In the last twelve months Bitcoin has surged as one of the most known instruments on financial markets worldwide, raising in value from $700 on the dollar in November 2016 to more than $10,000 exactly one year later.
Bitcoin is a cryptocurrency, that is, a digital or virtual currency, wholly without a physical presence. A key feature of cryptocurrencies is their nature: they are not issued by any central banking authority, rendering them theoretically immune to government interference or manipulation.
Created by the anonymous and mysterious Satoshi Nakamoto back in 2009, Bitcoin is the most famous cryptocurrency, gathering more than 90% of all virtual currencies’ transactions. The idea behind it was truly revolutionary, offering the promise of much lower transaction fees than traditional online payment mechanisms
Bitcoin mining is the process through which new Bitcoins are released to come into circulation. Basically, it involves solving a computationally difficult puzzle online, and receiving a reward in the form of a few Bitcoins. As more and more bitcoins are created, the difficulty of the mining process – that is, the amount of computing power involved – increases.
However, because of the recent and exponential rise in the value of the Bitcoin, many have arisen doubts about the existence of a financial bubble behind it.
According to Nobel winner economist Robert Shiller’s checklist for testing the existence of a bubble, cryptocurrencies should have the following features:
- a sharp increase in the asset price;
- repeated stories of people earning a lot of money, causing envy among people who aren not;
- growing interest in the asset among the general public and the mass media;
- “new theories” justifying the unprecedented increase in the asset price.
Right now, it seems that Bitcoin, and cryptocurrencies in general, possess all of these characteristics.
Just a few weeks ago, JPMorgan Chase chairman and CEO Jamie Dimon claimed that cryptocurrencies are a fraud and that they are in a bubble that will burst soon, adding that he would have fired any employee in his trading division who would have speculated in that market. A couple of days ago, The Vanguard Group’s founder John C. Bogle, believed to be one of the greatest mutual fund managers in the history of finance, announced his agreement with Dimon’s words. Recently even Joseph Stiglitz, the worldwide known economist winner of the Nobel Prize in 2001 along with Michael Spence and George Akerlof, called cryptocurrencies a bubble during an interview on Bloomber TV, saying that they “ought to be outlawed”.
Moreover, Bitcoin also fails to be described as a currency in several ways.
A currency is defined by three key features:
- it is a storehouse of value;
- it is a unit of account;
- it is a medium of exchange.
As regards the first point, it is hard to determine whether Bitcoin is a storehouse of value of not. Daily volatility currently tops 5 percent to 10 percent while its “value” has skyrocketed. In this way, it fails to meet the first and the second criteria.
Analyzing the third and last feature, it can be easily noticed how Bitcoin may certainly be a medium of exchange, but only for a very few users.
Complicating all of this is the fact that cryptocurrencies are widely used in the “dark web” – the illegal side of Internet – for a variety of illicit activities, from money laundering to drug dealing to prostitution payments.
Additional issues involve sovereign nations and their desire to maintain the control of their respective currencies and money supplies, that makes the widespread use of Bitcoin really unlikely in the very short term.
Maybe one day in the future Bitcoins and cryptocurrencies will be widely accepted and used – like many Internet companies founded in the 1990s, like Amazon and Google, are now – but right in this moment they certainly are a financial bubble.
People, and investors in particular, should never forget the true key feature of a bubble: if you invest in it, you will realize you have been swindled only when it is too late to gain your money back.
So, follow the advice of the previously quoted John Bogle, and “avoid Bitcoin like the plague”.
- Irrational Exuberance, Robert J. Shiller