Bitcoin – a speculation bubble?

Tuesday 8th August 2017

Bitcoin – a speculation bubble?

I regret not buying a Bitcoin in 2012 when they cost just $5….

I was curious. I thought it might be interesting to own a Bitcoin. But I was busy and I didn’t know how to buy one, where to go or who to ask. I planned to find out, but life moved on and I failed to act.

Yesterday the cryptocurrency posted a new high. That Bitcoin I didn’t buy would have been worth $3,451.86. You’ll understand my regret….

Over the last 10-years, nothing has risen in value like Bitcoin. Had you invested $1000 in 2010, your holding today would be worth $40 million….

For perspective, the same $1000 in an S&P 500 tracker would be worth $2500….

And don’t forget, stocks have done nothing but grow over the period. Bitcoin has shot up like a rocket running on some strange new fuel….

  • Bitcoin in brief….

Bitcoin appeared in 2009, shortly after the last financial crisis. Early players wanted to participate in a currency market beyond the reach of meddling central banks….

This new currency (or the ‘blockchain’ technology underpinning it) enabled users to transfer values for free – taking the traditional middlemen (financial institutions) and their commissions out of the equation….

Now Bitcoin is touted as an alternative to established domestic currencies.

Independent businesses are starting to accept it. Consumers are using it in ever-growing numbers. Regulation will build mainstream confidence and increase usage further….

I think it safe to say that digital currencies are no fad. They won’t be going away.

Look at what happened with e-commerce, digital wallets and mobile payments over the last two-decades. The adoption and use of cryptocurrencies – Bitcoin and others – will go the same way. It will become a norm.

  • Bitcoin bulls with skin in the game….

When I took an interest in Bitcoin, few knew what a Bitcoin was. The subject was off-radar….

These days you can’t open a newspaper without tripping over stories about the cryptocurrency….

The Bitcoin phenomenon is now mainstream. Everybody’s talking about it. Everybody’s an expert. Everybody has an opinion. It’s the BIG financial story of our time (or this year, at least).

Most investors missed-out on gains made so far. Many are terrified of missing-out on those that might lie ahead….

Some serious people think those future gains will be huge. Take John McAfee, founder of the McAfee antivirus software company. He reckons Bitcoin is headed for $500,000 within three years….

If McAfee is correct, it is still not too late to board the Bitcoin bandwagon. Far from it. There are still massive and life-changing gains to be made – if McAfee is right.

But, hold on. McAfee has skin in the game – as do many other ‘Bitcoin bulls’. How much of their confidence is rooted in where they’d like to see their current positions go to?

I don’t know. But, I’m always wary about the confidence of others – and I’d urge caution….

  • The road ahead is far from clear….

Cryptocurrencies are a complex area….

The technology is hard for a layman to penetrate and understand. The way Bitcoins come into existence is, frankly, mind-boggling. The way cryptocurrency transactions work is difficult to grasp – especially when you’re well on the wrong side of 40….

I’ve still not got my head completely around it – and I’ve spent time studying up. I’m not sure I want to invest in something I can’t properly explain to someone else – whatever the price….

And it’s not as if the future of Bitcoin is clearly mapped out. There’s no business plan. There’s no cast-iron agreements in place. Nobody knows what’s going to happen or how things will play out….

Only last week Bitcoin ‘forked’ into two different strands because bigwigs at the business end of the currency are locked in disputes over transaction speed, security and other issues.

Now there’s old Bitcoin and a new thing called Bitcoin Cash. Nobody is clear on exactly what that is, how it affects old Bitcoin and how it’s all going to hang together. At least nobody I know….

The potential for fraud is a clear and present danger….

I don’t doubt the legitimacy of Bitcoin. But I also know that, where value exists, sophisticated criminal elements will be working hard to defraud the system.

Only last year, a hacker robbed $65 million from Bitfinex, the cryptocurrency exchange. Regulation will help build confidence. But that regulation is not yet in place. It will take time.

And Bitcoin is still very much on the outside of the established financial system….

Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, made a good point recently when he said that Bitcoin still has a way to go before it can be considered a legal tender.

‘Most regulated financial institutions allow their clients to borrow against financial or physical assets, but we are not aware of any major institution that takes cryptocurrency as collateral.’

Bitcoin has not yet conquered the world. And there is a long way to go and a lot of wrangling before that happens. Assuming it ever does….

  • My biggest reservation….

People ask about Bitcoin. What do I think? Is it a good investment? Is now the time to get in?

In all honesty, I don’t know enough to offer concrete guidance. All I can tell you is that I have reservations.

My biggest reservation is this: I’m not sure whether money going into Bitcoin represents an investment or a speculation. There’s a big difference….

When you invest, you buy something because the price is attractive relative to what you believe its actual value to be.

A speculation is when you buy something regardless of the underlying value simply because you believe other people will pay more for it further down the road….

I wonder how much of Bitcoin’s current value is driven by what it is worth. And how much has been driven by the speculative activity of momentum investors jumping onboard a rapidly rising price in the belief it is going higher still – activity which, in a climate of helpful media hype, encourages the higher price to materialize and to keep on materializing….

In short, I’m worried that the current price of Bitcoin is the result of a speculation bubble….

  • I am not alone….

Once again, I must confess that I don’t know. Not for sure. Nobody does.

But it’s something I’d be considering carefully if I was thinking about buying Bitcoin at its current price (which I’m not).

I’m not alone in my thinking….

A team of Morgan Stanley analysts recently produced a report that branded Bitcoin a ‘poster child’ for speculation.

They noted that the value of Bitcoin grew more than 250% over the last year despite the
number of online payment merchants accepting Bitcoin dropping to three (from just five to begin with) over the same period. They wrote….

‘The disparity between virtually no merchant acceptance and Bitcoin’s rapid appreciation is striking.’

Howard Marks, the co-chairman of Oaktree Capital Management, also sounds alarm bells. Marks was one of the first to raise red flags ahead of the 2008 global financial crisis. Now he’s on Bitcoin’s case. In a memo to investors he wrote….

‘[Bitcoin is] based on a willingness to ascribe value to something that has little or none beyond what people will pay for it.’

Billionaire Marc Cuban is another bubble believer….

He recently went on record saying that when everybody is bragging about how easy they are making money – that equates to a bubble.

And a lot of people are bragging right now about how much they’ve made from betting on Bitcoin….

  • Nobody knows – but….

Of course, these are just opinions. Nobody knows. Not for sure….

But the last word should go to someone who posted a comment on social media last week. I don’t know who it was. I read the comment second-hand in a newspaper – but it resonated with me, so I’ll share it….

The poster said this: ‘You know it’s a bubble when a random Twitter thread bounces the price.’

I think that’s a concise assessment of what’s been happening and what is happening right now.

There’s been a Bitcoin speculation frenzy in play for some time. That frenzy has been fed and watered by a slavering media. And it is that self-perpetuating frenzy – that has driven the Bitcoin price to its present high-water mark….

Bitcoin is likely here to stay. Bitcoin and other emerging cryptocurrencies are set to form part of the future economic landscape….

But there’s a long way to go. There are many humps in the road to be negotiated. And the current Bitcoin price appears to me to have more to do with speculation than it does with any present inherent value.

What’s my bottom line? If you’re thinking of investing in Bitcoin today, proceed with extreme caution. What goes up fast on the back of naked speculation can come crashing back down twice as hard and twice as quick.

Momentum can take you so far. But eventually it dissipates and if you’re not on solid ground there’s nowhere to go but back the way you came….

More to come on this….

That’s how it looks from here.

I’ll be back in your inbox on Friday with something very interesting….

All the best,

Dave Gibson

Money Truths