Fullerton
Since it established itself as the first publicly traded cryptocurrency in 2009, Bitcoin has experienced a very tumultuous history. After years of critics calling the cryptocurrency “worthless”, this unique financial asset eventually grew in value from mere pennies per coin to a peak of value of $19,783.06 (December 17th, 2017). Those who were willing to take a risk and invest early on were rewarded with riches potentially in the millions.
As of April 3rd, 2019, Bitcoin is trading for $5,044.43. This figure is roughly 25 percent of its peak value, which naturally means that some investors have lost a considerable amount of money. However, what is important to note is that—while Bitcoin is nowhere near its original peak—this value remains far above zero. People are actively paying around $5,000 for a stake in the Bitcoin market and, in response, analysts everywhere are trying to figure out why.
The value of Bitcoin is governed by the same principles of supply and demand that can be observed in every other market. In fact, the true value of Bitcoin, without a doubt, is whatever it is that people are willing to pay for it. However, the sudden rise and decline of this unique financial asset seems to be rather unique. Is Bitcoin an asset that is currently overvalued or undervalued?
In this article, we will discuss whether or not Bitcoin experienced a true bubble. We will also compare Bitcoin to some of history’s most famous trading bubbles, such as the “Tulip Bubble” that took over the Netherlands in the 1630s. Though the fundamentals of economics have remained unchanged since the early days of commodity trading, there are still quite a few reasons to believe that the rise and fall (and possibly future rise) of Bitcoin is unique to this era.
Taking a Look Back at the Tulip Bubble
Though “Tulip Mania” may not have been the first commodity bubble to ever exist (there was a bubble in Germany in the 1620s), it is certainly among the most famous. Within a matter of years, tulips exploded in value without any clear justification (outside of supply and demand). At the height of Tulip Mania in 1637, the cost of a single tulip bulb was roughly 10 times that of the average skilled worker’s salary.
While this apparent bubble would eventually implode, the Aalsmeer Flower Auction Building (Netherlands) remains the largest building in the world—a remnant of the tulip legacy that has lingered for centuries. The question that economists are still asking themselves is, why were tulips perceived to be so valuable? After all, tulips do not really offer any nutritional value nor are they particularly useful as building materials. But tulips were trading like “crazy” due to the forces of supply and demand. The perceived future value of tulips caused merchants of all kinds to sacrifice large amounts of money in the present.
What Makes Something a Bubble?
The term “bubble” is often used quite casually to describe the increased value of an asset without a clear reason. The formal definition of an asset bubble is the “trade in an asset at a price or a price range that strongly exceeds the asset’s intrinsic value.” While this definition is fairly straightforward, it offers very little relief. What is the “intrinsic value” of an asset? Would the multi-billion dollar diamond industry qualify as a bubble?
The diamond industry offers an interesting comparison because while diamonds are clearly sold for prices well above their “usefulness”, their values have remained strong for decades. Like diamonds, the apparent value of tulips was also largely due to their aesthetics and perceived luxuriousness. But this “bubble” came and went in a very short amount of time. Consequently, it seems that in order for the trading price of an asset to have actually deviated from its intrinsic value, the asset should not be something that can be sold for a similar value in the future.
Was there a Genuine Bitcoin Bubble?
The apparent “tulip bubble” was characterized by a roughly 6,000 percent increase in price (in less than two years), followed by an immediate return to previous values. In the nearly 400 years that have passed since the peak of Tulip mania, tulips have never traded for a value anywhere remotely as high as their peak value (possibly as high as $400,000 per bulb in today’s dollars).
There is no doubt that Bitcoin has lost a considerable amount of value since its peak in December 2017. But the drivers of value of Bitcoin still remain. Bitcoin is still the largest and most frequently traded cryptocurrency in existence. Bitcoin has also enjoyed significant price increases on a regular basis. If there were a Bitcoin “bubble”—a term whose definition is admittedly arbitrary—it certainly was not a bubble comparable to tulips in the 1630s.
If anything, this bubble should be compared to the housing bubble of 2008. Like houses in the United States, Bitcoin experienced a sharp rise in value, followed by an even sharper retraction. Bitcoin—like the home you are currently living in—still has a tremendous intrinsic value, even if the trading value is much lower than it was at its peak. This is the precise reason why people are still paying nearly $5,000 to own a single coin (something that was worth less than a nickel just one decade ago).
Why Bitcoin is Characteristically Different than Tulips
The most obvious reason why Bitcoin differs from tulips is that, even since its initial decline, the currency has demonstrated an ability to regain its value. Following the currency’s peak value (nearly $20,000 per coin), prices plummeted to around $6,900. Within a month of that particular trough, however, prices would turn around and rise to nearly $9,800.
Bitcoin has experienced a series of ups and downs, but what is perhaps most remarkable is that prices have been increasing over the course of the past four months. On December 15th, 2018, Bitcoin was trading for roughly $3,100. Today, it trades for over $4,900. The 58 percent ROI that has occurred over the past four months suggests that the “intrinsic” value of Bitcoin has hardly gone away. What is perhaps even more remarkable is the fact the—contrary to the coin’s explosion in value a few years ago—the recent growth of Bitcoin has been remarkably linear. Instead of exhibiting behaviors similar to tulips or other highly speculative assets, Bitcoin is now behaving much more like a blue chip stock. Though it may experience ups and downs in the future, Bitcoin has achieved stable values that are less volatile than ever before.
Looking Towards the Future
What remains clear is that Bitcoin is certainly not going away. Bitcoin is the anchor of the cryptocurrency market. Adoption from users and bitcoin day traders is increasing. Currently, there are more than 800 different cryptocurrencies available for traders to choose from and the value of each of them is directly affected by the value of Bitcoin.
Any asset that can yield a stable 58 percent ROI over four months is one that will surely attract the attention of investors. Bitcoin still has an intrinsic value, and as cryptocurrency continues to become a more acceptable form of payment in an increasingly globalized world, this value will be effectively sustained. While it may be difficult to predict how much Bitcoin will be worth in the future, there is no doubt that this explosive asset is characteristically different from the tulip market in the 1630s. Incorporating Bitcoin into any risk tolerant trading strategy may still be a very good idea.
