People have been predicting the death of Bitcoin for a long time now, prior to its meteoric rise, and especially during the ensuing collapse. The monster is far from dead now.
Comparing Bitcoin to the Dutch tulip craze of the 16th century, Tulip Mania as it is known as, might have held some weight at one time. It went up like the tulips did, and both dropped like a rock once the frenzy subsided.
There are some other noteworthy similarities as well. Tulips weren’t worth anything close to the price that they sold at during this time, deriving almost all of their excess value from the market itself, what people were willing to pay for them versus their market value. Bitcoin derives all of its value from these forces, as its sole value resides in what people are willing to pay for them.
There are a lot of people who don’t really grasp market value though, and this confusion doesn’t just show its face with things like 16th century tulips or 21st century digital currencies, it extends to every sort of investment.
People pay millions of dollars for certain paintings which at most would be worth a few dollars, the cost of the materials and paying someone to paint them, and we might even argue that we could find a more skilled painter who could produce something even more appealing for a tiny fraction of the cost.
Some paintings command prices in the tens and even hundreds of millions of dollars, with one going for as high as $300 million. This is what you call an extreme valuation if there ever was one, but this is what happens when extremely wealthy people fight it out in auctions with the only limitation on value being how much of one’s wealth that one is prepared to part with to obtain such a thing.
The problem with the tulip craze is that these exact goods could be produced quite cheaply, and this price surge occurred partly due to the fact that tulips were imported from abroad back then, and therefore the supply was quite contained for a time at least.
The supply of paintings that people would consider spending millions of dollars for is extremely constrained, and in the case of a single one that is desired by many people, this really allows demand free reign. There are no intrinsic limitations on it at all in fact because there aren’t any more copies of it.
Bitcoin’s market is also constrained, as there is a fixed amount of them that are possible, and that makes demand rule the market much more than it would if a good could be manufactured or even mined as gold is.
Gold also derives its value from a combination of limited supply and a lot of demand, and as demand waxes and wanes, its price follows. There is a little supply that is added each year but not enough to influence its price very much, and therefore, price change is almost all a function of demand.
It Is All About Expectations, and Bitcoin’s Are Far Less Limited
When we use the word craze or a similar term to describe Bitcoin popularity, it’s important to realize that this does not involve a crazy model but just uses the good old supply and demand model that we use in economics for everything. Bitcoin, which doesn’t even exist apart from the digital realm, making it a fiction of sorts, might not seem to have any real value at all, but the value that the market places upon it by way of what it is trading at is very real.
Could it be crazy to have people pay $13,000 for one Bitcoin, a unit of value which is just something on a ledger and does not even have a corresponding component in the real world? Should we worry that since this does not have any “real” value that we have lost our minds and are just setting us up to get creamed like those poor Dutch who lost a lot of money with speculating on tulips?
The tulip craze just wasn’t durable, and that was actually the only real thing wrong with this model. At some point, it becomes profitable to just grow some more and this adds to the supply, and supply and demand will be driven toward a much lower equilibrium, such as we have with the tulip market today.
Bitcoin, on the other hand, cannot have its supply manipulated like this and doesn’t even have a competitive good in the real world, since it doesn’t even exist in this world. We might want to say that other cryptocurrencies provide competition, but these are also goods that are purely intangible and have their supplies fixed, and while it’s possible to see a cryptocurrency wither due to neglect, Bitcoin is the king of them and is too popular among them to see this happen.
Whenever we speculate on something, whether that be with Bitcoin, a stock, a property, a futures contract, currency, or what have you, the intention is to hold it while its market value increases and hopefully turn a profit. Market value is always subject to the forces of supply and demand because that’s what sets prices, period.
If you pay a million dollars or any amount of money for a Bitcoin, you are doing so expecting that people will pay even more for it later and you’ll cash in then. If there are no real limitations to how much people will pay other than just their future expectations, this can create some big-time momentum indeed.
Unlike a painting, Bitcoin is divisible to the degree that even very small investors can get in on it by buying whatever portion of one they can afford. This is not true with any physical asset and it is because Bitcoin is merely theoretical, but theoretical things can be worth a lot of money as we are seeing. The phenomenon of increasing prices constraining demand, where less can afford it as it moves up, simply is not present with Bitcoin and this in itself is a powerful influence.
Bitcoin reached the $20,000 area during its famous explosion not all that long ago, and the reason why it fell from this point is that this was the area that the speculation of it going higher was exceeded by the expectation of it going lower.
This is what happens with stocks as well, not in a similar manner but an exact one, and the great majority of investors do not understand this and could certainly benefit by paying attention to what actually moves stock prices, which is the competition between these speculative forces.
Unless there is a mechanism for arbitrage with something, which provides a price floor that will hold up price independent of demand, the only thing that influences the price of something is its speculative forces, what people are willing to buy and sell it for and what they think about where it is going based upon that. Bitcoin is all about speculation, but so is everything, and the difference is that people’s beliefs about Bitcoin are not so constrained. This belief manifest as such beliefs always do, but this is a much more unchained dream.
There is Still Room to Grow from Here
Since Bitcoin broke new ground all the way up, no one knew just how far it would go, but there are indeed limits on this, which consist of the area where people become concerned enough about the prospects of it going down and cause the very thing that they are afraid of to materialize.
People thinking about it going up is what caused it to go up in the first place, and these two forces, the positive and negative outlooks, are the ones that battle it out in the markets of everything every day. We could call these forces hope on the upside and fear on the downside. One side may move ahead, and the other side may end up taking over for a while, and we can view this battle from different perspectives to see where trends of varying lengths may be pointed.
The key point to understand with all this is that these forces, beliefs that something will go up or down we could call them, aren’t just valid in terms of the valuation of an asset, they are actually central to it. Anyone who claims that the movement in Bitcoin either then or now is somehow vacuous or less real than other investments suffer from a fundamental understanding of how all these things work because everything works this way, even though it happens to Bitcoin on a much grander scale.
For those who thought that Bitcoin’s day in the sun was over for good, and that it would just keep sinking until it reached what they felt was its equilibrium with its price and tangible value, in other words worth nothing, have hopefully learned a lesson with Bitcoin’s resurgence.
Bitcoin is back and with a vengeance, and has been on a nice run this year. A nice year for Bitcoin isn’t your pedestrian 20%, or even 100%, as it’s up 239% in just half a year. It is up 76% in just the last 2 ½ weeks. It can deliver what most investors would be happy as an annual return in a matter of days.
What goes up this fast can also go down this fast as well, so this requires much more care and attention than anything else in the history of the world. If we have the daring to get in on something that moves like this, we’re going to have to be both wise and nimble.
The good news is that this time, we’re on a path that has already been traveled, and won’t break new ground until Bitcoin gets above $20,000. As far as the risk side goes, we know how quickly this can turn, but it really doesn’t move that far in a day and as long as we are paying attention and have the will to act when we need to, this isn’t as risky as many hold it to be.
Even investments that operate at such an incredible speed can still be managed well, because this still happens rather gradually, although nothing like the graduations of other assets. Perhaps a single bad day will tell enough of a story to have us wanting to exit, but there will be a threshold and there will be time to decide.
In our previous articles on Bitcoin earlier this year, we told you that it may have found its bottom and is poised to make another run for it. This has certainly come true and perhaps well beyond the expectations of most people, but the key is that you need to understand that this is a pure momentum play and the potential for momentum with this is simply unsurpassed, and we’re seeing this play out again.
No one really knows when this ride will end, other than it isn’t ending now, and when something is on fire like this, we will know when the fire isn’t burning with the same intensity and we may have saturated it once again.
The real risk of highly volatile assets isn’t the upward volatility, it’s the downward blowups it can suffer. As long as it is moving the right way, and especially when it’s moving so fast, taking a ride on a train like this can be a most pleasant and profitable journey, just as long as we know when to jump off.