredibly volatile, and it has been known
to lose 30% of its value in under a day. These rank fluctuations highlight how unsustainable Bitcoin’s growth is, and
aside from the Bitcoin evangelicals, most would agree that a sharp decline is foreseeable. Is a crash likely? Yes. And
when will this crash happen? Go and ask your shoeshine.

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