A ‘bubble’ in financial markets is defined as an asset that strongly exceeds its intrinsic value. Famous bubbles in history have included the Dutch Tulip Bubble of the 17th century, the South Sea Bubble in England in the 18th century, and more recently the Dot-com Stocks Bubble that ended in 2000.
So, to establish if there is a bitcoin bubble, we must first derive value for bitcoin, beyond that of a daily moving price. And here we have a problem. Stocks can be valued by their earnings, sales, book value or a host of other metrics. Currencies can find value based on an exchange rate and whether it keeps imports and exports in balance, or whether it allows one to become larger than the other.
Bitcoin, on the other hand, is much harder to value. While the blockchain method of currencies, independent of a central bank, may well be the future, what has driven the price over the past year or so? Bitcoin has caught a narrative, a point picked up by Robert Shiller, the man who created the Shiller CAPE Ratio to value markets.
Rather than an intrinsic value, bitcoin is a story, one that latches on to the angst felt by people in the developed world. Over the past 500 trading days, bitcoin has gone up by over 2000%. Compare that to the tech bubble from 1994 to 2000, which took over 1500 trading days to go above 1000%, before slumping and then only surpassing this gain once 5500 days had elapsed.
Bitcoin may well be a bubble, but that won’t stop the price from going up. Instead, we will need to see a new rival emerge, or see a general disillusionment with cryptocurrencies take hold.
For now, it is tradeable, but it requires iron discipline and risk management. It is certainly not for the faint-hearted.