Perhaps you’re not familiar with the concept.
From around 1600 to 1643 tulips, imported originally from Turkey, became highly desirable commodities in the Netherlands which, at the same time, was awash in Gold and Silver from it’s extremely successful trading empire (at the time they had a larger fleet than either England or Spain). It’s easy to understand why, they’re pretty and fragrant and they seemed a good store of value since, though the flowers may wilt and perish, the bulbs will produce for many years (about the same as a cow actually, but you can’t milk or eat them). Moreover through breeding and genetic tricks the Dutch were able to produce never before seen unique varieties.
They were more valuable (at the peak of the market) than their weight in Gold and circulated, as currency might, as a medium of exchange.
Now a Modern Monetary Theorist could point out they lacked at least one essential quality, they weren’t legal tender and you couldn’t pay your Taxes in them, but all you had to do was take them down to the market and trade them for Gold right?
A bubble? We don’t even know how to value Bitcoin
Alicia Cameron and Kelly Trinh, The Guardian
Wednesday 13 December 2017
Bitcoin is a “speculative mania” according to the governor of the Reserve Bank of Australia. But it’s not so easy to say that Bitcoin is a bubble – we don’t know how to value it.
Recent price rises (close to $18,000 in the past three months) may be too great and can’t continue. But the Bitcoin market is only just maturing as an investment and as a currency, and so it may still have room to grow.
A bubble is when the price of an asset diverges from its “fundamentals” – the aspects of an asset that investors use to value it. These could be the income that can be earned from a stock over time, a company’s cash flow, the state of a country’s economy, or even the rent from property.
But Bitcoin does not pay out profits (like shares) or rent (like property) and is not attached a national economy (like fiat currencies). This is part of the reason why it is hard to tell what the underlying value of Bitcoin is or should be.
If we take a close look, we can see how the price of Bitcoin may be diverging from these fundamentals. For instance, it is becoming less profitable to be a miner, especially as the energy required increases. At some stage the cost may exceed the price of Bitcoin, making the network less worthwhile to both mine and invest.
Bitcoin may be the best known cryptocurrency but it is also losing marketshare to other cryptocurrencies, such as Ethereum and Litecoin. Bitcoin currently accounts for 59.4% of the total global cryptocurrency market but at the beginning of 2016 it was 91.3%. Many of these other cryptocurrencies have more functionality than Bitcoin (such as Ethereum’s ability to execute smart contracts), or are more efficient and use less energy (such as Litecoin).
Government policy, such as taxation or the establishment of national digital currencies, may also make it riskier or less worthwhile to mine, transact or hold the cryptocurrency. China’s ban on initial coin offerings earlier this year reduced the value of Bitcoin by 20% in 24 hours.
Without these fundamentals the price of Bitcoin largely reflects speculation. And there is some evidence that people are simply buying and holding Bitcoin in the hope it will keep rising in value (also known as greater fool investing). Certainly, the cap on the total number (21 million) of Bitcoins that can exist makes the currency inherently deflationary – the value of the currency relative to goods and services will keep increasing even without speculation and so there is a disincentive to spend it.
In the end, this is uncharted territory. We don’t know how to value Bitcoin, or what will happen. Historical examples may or may not apply.
What we do know is that the technology behind most cryptocurrencies is enabling new models of value transfer through secure global consensus networks and that is causing excitement and nervousness. Investors should beware.
To be fair you can’t eat Gold either (well, you can, it doesn’t hurt you but it doesn’t help you either) and Bitcoin doesn’t rot like Bananas or stink like Oil.
However it is a Tulip, worth whatever you can get for it, only it isn’t as beautiful or smell as sweet.
It is an example of inflation in luxury items and raw speculation. A fake Leonardo. Too much money chasing too few goods.