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Is Bitcoin in a Bubble?

Is Bitcoin in a Bubble?


The Big Question:

This seems to be the question of the day, if not the decade.

Can cryptocurrencies replace money or are they just another bubble?

The answers vary.

To the optimist, but not necessarily the realist, bitcoin is already money. So, yes, not only will it replace all government fiat cash, but it will free the masses from the tyranny of the state. It will never “bubble” and the way it’s designed, it will only become more valuable with time. Freedom for all forever and all the drugs you want. Gold? It’s a quaint idea. Caveman monetary policy, complete with pretty rocks.

Okay, maybe that was a bit overboard.

To the pessimist, no. Bitcoin is a Ponzi scheme. It is a well-marketed fiat asset trick. Don’t fall for it. It will eventually bubble, crash and burn. In the meantime, it will benefit the criminal element. It must go and/or be regulated as soon as possible. The state should always be the final arbiter of monetary policy, after all.

To the middle-of-the-road folks? Bitcoin can exist along side the current fiat money systems. It should work within the current frameworks of nationalized  monies, however. It can improve things from there. We can create a sound money standard after we iron out all of the regulatory kinks within the new cryptocurrency technology.

Unfortunately, our governments, as they are now designed, will not be able to survive on a diet of sound money and that is why fiat money was created in the first place. To escape the bonds of reality with a legal fiction, all the while, kicking the inflation can down the road.

But why not stop inflation by connecting bitcoin with gold? Make each one represent a certain amount of some rare earth metal? Why not couple gold and cryptocurrency, privately? Because the political environment is fiscally destructive. That’s why.

We know that our centrally planned economies will not allow citizens to derail the inflation machine which keeps our governments in control. It is only when the puppeteers begin to loose control of inflation that the money strings of government unravel, resulting in a revolution against the “evils of money.” Such revolutions do not always end up with a population of free citizens, however.

Cryptocurrency Negatives:

So, let us be cruel to ourselves. Take it on the chin, like a good cryptocurrency enthusiast should.

What is often cited as the main reason that bitcoin (or any cryptocurrency) can never serve as money? There are many reasons actually and here are a few:

  • Unstable Value
  • Trust
  • Fiat
  • Acceptance
  • Taxation
  • Bubble

Now, before we go off spouting all the great things about cryptocurrency, lets define money. I mean, what is this paper stuff we carry in out wallets and what are those electronically recorded digits in our banks? Better yet, let’s just define a good money.

Money:

  • A tool of humans
  • Used when high level of productivity is reached
  • Desire for long-range control over their lives
  • A tool of saving for delayed consumption and later production
  • A material commodity which is:
    • imperishable
    • rare
    • homogeneous
    • easily stored
    • not subject to wide fluctuations of value
    • always in demand among those you trade with

Source: Ayn Rand Lexicon

Few people ever go this deep, however. The dollar, euro, yen, dinar, peso, franc, pound, lira, rupee, krone, zloty, rand, and the shekel are, for all intents, legal notes. It’s money for the masses. Buts it’s not real money. It’s fiat money, which represents nothing but trust. I trust you, do you trust me? Besides, what choice do we have, right? It’s legal tender. It’s easier to use than chunks of silver, which the government wants to value in fiat anyway.

You can, at least in the US, pay your taxes with fiat currency and most of us trust that the currency is money.

We also know everything is becoming more expensive, but few of realize that the root cause of inflation is not the weather, the wealthy or our enemies. It’s simple math. The more fiat notes we print or e-print, the less valuable they become. This holds true for some cryptocurrencies as well. You simply divide the value, in fiat currency, by the current number of altcoins. This gives you a rough estimate of the fiat value of a particular cryptocurrency, at a given moment in time.

So, it’s easier to understand values with cryptocurrencies, since their creation is usually straight forward. There is no Federal Reserve to manipulate alleged M1, M2 and so on. There are no banks to create endless supplies of fiat. The only inflation regulators in bitcoin, for example, is its code base. It is currently programmed to create a finite number of BTC’s. It’s not manipulated to screw the masses, but to retain its spending value.

Paper money used to represent or hold title to gold or silver. That was why it worked. Why it functioned. Once the paper no longer held title to some form of property, it became fiat. It became dysfunctional. At that point, almost always, economies begin their decline. Some economies decline faster than others of course.

Perhaps if our governments set hard long-term limits on fiat numbers, then our fiat monies might stand a chance. But there are no such limits.

High Hopes:

Many hoped that bitcoin could save our failing economies, tame our ever growing governments, and usher in some new global paradigm of wealth, but not without effort.  If this is your thinking, you are guilty of being overly optimistic and just maybe, a bit naive. Don’t worry, I’m rooting for you because I’m a near-convert myself.

What holds us back from becoming “one with the crypto?” History. It is full of examples of ledger based monetary systems that ultimately failed. It is replete with evidence that all of the fiat based systems failed as well. And the gold-backed systems — failed, but after the decoupling of functional money (paper notes) from the metals. The governments enforced these failures, often by confiscating the one form of money that has never become valueless: gold.

So we have to ask ourselves why have all monetary systems failed throughout history? Now, I’m not asserting that gold became worthless–ever. Fiats did. Ledger systems were scrapped or forced out. Seashells were abandoned. But not a single monetary system transcended all governments, in any cohesive fashion. Bitcoin, though an asset, does.

Asked another way. Aside from gold and silver being an asset for thousands of years, what monetary system, fiat or otherwise, has ever existed beyond the constructive control of all governments, simultaneously?

Bitcoin as an Asset:

The latest thinking is that bitcoin (cryptocurrency) is not money, but acts as like an asset. That is Peter Schiff’s thinking. Schiff works with Goldmoney Inc., based in Canada and he lives in Puerto Rico. Goldmoney(tm) is a company that allows you to spend gold, via a debit card, in many countries, for a small fee. You can also store gold in various vaults around the word. And there are other benefits.

You can find out about more about Schiff’s views easily. He has his a radio show, owns several companies, is an author, but to sum up his financial views I would offer this:

He has repeatedly held bullish views on long-term investments in foreign stocks and currencies in countries with sound fiscal and monetary policies, as well as global commodities including physical precious metals and has expressed bearish views on the US economy and the US dollar.

Source: Wikipedia

So what is an asset?

An asset is anything of value that can be converted into cash.

Source: Investopedia

It’s a bit more complicated than this, but for the sake of argument, all cryptocurrencies are assets, since conversions to some other form of trusted money is the fundamental purpose to both buy and hold bitcoins. I mean, that is the allegation, right? Moreover, as Schiff asserts, companies that accept bitcoin in payment for services or products, ultimately convert it to either fiat currency or some other more trusted asset. Sure they do. After all, what real choice do they have? None.

In other words, the companies that will accept your bitcoins direclty just want to sell you stuff. Of course they do and they are held to the regulations requiring them to report their earnings in a nationalized fiat currency format. A government euro. A dollar. One wonders what would happen if companies and citizens were not required to convert to government fiat money? If they were actually free to use the asset of their choosing for all debts, public and private.

But we are not free in this sense. Not completely.

You Must Comply:

Are we to then shrug and comply? I don’t think so. The future is not made by those in the halls of government. That is not the purpose of government. They are present simply to protect and serve the people. They are peace keepers, not currency makers. Currency and money should be denationalized anyway. Things like bitcoin serve as a reminder of who should be in charge. Even if it fails. Even if it is a bubble.

Under the current circumstances, bitcoin, as asserted by Peter Schiff, is untraceable. This, I’m afraid is close, but not the complete cigar. All bitcoin transactions are public. You can see them zip around the network, but they can be obfuscated for privacy and criminal reasons. And your name is not attached to your account. Other cryptocurrencies are much better at retaining your privacy.

A Common Criminal:

Naturally, Schiff keys in on the criminal aspect. We’ve all heard it. A terrorist or crook will send his bitcoin, instead of carrying cash. At some point the bitcoin will be converted into cash to buy or sell something illegal.

One of the main problems with this criminal tactic are the fluctuations in bitcoin prices. The criminal might have a set price for his product and bitcoin is terrible for that reason. Perhaps it would be better to use what is called Tether ™. It’s a bank backed cryptocurrency that is almost pegged at the US dollar. Better yet, use paper dollars or digital fiats. That’s the routine.

I used to work in criminal justice field, just a few years ago. We rarely came across evidence of cryptocurrency use. Maybe it’s more prevalent now. What we did come across were stolen credit cards, emailed cash, fiat bill, drugs, debit card numbers and so on. Criminals wanted dollars just as fast as they could get them. Not gold or silver coins, but paper fiats. They used the banking system and filed false IRS refunds (very lucrative since the IRS does a terrible job of policing their own refund system) as a way to easily subvert the antiquated, government regulated, fiat monetary system.

This is not to say that cryptocurrency is immune to criminal exploitation, but cash is king — by law. And even criminals love to exploit that law. Some even print their own bills. This is next to impossible with bitcoin.

Bubbles:

The comparison of cryptocurrencies to the Dot-com bubble is also interesting, but old. The idea that investing in cryptocurrency is similar to a fad or is speculative, is certainly a strong argument, however. More and more people are becoming aware of the technology and as a result, more money is flowing in. Is this a new opportunity for those who are already versed in their use and speculation? Sure it is. The first comers are on top of that pyramid, right? But can’t this also be said of a new stock? The more people buy the faster the value of the stock increases, right?

One must realize, however, that as cryptocurrencies become more and more popular, they become more and more risky. They are not stocks. There are few barriers to entry and trades are nearly instant. There are few restrictions. You are free to lose and gain and panic. At least with stocks, you have a broker who earns very high commissions by comparison, and you can execute trades reasonably quickly, in most cases. Oh, and you have no privacy. Every transaction is logged for tax and regulatory purposes, to ensure that you are not being cheated. That never happens…

This new injection of funds into the cryptosphere, ostensibly from a broader base — regular people — and not simply from the brokerage houses that fueled the Dot-coms, serves to magnify the potential bubble. This is a given. If such a bubble bursts, the fallout could eclipse a standard market collapse…in the future. Not right now though. Which is why the heat is not all that hot.

Currently, the amount of money in the cryptocurrency system is peanuts compared to the banking sector. Sure, lawsuits and investigations happened after the Dot-coms, the housing bubble — after any number of market implosions. Bailouts are always an option for government to soften the blow of poor investment decisions. But when banks collapse, governments step in and the insurers pay up. Then the arrests come. Fines and Senate Hearings, when the circus comes to town.

Brokerage houses are known entities. The mortgage companies and banks are all around us. If bitcoin fails, the loss is real. It will hurt millions, but in the scheme of things, it will be very small. Currently, if all the cryptocurrencies listed on coinmarketcap here went to zero overnight, it would only be half as bad as the Washington Mutual insolvency in 2008. One bank compared to over 1000 cryptocurrencies.

Diversification:

Diversification may not help. One might be safer with a mutual fund or an ETF but not a cryptocurrency. Why? Because there are few, what I will call base-cryptocurrencies, bitcoin being one. When bitcoin drops in value, nearly all cryptocurrencies lose value. So, loses are often magnified. When bitcoin recovers, so do the others. Tether cryptocurrency is one exception. It usually hovers around one US dollar in value, but it has little upside. Conversely, if say Ripple (tm) devalues, bitcoin may not.

The tie-in with bitcoin and all other cryptocurrencies happens because it was a first comer and trusted. If you want other cryptocurrencies you will often need to trade for them using your bitcoin. If you want to convert back to fiat, it is often best to use bitcoin. This is changing, however. Other coins are slowly earning a type of base-currency status.

Anti-Money:

The Fallout:

What do you suspect will happen to the hundreds of international cryptocurrency market exchanges, when (and if) the bubble bursts? Do we even know where they are? How about the US based exchanges? Will their doors be closed, their assets frozen? Will your bitcoins be stuck in Europe or Asia? Will you keep your BTC at home on your hard-drive or some other device. Will cryptocurrency developers in the US then be shuffled off to prison?

How about the giant bitcoin mining farms in China and the world over? Shut off? Scrapped? Bitcoins Confiscated? What about the cryptocurrencies that do not use the ‘farms?’ The ones like Peercoin ™, which is essentially PC based?

What of the decentralized cryptocurrency exchanges that exist only between you an unknown parties over the internet? Will these applications be shut down and their unknown creators sought?

The fact that Amazon ™ lost 90% of it’s stock value over as many years, as Schiff indicated, is his example of what can happen to bitcoin. The nearly constant ICO’s (Initial Coin Offerings), the new cryptocurrencies popping up like so much graffiti, will not survive, even if they use the latest blockchain technology or some variant of it. There will be a saturation point, no doubt. Already, there is talk that if you are in “blockchain” (your company invests or develops this type of new tech) you don’t make any money.

Some companies can exist in the red for years, but at some point they must turn a profit or fail. The only other option is to ask for a loan. In any event, even Amazon ™ has not failed, but it has real products as well as software. (Bitcoin is software. An intangible asset.)

The Beginning of the End?

Flipping houses before the market imploded was all the rage before 2007. It still happens today, in Florida, where I live, but not nearly at the pace of a decade earlier. When friends quit their jobs back then, bought huge homes, new cars and lived the life, only to be financially destroyed later, it was rough. The house flippers paid the price. After the building boom things slowed and housing prices dropped. We can argue all day about how and why the crisis began. One thing is certain, however, irrational exuberance was the norm.

Is that beginning to happen with cryptocurrencies now? In a sense, flipping cryptocurrencies doesn’t really happen. You can’t buy one, improve it, unless you are the developer, sell it and walk away. You can however, buy one at the bottom, when it’s cheap, then trade it for bitcoin or Tether, when it increases in value. Unfortunately, the tax headaches in some countries makes this type of arbitrage unprofitable. If you ignore the taxes, you are chancing fines or worse.

But what of the P/E Ration? I mean, we can calculate the price to earnings ratio of a stock, but how would you do that with bitcoin? Can we ever know when and if it is overvalued? We can see when underlying government fiat money is devaluing by comparing it to something like gold. When more fiat buys less gold we have inflation or more correctly, currency devaluation. When less bitcoin buys more fiat dollars, what is occurring? Is bitcoin becoming more popular or is it acting like gold? Is it becoming like a peoples’ barometer of their own fiat money — worldwide?

The Aftermath?

After this cryptocurrency bubble bursts, if it does, what might remain? Cryptocurrencies which offer a type of service, like Ethereum ™? Ones that offer fiat trading via third parties, and other services, like Stellar ™? Newer models, such as Iota ™ or Neo ™? It’s your guess.

Worse case? Your country outlaws innovation or co-ops it, then slowly destroys it.

The best case scenario, for now? Bitcoin keeps growing and more nationalized fiat  currencies fail. The cryptosphere becomes indispensable, trusted by people everywhere, and nations begin to compete by adopting sound monetary policies.

In the meantime, don’t fall for the hype. Do your homework if you are curious about cryptocurrencies.

And a parting thought. At some point, technology will be able to create physical items upon demand. If we are then able to create gold by recombining atoms and molecules, an abundant resource nearly everywhere where we look, on the cheap, how will we then design a voluntary, sound monetary system?

 

Good Day,

Jack Shorebird.


 

 

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