Just Logic #2: Is Bitcoin a Bubble?

Did you scoff at Warren Buffet when he called it a bubble? If you agree, here's why you're wrong!

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Let's take an example from astronomy. How do we know what the milky way galaxy looks like?

We don't.

Since we live inside the milky way, we can't take a portrait of ourselves. What we can do, is look at all the other galaxies around us and try to come up with the an educated guess on how our galaxy may appear. Bitcoin may very well be a bubble, but it is impossible to say for a fact. BUT! We can look beyond bitcoin and compare it to other bubbles we've seen to help us find some clues. Let's take a look at a few of the past bubbles.

Tulip bubble

The tulip bubble was created by the dramatic increase in the price of future contracts to purchase tulip bulbs. It spanned a 6 month period between November 1636 to April 1637. In The Netherlands, the blooming of tulips occurred around April-May and the bulbs could only be uprooted for sale in June - September. Since the bulbs themselves are rather difficult to grow, and are in high demand, people would pre purchase their bulbs to secure the best available price. Once someone sells a contract for more than the contract's value, the subject of the contract automatically increases in value despite the contract never having been executed.

The tulip bulb bubble likely occurred without a single bulb ever actually changing hands and was likely burst when the first physical transaction was made.

How does that compare to the supposed Bitcoin bubble?

Bitcoin could be represented by the contract, and the bulb itself is USD. In this case, bitcoin is a contract to be exchanged for USD. The value of the bitcoin is the value of the contract itself. Theoretically, if all the contracts executed, then all is fair game and the price was justified since everyone paid fair and square for their product.

But wait, there's a huge flaw to this thinking. The bulb is purely for visual pleasure. It has zero security to have a stable value because anyone with enough effort could create more bulbs and the bulbs themselves are perishable. Bitcoin on the other hand, cannot be created by anyone, since the creation of bitcoin is powered by the code itself

Bitcoin, once created, will never erode unless the network is completely abandoned and every bit of the blockchain is deleted from computers all over the world. That doesn't mean that people can't perform a raw abandonment of the software though. If user's simply migrate away from the network, the price of bitcoin will come to the same conclusion, which is a significant drop in the value of the coin.

So while it is easy to say that Bitcoin is like the Tulip Bubble, it has key aspects that distinctly make this a debunked myth with no thought to it.

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Dot.com Bubble

The dot.com bubble was an interesting stock market bubble that was created due to the increasing price of internet based companies. The turn of the century development of broadband internet allowed e-commerce to explode in growth. E-commerce allowed consumers to save on both sales tax and retail storefront prices resulting in a huge influx of new internet based companies. People would purchase stock in these retail companies in excess of their actual earnings because they thought next year's earnings would beat the current years, and it was a guaranteed way to make money. Eventually the bubble burst when the earnings reports came back less than what people expected and a massive sell off occurred.

The dot.com bubble was largely fueled by cheap money due to low interest rates, and the sale of underperforming assets to buy the "over" performing dot.com stocks.

The tulip bubble was fueled by other investors looking to turn a quick buck since the tulip bulb had no other future expectation, other than to grow into a tulip flower. The tulip bubble was bound to explode once the first delivery took place.

Likewise, the dot.com bubble was bound to explode once the expected future earnings were not as expected.

How does that compare to the supposed Bitcoin bubble?

Bitcoin would be the stock. The price of the stock would be the price of 1 bitcoin token. The rise in stock value is pegged to the earnings of the company, and the rise in each bitcoin would be pegged to...?

ABSOLUTELY NOTHING!

It is not a stock because it does not follow the performance of a company. It is a token that requires work to create, and it's creation is limited by its physical supply. It is most easily comparable to gold;

• Both have a finite supply
• Both can only be create naturally, gold being mined, and bitcoin being awarded by the code
• Both require the transfer of real world work to acquire. Gold to physically retrieve it, and bitcoin to pay for the electricity that processes the transactions, which then award the processor

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The Housing Bubble

The housing bubble started when banks sold the mortgage contracts for the future value of the home, expecting them to be worth more on the next sale. It is nearly identical to the tulip futures contracts bubble, with the exception of the underlying asset, in this case, a house instead of a tulip. Unlike tulip bulbs, the house is valued by the land it sits on and the utility of the home. If you took out a mortgage for $500,000 to purchase a plot of land and the house on it, it will provide shelter to you for as long as you make your payments and maintain the house. Eventually, once the mortgage contract is completed, you now properly own a piece of land and a house that is yours forever until you sell it. It is largely expected that due to increasing demand, and limited supply of desirable homes around that area, you will end up selling it for more than it's worth, adjusted for inflation. The sale of mortgage contracts therefore, have some real world measureable value. And like any product contract, you can make or lose money depending on how the asset performs.

The fuel for the bubble was investors who expected the price of the houses to continue to increase with each sale. Eventually the real world economy could not support the uneducated buyer, and the buyer defaulted on their mortgage payments. Quickly, the houses fell in value and people abandoned their mortgages as the value of their house tanked.

This is similar to the dot.com bubble since it was based on someone else's paycheck. It is important to make a distinction however since overtime, the price of the home reached the price that caused the bubble to pop, how this was done is the magic of a fiat currency system, which is another discussion in itself.

How does that compare to the supposed Bitcoin bubble?

This is much more difficult of a task than the previous examples. The coin itself has zero necessity and close to zero utility. It is not a home that we must have in order to stay safe. The coin does have a hard value born from labor and effort needed to create it. Someone had to manufacture the computer's that "mine" or process the bitcoin transactions. Those computers require real world electricity to operate, and so you CAN actually composite the price to create a bitcoin and average it out over all coins in existence. That would theoretically be the true value of bitcoin, and similarly, a physical home; which needs the designing of the structure, the purchasing of material, and the labor required to put it together.

The coin itself still doesn't have much utility though. It isn't stable enough to use as a currency, but its underlying code is great at performing fast and cheap transactions. That means the technology behind bitcoin has great value, but since it is easily replicated, why not an altcoin such as Etherium or Litecoin?

That is where the comparison really ends and the mystery begins.

We know that the fuel for the supposed bitcoin bubble is the same as housing and dot.com bubble, that is, investors expecting the value of the coin will continue to increase. The primer for the pop for dot.com was missed earnings, and for the housing, was inability for people to make payments once their cost exceeded their income. So the big question is:

If bitcoin is a bubble, what will cause it to pop?

Could it be excessive electricity prices? No, because that would cause an economy to pop since we depend on electricity.

Could it be security issues? Possibly, but that can be addressed with blockchain code updates through hardforks.

The reality is that, we don't know it's a bubble until it pops since cryptocurrencies are a new asset class in its own right.

What I can say is this, cryptocurrency is here to stay. The success of bitcoin as a widely accepted means of completing financial obligations requires massive investment by the world community. This requires the world to exchange their local currency for the digital currency by buying more coins. If this happens, the value of all bitcoins in existence would be equal to sum of all the trade that occurs around the world priced against the USD. Effectively, the magnitude of the total value of all bitcoin in existence, would be so large, that normal transactions, which currently dominate the network, would have near zero ability to affect the price in bitcoin. This means we will effectively have the world's first standardized currency. Is this good or bad? Follow me and read on!