I’m sure many people reading this have heard about how much money friends of friends made buying Bitcoin before the price spiked in late 2017 and feel like you’re missing out making risk less profit simply buying Bitcoin or other cryptocurrencies. Well I’m here to put that straight. This will answer 2 questions I’m sure many of you have, them being 1) Should I invest in Bitcoin?, and 2) What is a bubble? Bitcoin is the perfect example of what exactly a bubble is in finance.
As I mentioned in my first blog post, Bitcoin was made to facilitate transactions without the need of banks to act as the middle man and this is why cyberphunks back cryptocurrencies. It was never meant to be used as an investment tool. Investing in Bitcoin for the purpose of turning a profit is definitely not the main function of Bitcoin. The price of Bitcoin peaked in late 2017 at $19650.91 (£14748.90). But how on earth did the price get that high?
First, let’s consider a currency issued by a central bank such as British pounds, the Euro or the US Dollar. The reason these currencies have value is because it is issued by central bank or government who have the power to raise taxes, has a monopoly on printing new money and is recognised by other nation states. This means that these currencies are relatively stable and are good for investments and deposits in bank because of low volatility in its value. In contrast, Bitcoin is decentralised and is not based in any specific country, making it very volatile.
Put simply, a bubble is when prices of an asset increase with no fundamental reason behind the increase in the value. Before the recession, housing prices increased dramatically when in actual fact there was no fundamentals behind these increases. During 2008 we saw this bubble pop and the prices of houses decreased. This is the same thing that happened Bitcoin in December 2017 Bitcoin’s value is so arbitrary with no fundamental reasons behind the huge price increases up to December 2017. It is the best example of a bubble in modern times. Many of those who advocate Bitcoin investing argue that Bitcoin’s value is derived from the usefulness or success of the blockchain technology behind Bitcoin. This would be true if this blockchain technology used by Bitcoin was being updated somehow as time went on to facilitate more transactions or to increase anonymity or to do so using less electricity etc. when in actual fact the technology has remained unchanged since the first Bitcoin was mined.
I do believe that blockchain technology will become useful in later years and the technology has the potential to be revolutionary. Companies are using similar technologies in their business operations now, for example, Ford use what they call "blockchain technology" to make sure the cobalt sourced for their electric car batteries is not mined by children in Chinese mines. Although one of the fundamental components of blockchain is that the central ledger is public to anyone, but in this Ford example I doubt this ledger of where the Cobalt is sourced and for how much will be readily available to anyone who wants it. But this is a good example of how people are tweaking this technology to use in supply chain management.
However, in saying that Bitcoin derives its value from this potentially disruptive technology is just simply wrong. Bitcoin gets its value simply from people saying it has value. This is what makes it so volatile because when a few people think the price should be higher, the price will increase significantly, and if a few people thin the price should be lower, the price will decrease significantly. Traders can only use the market sentiment on Bitcoin to judge whether the value of their investment will increase or decrease, and cannot use fundamental or technical analysis to see if Bitcoin is fairly priced. For this reason I would highly recommend not buying Bitcoin or cryptocurrencies for investments. They are far too volatile and at the price they are now (about £2880 on the time this blog was posted) I would not recommend the readers to investment and to invest in something more legitimate, less volatile and widely used.
