Over the past month, Bitcoin has become almost synonymous with the word bubble. In fact, Google searches for the combination words “Bitcoin” and “bubble” has jumped exponentially. That is unsurprising considering Bitcoin’s phenomenal ascent—piercing through record after record.
Even as calls and forecasts for Bitcoin’s eventual collapse intensify, the enthusiasm has intensified, as well. The cryptocurrency is now available for trading on the Chicago Mercantile Exchange floor, making its way forward as a form of legal tender. It’s also unsurprising, then, that in another Google search, the word combo of “buy” and “Bitcoin” is also at a record high.
So, how can we gauge Bitcoin? We cannot! And that is what I call the Unknown Factor.
Chart courtesy of Google Trends
Bitcoin is No Tulip
Some prominent figures including Jaime Dimon CEO of JPMorgan Chase & Co and John C. Bogle-founder of Vanguard Group. have labeled Bitcoin as a bubble, even the world's most famous investor Warren Buffet has been a skeptic on Bitcoin labeling digital currencies a “mirage.” In fact, most of all, the latest Bitcoin surge is compared to the Tulip Mania that took place way back in the 17th century in the Dutch Republic. Back then, Investors got caught up in a frenzy of tulips and began speculating on their price. A bubble was inflated, and eventually, like every inflated bubble, in 1637 the tulip bubble burst, leaving investors “wounded” and with “hefty losses.” The difference between then and now is that a tulip is, for lack of a better description, a “useless asset.” As a commodity, the tulip, albeit pretty, is nothing more than a decaying flower with no real use or applications in food or industry. Unlike a commodity such as gold or silver, a tulip cannot be used for jewelry.
The reality is that Bitcoin is no tulip, but it’s also not “just” currency. Bitcoin is a gateway into a monetary system that is decentralized and independent from any country or bank in the world. It is a system that allows the exchange of funds in total anonymity, in a fraction of a second, and with no transaction fees. And, as previously stated, Bitcoin is gradually becoming an acceptable form of legal tender. Each of those characteristics inherent in Bitcoin has value.
The problem is in assessing Bitcoin’s “fair value.” When an investor buys a stock, he can use certain rules of thumb to evaluate the risk and potential of his investment. For example, a P/E multiple indicates the stock’s valuation, the dividend suggests the dividend yield that the investor might expect, and the financial report is a reflection of the company’s financial health. When it comes to other asset classes, whether bonds or commodity futures, the metric changes but the situation remains the same; the investor can assess the risk he is taking, as well as his potential gain. But there are no real metrics for adequately assessing Bitcoin; Bitcoin’s “fair value” is a BIG unknown. And, after returning a jaw-dropping 651% over five months, this unknown is perceived by investors as having a limitless upside.
Chart courtesy of Bitcoin.com
But, though investors might be hesitant to admit it, much of the appetite for Bitcoin is derived from today’s upbeat economic environment. Annual GDP Growth in the US stabilizing above 2% for the past three quarters, China’s growth has stabilized around 6.7-6.8%, and even in the fragile Eurozone, growth is stabilizing above 2%. And inflation has also been rather stable, with inflation in the US, China and the Eurozone averaging between 1.5% and 2%. All told, both growth and inflation have been remarkably stable, with few surprises in either direction. In fact, lately, very few shocks have occurred in the global economy. Despite a few hiccups here and there, even Brexit seems to be drawing to a relatively smooth conclusion. When everything seems so predictable, returns are low, and investors become confident enough in that predictability that they are willing to seek higher returns with the unknown.
But, what happens when the economic environment stops being predictable? What if a crisis in the Middle East causes inflation to surge and triggers an economic crisis? What if China’s real estate starts collapsing again? Of course, the “what if’s” are plenty, but the results are always the same. When a crisis erupts, the economic environment becomes uncertain and investors crowd into assets with the most certainty and a known value, like top-rated stocks or US Treasuries, or else they simply hold US Dollars. Suddenly, the unknown value of Bitcoin is perceived, not as a limitless upside but, as a bottomless pit, as investors sell the unknown and flee to safe haven assets.
So, if you are thinking about buying Bitcoin, first gauge the economy and inflation because, more than anything else, that is the key to Bitcoin’s trend. That is what caused the Bitcoin rally to accelerate exponentially in the first place, and that is what will precipitate Bitcoin’s inevitable sell-off.
Look for my post next week.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.