Is Bitcoin In A Bubble, And Does It Matter?

Bitcoin is back in the news. At the time of writing, the virtual currency is trading at over $2700, a jump of over five hundred percent in one year. That has caused a frenzy of articles, many of which are incredibly uninformed, and created a huge temptation for me to say, “I told you so.”

I have, on many occasions, including here and here, recommended that investors take the upstart currency seriously and predicted some serious appreciation. My enthusiasm for the concept and recognition of the opportunity, however, do not nullify my trading instincts, and the pace and severity of this surge make me nervous.

That prompts the obvious question: Is Bitcoin in a bubble?

Based on the above six-month chart from the short, obvious answer to that question is yes, but it isn’t that simple. When any asset, be it a currency, a commodity, or a stock, appreciates at the rate that we have witnessed with Bitcoin recently, it usually ends in tears.

The chart is a scary thing for anybody with chart-reading experience.

The increasing size of the daily candles over the last week or so indicates a worrying decrease in liquidity that is usually a precursor of a collapse. Support is lent to the bubble theory by some of what is being written and said about Bitcoin right now, with even those who were previously skeptical jumping on the bandwagon. Pundits seem to be competing to see who can make the most outrageous price prediction, with a price of around $6000 being quoted.

Despite all of that, whether you take this opportunity to sell any Bitcoin you may have depends largely on your reasons for buying in the first place. If you bought Bitcoin as a trade, then taking at least some profit here makes sense. Greed is one of the biggest killers of traders; accounts and trading, by its very nature, involves taking profits at some point.

That said, markets have shown many times that buying frenzies can continue for a long time even once the point of logic is firmly in the rearview mirror, so dumping everything into a soaring market is not usually a good idea. However, from a trading perspective, it does make sense to start averaging out of some of your position.

If you own Bitcoin and you bought it as a long-term investment and a hedge against inflation, you may want to look at it differently. While a correction is inevitable at some point, and will most likely come soon, it will be just that, a correction. There is a danger that if it is severe the “bubble and bust” pattern of Bitcoin’s price will do damage to its immediate prospects, but the base case for staying invested is still there.

What those familiar with the subject know only too well is that Bitcoin is literally programmed to increase in value relative to other currencies. Traditional currencies deal with economic growth by governments issuing more of them. That, according to the basic laws of supply and demand, means that their relative value will decline over time. The total supply of Bitcoin is limited to around 21 million, however, and the protocol dictates that the rate of supply will decrease gradually.

Economic growth is dealt with by using smaller and smaller fraction of one unit to pay for things, which logically means that the purchasing power, or value, of each unit will increase as time passes. If you buy into the basic premise that the global economy can handle a disinflationary currency like that, or even that it needs one to encourage saving, then the current rate of exchange for other currencies is not the point.

When you consider recent price action, it is hard to argue that Bitcoin is not in a bubble of sorts. All the signs are there, from a distorted chart to ridiculous predictions, but for those who believe that Bitcoin really is the future that doesn’t matter. They have, over time, become accustomed to volatility, and will look back to when Bitcoin “peaked” at around $1200 in late 2014 before declining rapidly.

Mainstream opinion then was that cryptocurrencies were at best nothing but a fad and at worst some kind of a Ponzi scheme. They stated with certainty that those levels would never be seen again. They were wrong then, and when the correction comes and they repeat those statements, they will be wrong again.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

More Related Articles

Info icon

This data feed is not available at this time.

Sign up for the TradeTalks newsletter to receive your weekly dose of trading news, trends and education. Delivered Wednesdays.