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Could Bitcoin be a Bubble?

The statements that talk about Bitcoin and the cryptocurrencies in general as a bubble are not a new thing. Several years ago, some renowned people from the traditional finance world talked negatively about Bitcoin and accused it to be a type of speculative scheme. The best way to answer the question whether or not Bitcoin and other cryptocurrencies are a bubble or not is to analyze what a financial bubble consist consists of.

Juan Ramón Fallo, a renowned economist from Spain, summarized that a bubble occurs when the price of an active asset exceeds by far the present value of its future cash flows. This can happen, for example, with a real estate asset, stocks of a company that is listed on the stock market or with a commodity, where the current price of an asset is much higher than the current value of its future performance.

So, when the majority of people talk about a speculative bubble, they refer the situation when the price of an asset increases beyond its natural price, which means it is overrated and it is only a matter of time before the bubble bursts and the price drops significantly, causing considerable losses for the owners of that particular asset.

However, it is important to say that not all the assets are subject to this type of analysis. This is the case with the monetary assets. These are the assets that are fundamentally used as money or means of exchange, such as currencies and gold. Certainly, Bitcoin is an asset that is being used as a mean of exchange by a lot of people and institutions.

The monetary assets simply do not possess future cash flows and thus cannot be analyzed similarly to the way the rest of the assets are analyzed and it would be incorrect to say they are in a bubble phase. Despite the fact that in some jurisdictions Bitcoin is considered as a commodity, this classification is not correct and could be responding to the interests of a particular legislation, whether it be because they find the position of Bitcoin on the global market of monetary assets to be uncomfortable or because they do not possess knowledge about the possibilities of adoption and use of this and other cryptocurrencies on the market.

We are talking about speculative bubbles when an active is being over demanded in the present in respect to the value of the future income that this particular assets would bring. On the other hand, we should remember that the fundamental use of the monetary assets is to be demanded as a method of exchange. So, a greater adoption of a monetary assets, such as Bitcoin, would be intrinsically linked with its fundamental use as money and would bring an inevitable increase of its current price as the people express the demand for it with greater intensity.

What the aforementioned would like to explain is that we cannot talk about over demand or a bubble of a monetary active when precisely its fundamental value depends on the demand expressed by the people. This is just like the way there could be a demand for a certain good that would be used later a a method of monetary exchange.

This is why we cannot simply say that Bitcoin is a bubble or in a bubble phase, simply because this type of analysis is not applicable to it. Now, this does not mean it is not subject to speculation and cannot suffer from variations of its price.

What we should not think is that all speculation is necessarily damaging. Exists a possibility that the speculators are right. Over the years, many people have been incorporating Bitcoin in their wallets as a method of investment, whether it was because of pure speculation or because they believed in the potential of the blockchain technology behind the cryptocurrencies. The reason is not important, these investors believe that in the future the adoption of Bitcoin as a method of exchange will continue to advance. On the other hand, the speculators could well be anticipating a strong monetary demand for Bitcoin, which would inevitably translate to the increase of its price without having to do anything with a financial bubble.

The speculative component is a frequent critic of Bitcoin and other cryptocurrencies and in some cases it is not justified. After all, all the people express demand for a monetary asset and prefer one over another. For example, one could decide to keep his or her savings in the US dollars and not in some other currency), because there are certain expectations about the future value of the asset these people are keeping. In this sense, any money has a speculative component.

So, the question might be why so many people decide to adopt Bitcoin? For some this is a natural response of the people that are trying to move away from the highly inefficient global monetary system that is creating bubbles and depend entirely on the power of the countries.

This last statement refers to the theory of economic cycles, where the control of the main variables of monetary market (interest rates, quantity of money in circulation, among other things) performed by the governments and central banks around the world ends up generating a series of distortions in the structure of the market. Especially important is the control of the interest rates. If set too low, this can lead to investments that are rentable only at this artificially low interest rate, creating an excess of investments in some sectors of the economy, which can only end with an inevitable correction of the interest rates, the breakdown of these investments that are no longer rentable with the new interest rate and the bubble bursts.

The most recent example of this was the financial crisis that occurred ten years ago. In October, 2008, in the face of the widespread distrust in the banking system, Satoshi Nakamoto published the white paper of Bitcoin.

This distrust of the people in the banking and financial system is not at all unjustified. We can see that during the last decade, the interest rates of the Federal Reserve of the United States of America were close to 0%, which makes it possible to affirm that Bitcoin is a response to the true bubbles that exist in the modern economy.

At this point it is important to remember that Bitcoin is a currency, as well as a digital system, which means it would be wise to analyze the part of Bitcoin which is not a monetary asset.

It is important to mention that Bitcoin is the first existing blockchain network, which presents an innovative technology that functions as an encrypted database where any type of information can be stored. This is why the blockchain technology has a relevant value in itself, which is based on the fact that each registered data is protected and marked with a unique digital fingerprint.

The blockchain represents a technology that could bring numerous benefits and potential uses, although it is important to say that this technology is still being developed for various applications by a large number of companies around the world.

It is hard, if not impossible to perform a monetary calculations of any type of technological advance, especially if it is still in the first years of development. First of all, a technology cannot be evaluated like a financial asset, which is expected to bring a series of future incomes to the owner, but this does not mean we should ask ourselves if we have went through a sort of unjustified euphoria when it comes to the blockchain technology,

Certainly, in 2017 there was an enormous growth of the prices on the cryptocurrency market. The total market capitalization went from 17.7 billion US dollars at the beginning of last year to 610 billion dollars at the end of 2017. It is important to point out that Bitcoin is the most popular cryptocurrency and it dominates the cryptocurrency market and holds around 40% of the total market capitalization.

By having in mind all we said before, it is possible to think the price of Bitcoin as a currency was confused with its value as a technology and this could explain the blockchain fever we saw last year. We should not forget that Bitcoin is still in its first years of development and that its multifaceted characteristic makes it extremely difficult to analyze it under the standards of traditional assets.

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