Recently my friends have been asking me about Bitcoin. The truth is that I don’t know anything about it, but I can tell you one thing, it does look like a bubble.
Thinking about Bitcoin made me think about the South Sea Bubble of 1720.
The South Sea Bubble of 1720
In 1711 the South Sea Company was founded. Due to its political connections, the company won a monopoly to trade with the Spanish colonies in South America.
The promoters of the company told the investors that South Americans were waiting in its shores with pots of gold to be exchanged for British textiles. After a few exploratory trips the imagination of the investors went wild, even the promoters of the stock started believing their own story.
On January 1720 the stock was worth 128£. On August it was worth 1,050£. That’s a rise of 750% in just a few months, in December it had collapsed back to 124£ and shortly after the company was closed.
On 2008 the cryptocurrency Bitcoin was created. It is supposed to be a peer-to-peer network where people can accept payments from this form of currency.
I am not going to argue for or against the merits of the currency, all I want to point out is that most people are buying Bitcoin not as a currency, they are buying it because other people are buying it and the end goal is to sell it to someone else. In short, the business plan is to buy it with the hope of finding another sucker who will buy it at a higher price. None of the current buyers are buying Bitcoin in order to pay for their groceries at the supermarket.
So far, since the creation, Bitcoin’s has grown more the 300% per year. To put it in perspective. Think of Warren Buffet, the richest investor in the world. He made his fortune by growing his investments at a rate of 20% per year. If we believe in the Bitcoin speculation craze, we all will be richer than Warren Buffett in less than 5 years. At a given moment we have to put our imagination on check and come back to reality.
Here are some amazing facts:
April 2010. 1 bitcoin = $0.003 US
July 2017. 1 bitcoin = $2,500 US
Five Steps of a Bubble
Economist Hyman Minsky says that a bubble has five stages: displacement, boom, euphoria, profit taking and panic.
- Displacement. Investors discover a new way of doing something, a new technology, a new paradigm.
- Boom. Prices start creeping upwards, but quickly gain momentum as people start spreading the news.
- Euphoria. People jump into the investment out of fear of missing out. Buy now and do due diligence later.
- Profit taking. At this time, some people realize that prices will not continue going up for ever and start cashing out their investments.
- Panic. As more and more people start cashing out, the rest of the people realize that current prices or growth rate is unsustainable and every one tries to get out before the next person creating a sudden drop in prices.
It is my believe that Bitcoin has all the characteristics of a bubble.
- Displacement. Bitcoin is a new way to transfer wealth from one person to the other. Its blockchain technology is a revolution in the way people do transactions. There is a permanent record of a transactions without the help of attorneys, notaries, nor bankers.
- Boom. Prices started creeping up slowly and accelerated as the news spread.
- Euphoria. Now, everywhere I go, people ask me about Bitcoin, everyone wants in. They don’t really understand it but hell, if everyone is making money, why not?
- Profit taking. Eventually some players will say to themselves: “Hey I am happy with 100% or 200% return on my money, I will take this dollars home. As some smart players take their profit other will follow.
- Panic. Some people will see the smart money leaving and they too will try to cash out at the peak. People will be in a hurry to sell to the next idiot, but the supply of idiots will run out.
Time will tell. The only thing that I can tell you for sure is that the past growth rate is impossible to sustain.