Objection No.1 – Bitcoin is in a bubble

Probably the most common objection to investing in cryptocurrencies is that they are in a bubble which is primed to burst.  I’m not going to argue that they aren’t in a bubble, they certainly are.  Financial bubbles are a result of asset classes being tremendously overvalued, which happens in ALL markets in circular motions.

Just before I dive into where I think cryptocurrencies will go, note that I am not a financial advisor and no-one has a crystal ball (apart from me 😉.)

To begin, let’s look at another ‘tech’ related bubble, the .com bubble or the original tech bubble of the early 2000’s.

The Dot com bubble was when investors in the late 90’s poured money into Internet start-ups in the hope that they would become profitable. The internet was a new technology and for good reason many investors got excited about the future of the internet. Investors were piling their money into anything that ended in .com for purely speculative reasons. This is similar in the crypto currency market, where there are hundreds of initial Coin Offerings that provide little real-world value, yet hundreds of millions of dollars are raised in their ICO.

The Dot com bubble eventually burst when the process of ‘Commercialisation’ took place. Commercialisation is just another way of saying when the general public adopted and widely invested in the technology. In the case of the Dot com bubble, it peaked on the 10th March 2000. I personally don’t believe that mass adoption of cryptocurrencies has occurred yet, the barriers to entry have been extremely high and the media do not portray cryptocurrencies as a legitimate investment vehicle (yet).  We’ve had an extreme surge of speculation in the market, especially around the end of 2017 and the beginning of 2018. Which has subsequently led to a ‘crash’ in the market.

It is worth noting that the tech bubble had a total market cap of over 3 trillion USD, and if you take into account inflation this figure would be around 5 Trillion today.  Cryptocurrencies have not even come close to this figure yet, and in this article, I will explain why I believe we will easily see a market cap of at least 5 trillion in the next couple of years.

After the .com rally peaked, it fell by near 80% from the peak of 5,132 points to the low of 1,135 points and then began its next rally. The total market cap for cryptocurrencies has fallen from 833B to just below 250B which is around a 70% decrease, I believe we still have further falling to around the 80% level in a similar fashion to the tech bubble which would be near 150B (Today is the 2nd April 2018 and the market cap is just over 260B).

 

 

*Financial Crisis.

 

Since the peak of the tech bubble, it has increased by more than 2,500 points or an additional 50% since the peak of the bubble.  The point I am trying to make is that even after the tech bubble burst, there was a larger bull market that followed.  This is why you will often hear long term investors in the stock and real estate markets state that they are not concerned about crashes as they are simply part of market cycles.  In order to keep this article short(er), I’m not going to be arguing this statement. Data from various markets tell us a few things…

  1. Assets normally begin by being undervalued
  2. Assets then become ‘fairly’ valued
  3. Assets then become overvalued
  4. Assets crash and move to the long term moving average

You’ve probably seen this chart a few times before, but it is worth highlighting for my argument:

 

 

Both the charts below follow this famous valuation cycle, I believe we are in between the ‘Capitulation’ and ‘Despair’ phase for cryptocurrencies.

The tech bubble has a lot of similarities to the cryptocurrency bubble, if we compare the charts they look almost identical.

 

 

Cryptocurrency bubble                                                 Tech Bubble

  

Purely based on the charts above, it seems as if cryptocurrencies does indeed have further falling to go.

Ok, so cryptocurrencies are in a ‘bubble’ and the bubble is currently bursting?

Yes.

I don’t think anyone can deny this, but as I mentioned before, all asset classes go through cycles and this is the first for cryptocurrencies. Let me explain why I think the next bull rally will make the peak market cap of 850 Billion look tiny and why I think it will happen a lot sooner than expected.

  1. Cryptocurrencies have never been exposed to a financial crisis.

Bitcoin is often referred to as ‘digital gold’ and viewed by many as a store of value.  If this is the definition of Bitcoin adopted by the mainstream investor, then during a financial crisis Bitcoin and other cryptocurrencies should see a massive surge of capital.  Precious metals are often safe havens during market crashes, as investors are looking to protect their worth against high inflation. With Bitcoin’s limited supply, it is deflationary by the very nature of it.  The truth is that no-one knows where mass investors will turn to in the event of a currency or financial crisis.  One theory that many cryptocurrency investors have is that, in the event of a currency collapse, the mass public will switch to cryptocurrencies and class it as acceptable currency.  Whilst this may seem extreme, it is important to remember that people only take action in extreme circumstances.  Events that could cause this movement would be a financial crisis / currency collapse or a mass loss of faith in global monetary policies.

Are cryptocurrencies a safe haven for a currency collapse? Time will tell, I believe the future will be entirely digital currency. It is likely that there will be one globally accepted currency that is build on a blockchain, will it be Bitcoin? I honestly don’t know. I think that it is far more likely that this currency has not been created yet.
I am not going to go in depth as to why I think another financial crisis is near, I’ll save that for another email.

  1. Cryptocurrencies have a tiny overall market cap

850 billion may seem like a huge amount but compared to the 75 Trillion global stock markets and even the 8 trillion market cap for gold, 850B really is a small amount.  This is both good and bad news, good as there is much room to grow but bad because small markets are ripe for manipulation, which we have seen over and over again.  One of the reasons why the market cap is relatively small for cryptocurrencies has been the huge barrier to entry.  When the December demand was at its peak, most well-known exchanges halted accepting new users as they could not handle the traffic. Only a select few exchanges let people invest. One of these exchanges was Coinbase, however Coinbase only lists a few cryptocurrencies. So even then it was limited.  Due to AML and KYC laws, verification for exchanges took weeks and the average person just gave up trying to invest as it was too difficult.  In order for the mass public to invest in cryptocurrencies, it needs to be an extremely simple process. This leads me on to my next point, the barrier to entry is being removed very quickly.  The original crypto exchanges such as Bittrex and Binance have announced that they are introducing Fiat to Crypto trading pairs, this is huge news as both of these exchanges list over 100 altcoins and are very easy to use.  Whilst this expansion was expected, what was not expected was a company that is backed by Goldman Sachs called Circle acquiring a popular exchange called Poloniex. Tell me, why would they buy a cryptocurrency exchange if they thought it was just a fad?  They paid a hefty sum for this exchange too, over $400 Million USD.  The reason why I am mentioning this is because they are developing an app for retail investors to purchase cryptocurrencies. This will lower the entry barrier significantly, and people already trust this ‘established’ company.  The conclusion to be made is that the barriers to entry will get smaller and smaller over the next year, meaning that the market can move higher a lot quicker than the December rally.

  1. Institutional Investors are not yet in

The big boys are coming to play. Unfortunately, funds who manage billions or even millions that want to enter the cryptocurrency market are not going to purchase when the market is clearly in a bull market, so they pay journalists and potentially even hackers to ensure the market cap falls significantly so they can buy. This is classic manipulation and it occurs in every market, because the cryptocurrency market is so small and so reliant on speculation, it is very easy to emotionally control.
Institutional investors are very likely going to enter soon, especially with more regulations on cryptocurrencies.
So yes, you could argue that the cryptocurrency market has ‘burst’ but I would argue that the cycle has simply reset, and next time it will be a lot bigger. As the technology is implemented into businesses globally and as more people become aware of the actual potential of blockchain. The key difference this time is that it will be a lot easier for both retail and institutional investors to invest in cryptocurrencies. Again, there’s a possibility of paper valued markets collapsing. No-one can know when, and equally no-one can predict where people will move their investments to. But a regulated, decentralised and deflationary market certainly sounds attractive on paper – especially in situations of distress.

Thanks for reading this article,

Devin