November 23, 2017

Bitcoin bubble? Not just for hackers

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Remember bitcoin? The online currency that burst into people’s consciousness a few years ago and then kind of drifted off to the margins, not really being of much significance to anyone outside money launderers and suchlike?

Sweeping generalisations aside, bitcoin never really went away. The reason for its loud arrival in 2013 can be put down to the following chart (price bubble) and the mainstream media fuss that was made of the cryptocurrency.

Bitcoin Price Rise

Image source: Economist – http://www.economist.com/news/leaders/21590901-it-looks-overvalued-even-if-digital-currency-crashes-others-will-follow-bitcoin

After that the price crashed and most people forgot about bitcoin.

But recently (May 2017) the price of bitcoins has been setting new records as can be seen from the following chart:

Source: Bitcoincharts.com

Bitcoin has also been in the news lately with the global hack on hundreds of thousands of computers, where the hackers have demanded payment in bitcoins. Is this a wise choice given the growing bubble?

Bitcoin recovery

Bitcoin is not the only cryptocurrency. It is estimated that there are now more than 830 different types of alt-coins (bitcoin-like tokens) on the market, with a combined value of more than $50 billion (May 2017).

Many of these coins have launched recently via initial coin offerings (ICO), which are similar in style to stock offerings via an initial public offering (IPO) where a company floats on the stock market, selling shares to investors, e.g. Snap in February 2017. While an IPO needs a comprehensive prospectus to attract investors, the cryptocurrency requires a white paper, which outlines the company’s business plan.

During the dot.com bubble of the 1990s, many people bought into the latest IPO by new start-up internet companies (it didn’t matter that they made no money and had hardly any sales either). Share prices of internet companies were soaring and investors got rich quickly. Some made fortunes, many more lost money when the market crashed.

Similar developments can be observed with the ICOs for ‘bitcoin-like’ companies. For example, a company called Ethereum raised $18m in 2014 with tokens at $0.40 each. The tokens are now worth $92 each.

If it looks like a bubble, smells like a bubble and walks like a bubble, is it a bubble? I would say yes. There are plenty of other ICOs for bitcoin-like companies just now, but when this bubble bursts, as it will, it will be like running for the exits when someone shouts fire in the cinema.

There is not the same liquidity in the cryptocurrency market as in the stock market and it is hard to sell in the stock market when there is a panic. With bitcoins a crash is likely to make the price fall hard and very fast, because of that lack of liquidity.

One comforting factor is that a crash in the cryptocurrency market is likely to have a relatively small impact compared to the great financial crash of 2008, from which many economies are still struggling to recover.

Why has the price been rising?

The market is unregulated, investors see prices rising and jump on board. There is also uncertainty in the wider markets. Bitcoin is up over 200 per cent since President Trump took office. Read here for some explanations for the price rise.

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