Bitcoin: Is this time different?

Spoiler: NO.

Bitcoin is the buzzword of our decade, even grandmas talk about it in their tea sessions with friends. Is Bitcoin the future? Will it substitute fiat money? Has it really a value? The aim of this article is to address these questions with tested frameworks and examples from the past to provide simple and practical answers.

What is the value of Bitcoin? Is it a Bubble?

Well, let’s start from a very basic concept: there is no existing way to calculate Bitcoin’s value because there are no fundamentals or anchors to analyze and derive the cryptocurrency’s value. Furthermore, the average Joe has not fully understood Bitcoin, and no one knows who is actually behind the creation of the cryptocurrency. This environment of disinformation is fueling the irrationality of market participants, which are governed by the Fear of Missing Out on the next big thing. The extreme shifts in sentiment can explain why the cryptocurrency is the most volatile instrument at the moment, jumping from $19,000 to $13,000 in 6 days (16th Dec – 22nd Dec). Bitcoin has returned a stunning 1400% in 2017 and this raises concerns about the possibility of a bubble. However, the disruptive nature of Blockchain, which aims at eliminating intermediary costs and creating efficiency, does not mean that Bitcoin will be the future universal currency and does not justify such returns. Indeed, the price is held up only by the belief that someone else will bid a higher price in the future, no cash flows distribution or asset appreciation. Finally, by looking at some objective facts, Bitcoin matches all 5 criteria for a speculative bubble that Richard Bernstein, former Merrill Lynch Chief Investment Strategist, has expressed as follows:

1- High liquidity encouraging speculation – current monetary policies implemented by central banks;

2- Leverage increase – introduction of “Bitcoin future” which allow to buy more instruments with smaller amount of money;

3- Market “democratization” – everyone talks about Bitcoin;

4- Supply increase pushed by demand increase – more than 1,000 cryptocurrencies and dozens of ICOs (Initial Coin Offerings);

5- Trading volume increase – number of trades per day continue to raise.

These 5 factors give an objective definition of a bubble and Bitcoin seems to match all of them. Does that mean it is a bubble? No. It means that the cryptocurrency has all the prerequisites to be a bubble but that depending on how things will evolve, this market might crash or flourish. By still looking at facts, it is clear that investment banks’ behavior is fueling some of the causes of bubbles’ creation. For instance, Goldman Sachs has announced the implementation of a cryptocurrency dedicated desk within the commodity division in order to act as clearing house and charge fat fees on brokers (e.g. 100% margin). This happens because investment banks found in Bitcoin a way to profit from volatility during a low-volatility period of time. Commissions from trading have slumped in recent years, as testified by recent earnings releases of JP Morgan and Goldman Sachs, Bitcoin and Cryptocurrencies represent a valid alternative. This volatility appetite pushes banks to enter the market creating more supply to satisfy the raising demand and then increasing liquidity and trading volume, hence the probability of a bubble. However, not only banks are contributing to this risky game but Institutions seem to feed this bubble’s risk too. For instance, the choice of creating “Bitcoin future” from CME (Chicago Mercantile Exchange) has allowed more investors to enter the cryptocurrency market by investing a significant amount of money in products whose value derives from Bitcoin’s one. Exotic products like leveraged ETFs are waiting for approval from SEC administration, ready to attract more capitals in this modern gold rush.


Dotcom Bubble Case

Looking backward it is easy to spot bubbles and have a perfect accuracy in doing so, everything makes perfect sense after it has happened. The most similar example to what is happening today is represented by the Technology bubble, which lasted for more than five years from 1995 to 2000. The late 1990s were characterized by the Internet revolution, a period of rapid technological advancements and unlimited possibilities, at least on paper. The Internet promised to change everyday life in unimaginable ways, enhancing the potential growth of companies which would have dominated their markets in few years. Just add “.com” to the company’s name, fill a paper with stunning future prospects and unrealistic business plan and the game was on. During the formation of the bubble investors were thinking of the opportunity to be too huge to be missed, and that conventional metrics of evaluation were not applicable as that time was different. The availability of cheap money and easy capital thanks to low interest rates fueled the confidence of investors who consequently underestimated risks or totally neglected them. The froth pervaded all levels of investment environment from venture capitals to public markets; profits and revenues were not considered, only rising prices mattered. From 1995 to the peak of 2000, the Nasdaq Composite the major technology index, returned more than 1200% reaching a size of 3-5$ Trillion.

As the Federal Reserve increased interest rates reducing the liquidity available, investors started pulling money out of the market and panic selling was the ending of the bubble, until the bottom was found in late 2002.

Even if professional investors and eminent professors like Warren Buffett, Robert Schiller and Alan Greenspan warned of the “Irrational Exuberance” of market participants, the feedback loop of rising prices was enough to attract and finally destroy wealth.

If someone had invested at the peak in 2000, he would have got back his money only seventeen years later in 2017, when the Nasdaq Index made new highs. Internet has really changed the world, but negative returns for two decades are not attractive for any kind of investor.

Invest in Bitcoin… Or Speculate?

Investing and speculating are two very different things. Investing means strategically buying something which, according to qualitative and quantitative analyses, will have high probability to generate additional income or profit with a low downturn risk. This is the only essence of any wealth building over time. On the other hand, speculating has a significant risk of losing all the initial capital in change of an expectation of big gains which in other words means: betting. Pay attention, anyone decides to invest his own money as wished since different people have different risk profiles which means that they might prefer betting over investing or vice versa. Therefore, there is not right or wrong answer, it just depends on whether being and investor or a speculator. Furthermore, statistically speaking it is preferable to keep control of finances by reducing as much as possible the effect of random variables on investments, but probably someone else likes more the hazard of venturing. Bitcoin does not represent an investment opportunity but a speculative one, therefore the real question at the end of the day, should be: Are you investing or betting?


Authors: Alessandro Sicilia and Mario Stopponi


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