Just before Christmas, 2017, Bitcoin seemed unstoppable. Its value was rising exponentially as more and more investors piled in to the digital currency, hoping to profit from its sudden popularity. Other cryptocurrencies benefited too, as investors diversified their cryptocurrency holdings and arbitraged differences. Demand was so heavy that cryptocurrency exchanges crashed. Those who had held (or HODLed) cryptocurrencies for some time received the biggest Christmas present of their lives.
Professional investors and amateur traders alike predicted that Bitcoin’s price would increase even more in 2018. “Bitcoin will never crash,” said one Reddit user, “because then everyone would buy it when it’s much cheaper.” Like everyone buys the dips in a highly volatile high-yield market.
Others looked forward to universal adoption and a price tag in the millions. They might have trouble cashing in their windfall now, but that didn’t matter. Once everyone was using cryptocurrencies, fiat currency would be irrelevant and they would be the new super-rich. Some even started setting up a cryptocurrency Utopia in Puerto Rico, principally it seems to avoid the very large tax bills they would have to pay if they ever managed to convert their cryptocurrencies to dollars. Hmm.
Even in January 2018, as Bitcoin’s price crashed to less than half its December value, Bitcoin enthusiasts were still optimistic, predicting that Bitcoin’s price could rise to as much as $100,000 by the end of the year.
But here we are in March, and Bitcoin is still hovering around $8,000 dollars. Bitcoin bears are saying it is a classic bubble bursting, and making dark remarks about the price going to zero. If they are right, then a lot of people stand to lose a lot of money. How much further will Bitcoin fall?
The shape of Bitcoin’s price chart suggests a classic bubble bursting (this chart is from March 19th):
This chart shows one of the most famous stock market crashes in history – the Wall Street Crash of 1929:
There was a sizeable rally after the initial crash, followed by several smaller ones. But the underlying trend was still downward. Eventually, stocks lost all of the value they had built up over the previousdecade. If Bitcoin’s collapse follows this pattern, its price could indeed fall to zero.
The characteristic “sharks-tooth” shape of a financial bubble stems from the three phases of its lifecycle, which I have annotated on the Wall Street Crash chart:
- The “Free Lunch” period. A long, slow buildup of price distortion, during which investors convince themselves that rising prices are entirely justified by fundamentals, even though it is apparent to (rational) observers that they are buying castles built on sand.
- The “This is nuts, when’s the crash?” period. Everyone knows prices are far out of line with fundamentals, but they carry on buying in the irrational belief they can get out before the crash they all know is coming. Speculators pile in, hoping to make a quick profit. Prices spike.
- The “Every man for himself” period. Prices crash as everyone runs for the exit. This can happen a number of times, separated by brief periods of stability when everyone congratulates themselves on a lucky escape. But they are wrong. The ship is sinking.
Bitcoin was in phase 2 before Christmas 2017. It is now in phase 3.
Understandably, HODLers are desperately talking up the market. Pointing to Bitcoin’s history of market crashes and recoveries, they insist that Bitcoin will rise again from the ashes, becoming bigger and better than ever before. Perhaps we should call this new improved cryptocurrency “Phoenixcoin”.
They do have a point. “Bitcoin bear markets are nothing new,” say analysts at Morgan Stanley. “Since the coin’s creation in 2009 there have been four prior bear markets, with price falls ranging from 28% to 92%, so the recent fall of 70% was nothing out of the ordinary.” Meh, apparently.
However, Morgan Stanley’s analysts think Bitcoin’s price chart looks much like the Nasdaq in the dot-com bubble of 2000. Indeed it does:
I’m afraid this tends to support the argument that Bitcoin has much further to fall. It also suggests that there will soon be a major market shake-out in which most of the current crop of cryptocurrencies will vanish.
But not all of them. After all, some of the biggest tech companies in the world today are survivors of the dot-com crash.
Personally, I would be looking at what really gives a cryptocurrency value – its real-world usefulness. After all, people still buy tulip bulbs today. They are not valueless. But now they are valued for their ability to produce pretty flowers that brighten up our lives.
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