Sharpen the pitchforks and log in to Reddit, friends. Because I’m the latest talking head who is foolish enough to use the B-word to refer to bitcoin.
For the record, I’m not calling a top in the cryptocurrency space. Market timing in general is a fool’s errand, and particularly troublesome with a phenomenon like bitcoin BTCUSD, -2.77% that has surged 17-fold in the last year while the S&P 500 SPX, +0.15% is up about 18%.
I am actually quite impressed with the value of blockchain as part of the global economy. The technology behind bitcoin has real utility, even if I think the valuation of the digital currency itself is a bit crazy right now.
But when you take a hard look at the last few years, it’s hard to deny that the run-up is starting to look shaky. And compared with past events, the rise of cryptocurrencies has all the hallmarks of a disaster waiting to happen.
Here’s what a bitcoin bubble looks like:
It starts as a phenomenon that’s enjoyed by a small group of speculators who see huge success. But eventually the investment transcends normal investing barriers. Fans of hard assets like gold see bitcoin as a similar bet against financial disaster. On the other end of the spectrum, aggressive growth investors draw correlations between bitcoin’s rapid growth and high-tech utility just like Amazon.com. AMZN, -0.33%
After the phenomenon gains broader appeal in the investing world, general interest publications jump in. It starts innocuously with profiles and explainatory pieces meant to demystify a fashionable trend. But eventually, it becomes a feeding frenzy. Media outlets go out of their way to cover a given investment theme just to prey on that interest — like comparing Republican tax cuts in some weird way to bitcoin on the Huffington Post.
And why shouldn’t we be captivated, considering stories like the Winklevoss twins becoming bitcoin billionaires — or better yet, the “crypto castle” where a bunch of San Francisco millennials living in the same house have become bitcoin millionaires overnight. The stories are simply too much to pass over, and help fuel hope as well as interest in the investment.
Meanwhile, predictions go from simply credulous forecasts of success to outlandish targets seemingly derived only for shock value. Like a prediction that one bitcoin will be worth $1 million by 2020.
At the same time, the early warnings or downside predictions are thrown back in the face of the media and Wall Street fat cats who were foolish enough to doubt the trend. They are “panic sellers” for jumping out too soon, or declaring bitcoin is a bubble is just “sour grapes” where “they missed the boat but are too proud to admit they didn’t grasp the significance.” The bulls are right and the bears are wrong, forevermore.
This creates a feedback loop that is difficult to break. When people express skepticism over the rapid rise of an investment, they are labeled as idiots who simply don’t understand things. Take the assertion from a bitcoin booster that “U.S. dollars are not backed by anything other than the faith of the fools who accept it as payment and of other fools who agree in turn to accept it as payment from them.” Not only are bearish targets from naysayers stupid, but their whole darn worldview is, too.
Unsurprisingly, this one-dimensional view encourages a herd mentality. While early adopters tend to have at least peripheral knowledge of the investment in question, eventually those without any understanding of finance or investing are sucked in simply by the promise of returns. Case in point: Nearly 1 in 3 millennials would rather own bitcoin than stocks, according to a November report.
Where there is a herd, there are always marketers looking to do some fleecing. Salesmen pitch overpriced advisory services, add-on apps, product imitations and anything else on which they can make a quick buck. Just one example are the “initial coin offerings” that have been coming hot and heavy — to the tune of more than 200 ICOs in 2017.
Eventually, the lines get blurred between aggressive salesmanship and criminal wrongdoing. That was the case with the recent Munchee ICO that prompted a “cease and desist” order from the Securities and Exchange Commission, or Bitcoin Platinum that was created in South Korea by a teen and turned out to be an outright scam.
All of this starts to become simply too much to bear. But the music hasn’t stopped yet, so the next chapter is to anticipate a bubble bursting and simply pivot to a derivative investment. Pundits now are quick to plug the “next” version of this investment trend instead of trying to tout what is clearly an inflated asset. This is a thinly veiled admission that the original wave is likely to end soon, but it still allows access to the underlying interest.
There other tell-tale indicators that will come, of course, and many likely will only be visible with hindsight. And let’s be frank and admit that bitcoin may very well continue soaring despite whatever “evidence” comes to light. Bubbles are never driven by rational thinking, and in 2017 it seems that base emotional arguments seem to matter more on most front than facts or historical norms.
But even if bitcoin doesn’t crash for a while, the signs all point to a reckoning.
It’s possible that those who bought bitcoin many months or years ago may still wind up ahead because they bought so early. It’s also possible that after a brief dip that bitcoin recovers, as many investments do after short-term volatility.
And of course, I’ll also admit that a crash may never happen. I expected a heck of a lot more volatility after bitcoin futures started trading, so there’s a non-zero chance that there’s nowhere to go but up.
However, “irrational exuberance” is used to describe bubbles for a reason, and there is a real danger of that sentiment with bitcoin.
If you’ve made a ton of money in bitcoin, good for you. But new money needs to know the state of play and heed these warning signs before simply jumping in.
Because at best it’s a mature rally that has already achieved much of its gains, and at worst it’s a recipe for disaster as you buy at or near the top.