ASK DR HEGHOG: THE CRYPTOCURRENCY ERA OUR NEXT ECONOMIC BUBBLE? [Part 2 of 3]
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With the great uproar of cryptocurrency gains and appeal making its way into mainstream knowledge, we can observe how its newfound popularity can subject cryptocurrencies to great speculative behaviour as seen with stock prices in 1929. This signal seems to be the main conjecture to those who advocate an imminent ‘crypto-bubble’. Eerily, Initial Coin Offerings (ICOs) have also seen similar hype and huge investment volumes with the Initial Public Offerings (IPOs) during the ‘dotcom’ bubble era. Both ICOs and ‘dotcom’ IPOs have the same faulty ‘modus operandi’ of gaining huge tractions in investments but with no profitable business plan. What followed suit with the ‘dotcom’ IPOs were bankruptcies of many start-ups, which became a significant factor in the ‘dotcom’ bubble burst.
This could very well be the case for the wealth of ICOs as well, contributing greatly to a crypto-bubble. However, to fully assess how current cryptocurrency markets can be assimilated to a bubble, let us look at the individual components that make up the whole of a bubble. Economist, Hyman P. Minsky discussed the stages of a bubble in his book “Stabilizing an Unstable Economy” (1986), where his work has seen increased adoption after the 2007-2010 financial crises [5]. Minsky [6] correlated the credit cycle of a financial market with speculative investment behaviour to present 5 stages of an economic bubble:
- Displacement
- Boom
- Euphoria
- Profit Taking
- Panic
For brevity, this paper will directly compare each stage with current situations in the crypto-markets, without further delving each stage’s definitions.
Let’s look at the first three stages. ‘Displacement’ occurs when an underlying asset proposes a paradigm shift, which in the case of cryptocurrencies, provides an innovative disruption to the currency institution. The creation of Bitcoin by Satoshi Nakamoto in 2009 realised the potential of cryptocurrencies to replace how money works, and how transactions can be decentralised using a trust-less unalterable P2P ledger system known as the ‘blockchain’. This potential led to Bitcoin having a dedicated fan-base that believes in the blockchain technology, giving way to early investors.
However, prices were rising slowly, as early investors only comprised of Bitcoin’s fan base and those using Bitcoins for illicit purposes. It wasn’t until more recently that Bitcoins, as well as the birth of other cryptocurrencies, came into coverage as their prices started to inflate exponentially. In 2013, Bitcoins went up by 9000% from the subsequent year of $13 [6], marking a significant price increase for Bitcoins and in the process, riled up many hungry investors. This shifted cryptocurrencies into the ‘Boom’ stage, where cryptocurrencies draw more widespread media coverage, and FOMO becomes rampant. Here, more and more investors start to enter the crypto-market space. It can be argued that a large percentage of these investors were motivated either by profits or the promise of an innovative technology, or a combination of both.
As markets gain large amounts of momentum, cryptocurrencies turn to the third stage, ‘Euphoria’, where price valuations sky-rocket and new highs are achieved regularly. At the time of writing, current market cap for all cryptocurrencies has reached a staggering number of roughly 170 Billion USD, surpassing the GDP of many small countries [2][8][9]. Cryptocurrencies have grown a long way from a technological concept to amassing large amounts of the world’s fortune comparable to large corporations and small countries.
References:
- Kharpal, A. (2017). Ethereum hits another record high after bitcoin and is up over 5,000% since the start of the year. [online] CNBC. Available at: https://www.cnbc.com/2017/06/12/ethereum-price-hits-record-high-after-bitcoin.html [Accessed 13 Oct. 2017].
- Coinmarketcap.com. (2017). Cryptocurrency Market Capitalizations | CoinMarketCap. [online] Available at: https://coinmarketcap.com [Accessed 13 Oct. 2017].
- NASDAQ.com. Definition of "Economic bubble " - NASDAQ Financial Glossary. [online] Available at: http://www.nasdaq.com/investing/glossary/e/economic-bubble [Accessed 13 Oct. 2017].
- Rothchlid, J. (1996). WHEN THE SHOESHINE BOYS TALK STOCKS IT WAS A GREAT SELL SIGNAL IN 1929. SO WHAT ARE THE SHOESHINE BOYS TALKING ABOUT NOW? - April 15, 1996. [online] Archive.fortune.com. Available at: http://archive.fortune.com/magazines/fortune/fortune_archive/1996/04/15/211503/index.htm [Accessed 13 Oct. 2017].
- Yellen, J. (2009). A Minsky Meltdown: Lessons for Central Bankers. [online] Federal Reserve Bank of San Francisco. Available at: http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2009/april/yellen-minsky-meltdown-central-bankers/ [Accessed 13 Oct. 2017].
- Minsky, H. (2008). Stabilizing an unstable economy. [New York]: McGraw-Hill.
- Nugent, J. (2017). The Bitcoin Boom. [online] Forbes.com. Available at: https://www.forbes.com/sites/riskmap/2013/12/17/the-bitcoin-boom/#1c234221364e [Accessed 14 Oct. 2017].
- Young, J. (2017). Bitcoin is Now Larger Than Most Fiat Currencies in Europe & Americas in Market Cap. [online] CryptoCoinsNews. Available at: https://www.cryptocoinsnews.com/bitcoin-now-larger-fiat-currencies-europe-americas-market-cap/ [Accessed 14 Oct. 2017].
- Bendella, W. (2017). How Bitcoin Does Versus Gold, Fiat and All World's Money. [online] Cointelegraph. Available at: https://cointelegraph.com/news/how-bitcoin-does-versus-gold-fiat-and-all-worlds-money [Accessed 14 Oct. 2017].
END OF PART 2
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