The investment community is continually taking a keen interest in trading in the relatively juvenile bitcoin market. Many are left to wonder if the increasing demand and rising bitcoin prices have resulted in the creation of a bubble within the market. That being said, there is another side to this story. A significant number of investors believe that the bubble in the bitcoin market is only a myth. Therefore, this article will attempt to put this question to rest after a thorough inspection of the facts.
In its 12 years of existence, the bitcoin market has caused quite the stir. Being such a volatile market, the investment community still chooses to trade carefully when they trade using the bitcoin currency. The bitcoin craze that seemed to envelop traders sometimes seems to create an economic phenomenon known as a “Bubble”. Many experts state that the rise in bitcoin prices which is now at $43,113 as of 1st October 2021, is similar to that of a bubble and will only crash shortly.
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The origin of bitcoin
To understand why this cryptocurrency is so talked about in today’s market conditions, it is important to look at how bitcoin came to be what it is today. This digital currency was first mentioned by its creator Satoshi Nakamoto in a whitepaper in January of 2009.
Differing from traditional trading assets, this currency is not under a centralized authority. Instead, a decentralized ledger system known as a blockchain and is open to the public with everyone having transparent access to it. With only around 21 million bitcoin tokens in existence, the demand for the bitcoin currency will only increase shortly.
Understanding the bubble
To make a compelling argument as to why bitcoin is not a bubble, it would seem fitting to define what a typical bubble looks like. A bubble which is also known as an asset or speculative bubble refers to a sequence of events that takes place with regards to the market value of a certain asset. In general, bubbles are characterized by a rapid increase in the valuation or price of the asset. This will later result in a contraction or crash which essentially involves an even rapid decrease in the price.
However, for an economic cycle to be deemed a bubble, the price of the asset must be significantly more than that of the intrinsic value it possesses. The exact reason for the creation of a bubble does not have very concrete proof but there are two major theories put forward by several experts. According to one research paper, the reason why bubbles appear is because of rising momentum and the changes that take place in investor behaviour.
The rapid increase in the bitcoin prices came in 2017 when it rose to almost 2,000% of its previous value and a price of $19, 834.93. This exponential growth seemed to be a reason to celebrate from one of its lowest values at $3,300 in December of 2018. This sudden rise and drop in a year are what many claim to be the bitcoin bubble.
The argument for the bitcoin bubble
In 2018, when the value of bitcoin was at its lowest, many blamed a phenomenon known as asymmetric information flow. This tends to happen when there is an imbalance in the information present on both sides of the trade. Some papers even stated that this asymmetry was brought about by bringing in a new cryptocurrency named tether. This currency was used to increase the price of the bitcoin currency drastically and therefore, obtain control of the market. This theory blamed the “lack of transparency” present within the market resulting in the creation of a bubble.
Reasons why bitcoin is not a bubble
From the above definition and explanation, it would seem like the behavior of the bitcoin market is similar to that of a bubble. However, here are five trends that are present in the cryptocurrency market that prove that the value of bitcoin will see an upward growth. These include:
- A legal tender:
A legal tender refers to a payment instrument that one can use to pay off a financial commitment. In other words, legally accepted banknotes. As a result of the negative connotations that accompanied bitcoin and the decentralized nature that it possesses, legal systems were unable to accept that bitcoin can become a legal tender.
However, with the degree of transparency increasing in the market as well as the many applications it has, more countries are warming up to the fact that this can indeed become a legal tender. In fact, as of 2021, Japan, El Salvador, the Philippines, Australia, the USA, and more state that bitcoin is or will become an acceptable and legal form of payment.
- Storehouse for crashing economies
In several economically backward countries, the bitcoin currency has seen the increasing application. These include countries that have experienced hyperinflation of their currencies as seen in Venezuela, Bolivia, and other countries, especially in the continent of Africa. This is because, although these countries’ currencies hold little to no value, bitcoin still possesses a pretty significant amount of value even in a global market. For this reason, countries that are in or recovering from fractured economies will most likely adopt bitcoin in some way or another resulting in increasing demand for it.
- The mainstream trajectory
Since the adoption of bitcoin as a legal tender and a source of value to distressed countries, the use of bitcoin has become more and more mainstream. In addition to this, large-scale companies like Microsoft and Tesla are investing in bitcoin. This is also reflected in the increased adoption of bitcoin by online businesses.
Even Amazon is working towards allowing customers to make purchases and payments through bitcoin. The reason why so many online platforms are adopting bitcoin transactions is because of the several benefits it offers. These include lower fees when paying with credit cards, elimination of chargeback fraud while becoming an attractive prospect for tech-savvy customers.
- Limited tokens:
Another reason why the bitcoin bubble hypothesis is untrue is because of the fixed limited supply. That is, since its inception in 2009, only 21 million coins are available for circulation in the market. Meaning that there are only 21 million tokens that will be able to circulate after bitcoin mining. In addition to this, the process of mining can take a long time and may not be worth the reward that the miner receives. Therefore, with increasing demand and decreasing supply, the value is bound to skyrocket in the coming years.
In addition to this, certain characteristics of the very nature of bitcoin will also disprove the hypothesis that the bitcoin currency is in a bubble. As mentioned in the above definition of an asset bubble, bitcoin is in a bubble only when the bitcoin price is more than that of its intrinsic value.
However, the nature of this currency is
such that there is no set intrinsic or fundamental value. It is also near impossible for anyone to place a certain value in it with the help of traditional techniques for valuation. Although there may be a range of papers and opinions stating that it has a set value, they remain just that, opinions and theories.
This is primarily because bitcoin is still a relatively new concept whose applications in the financial ecosystem are still developing. Therefore, even if these reasons do not completely disprove the creation of a bitcoin bubble, it is still enough to show that the market may not decline as drastically as a typical asset bubble would.
Frequently asked questions
- Can bitcoin crash to zero?
The value of a bitcoin is unlikely to crash to zero or in other words to become completely worthless. A 2018 report states that the odds of the bitcoin currency crashing to zero is a mere 0.4%. The odds are this low because it is one of the most sought-after cryptocurrencies in the world. In addition to this, the recent investments that have been made in bitcoin by several big-name companies.
- Is bitcoin overvalued?
As per the stock-to-flow model, bitcoin is currently above the median, meaning that it is overvalued in comparison to its last cycle. Some experts feel that the argument of whether bitcoin is overvalued or not comes down to what makes it so valuable. Presently, the token value and therefore, the market cap of bitcoin is so valuable not because of activity as a whole (meaning both non-trading and trading activity), rather, it is based primarily on trading activity.
In other words, the intrinsic value of bitcoin would be significantly lower if the total number of transactions taking place were directly tied to the token value.
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