Part 2: Is the market in a bubble?
Almost every article that discusses cryptocurrencies will inevitably raise the notion that the market is in a bubble which is set to burst at any moment. The reasons for this have been well discussed, but the core proposition is that the huge price rises cannot be sustained and have outstripped the actual usage of blockchain today. The party, it is said, is close to an end.
Cryptocurrencies are a technology in their infancy, and as with any network based proposition, the value of it grows exponentially as more people join the ecosystem. From February 2014 (once prices had already cooled off post Mt Gox) to February 2017 (when the market began to take off) prices increased c. 30%. And yet, in this three year span, daily transactions rose six fold, soaring from c. 50,000 to over 300,000. Ethereum, meanwhile, saw its market capitalisation rise from $200m to $1bn – and yet daily transactions rose from 5,000 to 50,000. Today Bitcoin processes around 400,000 transactions a day, Ethereum in the region of 1.1m, and there are hundreds of other cryptocurrencies that are being used on a daily basis.
Commentators like to focus on why cryptocurrencies are overvalued, rather than looking at if the sector was wholly undervalued coming into 2017. The market in January 2017 stood at $2bn, not much more than it was three years before. The sector had barely moved in three years according to its price – and yet it had dramatically changed.
For one, there were new projects starting to be realised. Rather than mere Bitcoin forks, the market was starting to fill up with exciting new projects that tried to tackle something different. Secondly, developer talent was starting to move into the area. And third, the services around Bitcoin and the other cryptocurrencies were beginning to become more user friendly. Services like Coinbase meant that the average user could actually buy with ease, banks were loosening their restrictions on crypto purchases, and media and public awareness was beginning to grow. This mixture of increasing utility, user friendliness and awareness is deserving of significant price rises.
However, how much is a ‘deserved’ price rise?
The truth is, nobody knows. Cryptocurrencies are a fundamentally new asset class, one that is hard to analyse according to conventional valuation methods. In many ways, Satoshi Nakamoto and early adopters perhaps set the market back price wise by years when Bitcoins were valued at a fraction of a cent initially. Just to get to $1 took price rises of thousands of %. Perhaps if the difficulty of mining had been set harder initially, and thus more energy required to mine with ensuing costs, then Bitcoin and cryptocurrencies may have been valued at a higher amount from an earlier stage (equally, of course, it may have dissuaded anyone from buying them and thus removed the chance of any adoption).
People talk about the space having no intrinsic value – but Bitcoin alone facilitates a global financial network processing (increasingly less so) rapid payments without a third party that can never be shut down by governments. That alone is of value, as demonstrated by the price premiums of Bitcoin in countries where governments can’t be trusted such as Venezuela and Zimbabwe. The power of this idea is not one that is of immediate utility to everyone - but that does not mean it lacks value.
The market remains in one of price discovery, which is why commenters have wildly different price targets which range from $0 to $500,000+. Participants also focus their attention on market capitalisation, which is an imprecise and often unhelpful measure. As an example, although Bitcoin is measured according to its total circulating supply of c. 16.8m, there are millions of coins that have been lost and – just as importantly – the active circulating supply (e.g. that is being traded or used) is far lower than even these estimates. Most people are simply holding their BTC in storage, reducing the supply and therefore driving up demand.
Furthermore, cryptocurrencies attract a global userbase that (as discussed here) are short on ideas or opportunities on where to put their money to work. People make lazy comparisons to the dotcom boom, largely because this is also technology based and because of the shared price appreciation, but this is a global market that has captured the imagination and attention of people across the world.
A revolution does not happen overnight. The hardest part of Bitcoin’s rise was to get through the earliest days, when it was solely the preserve of a niche audience, and get to formal exchanges and widespread mining. Bitcoin and cryptocurrencies represent a different proposition to more consumer facing technology. One could point to Facebook or Twitter and argue that they achieved global domination in mere years, so why can’t Bitcoin? But Facebook and Twitter did not face the same barriers to entry as those of Bitcoin. Facebook and Twitter were not attempting to overhaul hundreds of years of conventional wisdom as to how a money supply should be distributed and operated. They were not threatening a financial system unused to coming across any threat to the status quo. The scope of what cryptocurrencies are trying to achieve idealistically is on a greater scale than any technology since the emergence of the internet which itself took a long time to resemble the internet of today.
We may see a crash tomorrow. Many cryptocurrencies are destined to die out, never to be used on a meaningful scale, and some of the ideas are patently ludicrous. But that does not mean the space as a whole is necessarily in a bubble. People have been calling the cryptocurrency bubble for nigh on a decade now – if anything the space is in the best state it has ever been in. Why should we believe that this is the high point for cryptocurrency prices when the technology is right at the start of its journey?