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Is Bitcoin a bubble? Is it too late to invest?

by | Dec 17, 2017

Before we dive in, we need to define a bubble. Investopedia’s definition is that a bubble is “an economic cycle characterized by rapid escalation of asset prices followed by a contraction.” This means that the price of something goes up really quickly, and then crashes. Usually, the rise in prices in a bubble is not backed by fundamentals, but rather by irrational market behavior. When no more investors are willing to buy, a sell-off occurs and the price plummets.

In 2017, Bitcoin and other cryptocurrencies achieved mainstream popularity, and prices skyrocketed. The price for Bitcoin grew from ~$1,000 all the way up to ~$19,000 at its peak. At the same time, Google Trends recorded the highest amount of search interest ever for crypto-related topics, exchanges such as Coinbase gained staggering amounts of new members.

Reasons For Concern

During Bitcoin’s meteoric rise, many people took a closer look and found reasons to be skeptical of the unprecedented price increase:

  • Irrational behavior: Everyone wants to get into the crypto frenzy, and not all of them do so for solid financial reasons. Many investors spend all of 2 minutes researching an ICO before throwing money at it, instead of making informed and responsible decision. This market behavior is driven by greed and irrationality, not prudent investment strategies, and this is a key factor in a bubble-like price increase.
  • Famous investor caution: Many old-school investors such as Warren Buffett, Jack Bogle (Vanguard), Jamie Dimon (J.P. Morgan), and Mark Cuban, have publically voiced concerns about Bitcoin, pointing to its bubble-like price behavior.
  • Technical limitations: Most cryptocurrencies are still in their early stages and have large technical challenges to overcome before they are ready for mainstream adoption. The crypto world is definitely a case of technology lagging behind valuation.
  • Market manipulations: Crypto markets are young and unregulated, so some trading techniques that are banned in more mature markets are used regularly to manipulate prices.
  • Regulation: Many countries have started to review their existing cryptocurrency regulations, some even deciding to restrict its use. In the latter part of 2017, China famously banned ICOs and crypto exchanges They wanted time to review the industry before deciding how to best proceed.
  • Scams: Because cryptocurrencies are anonymous and irreversible, many scammers prey on naive investors, successfully stealing large amounts of money.
  • Exchange insolvency: Some analysts hypothesize that several large exchanges are insolvent because they allegedly mint USD Tether tokens out of thin air, when in fact they are supposed to be backed 1-to-1 by actual US dollars. For more information, please Google: “Bitfinex Tether”.

These are all reasons to be careful in the crypto market and are important to keep in mind as you begin your investing journey. However, these should not scare you off! Some very important reasons to be optimistic are included below.

Some historians and analysts look at Bitcoin and are reminded of the Dutch Tulip mania and the Dotcom bubble; two of history’s most famous speculative bubbles. Whether or not you believe Bitcoin is a bubble, it’s a good idea to understand those in the past to prepare for the future.

As a thought exercise, what would a bubble pop even look like? First, it’s unlikely that the crypto market collapsing would even nudge the broader world economy. For comparison, as of December 9, 2017, the total market cap of all cryptocurrencies was around $436 billion. Amazon’s market cap alone was $560 billion. As you can see, crypto’s overall value is still pretty tiny compared to many traditional world markets. However, in a bubble pop “dumb money” would certainly flow out of crypto. These are people who invested out of FOMO or greed and never truly believed in the technology or use cases of cryptocurrencies. At the first sign of trouble, these investors would likely panic and sell, causing the price to drop even further.

How Can I Protect Myself?

If you are worried about a potential crash, there are steps you can take to protect your investments. Some common risk management tips include:

  • Diversify: Buy several different cryptocurrencies, and leave part of your portfolio reserved for non-crypto investments like stocks and bonds.
  • Cost average: Invest a small amount on a regular basis to avoid buying at peak prices.
  • Lock-in profits: Do not be afraid to sell some of your coins every once in a while to guarantee some profits.
  • Common sense: Never invest more than you can afford to lose and PLEASE do not borrow money to buy crypto.

Reasons for Optimism

Even if crypto markets crash, it is likely that those markets recover in the long run as long as the innovation of the related technology continues. After all, stock markets have crashed several times but always bounce back stronger than ever. And for crypto, there are many reasons for long-term optimism:

  • Bitcoin has been pronounced dead hundreds of times since its inception and has recovered after every single one.
  • The recent flood of capital is helping to foster innovation in the space.
  • Increased media attention helps with long-term adoption.
  • Many industries and processes have already been disrupted by blockchain technology. These changes are here to stay, regardless of the presence of irrational investment. For example, Initial Coin Offerings will remain a fundraising option for companies that would like to avoid raising capital via more traditional methods.
  • Citizens in countries like Venezuela and Zimbabwe are facing huge hyperinflation, and therefore, turn to digital currencies to store their wealth. In these situations, cryptocurrencies serve an immediate and direct need.
  • There is undeniable enterprise interest in blockchain technology. The Enterprise Ethereum Alliance is a great example of large companies looking to get involved and help grow the ecosystem.
  • Wall Street and other traditional financial institutions are showing interest. Some exchanges are beginning to offer financial instruments tied to Bitcoin. Also, there are ongoing efforts to create crypto ETFs. As crypto enters mainstream financial markets, it will gain legitimacy and become harder to get rid of.

Is It Too Late To Invest?

With all these points in mind, you might be wondering if you missed the boat. After all, Bitcoin’s price rose 10x last year. In our opinion: not at all. We believe in the disruptive abilities of blockchain and cryptocurrency technology, and think the space is only going to continue to grow. We think owning crypto is like owning a piece of the internet back in the day. In fact, many people wrote off the Internet in the late 1980s, calling it a fad. They could not comprehend the transformative nature of the Internet until years later. Cryptocurrencies could potentially be just as impactful, but the only way to know for sure is to wait and see! The bottom line is: do your own research, and if you see a future for this technology, it is never too late to get started!

Disclaimer:

This article was written to the best of our knowledge with the information available to us. We do not guarantee that every bit of information is completely accurate or up-to-date. Please use this information as a complement to your own research. Nothing we write in any of our articles is intended as investment advice nor as an endorsement to buy/sell/hold anything. Cryptocurrency investments are inherently risky so you should never invest more than you can afford to lose.

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