The emergence of bitcoin as a means of payment system in 2009 changed the nature of monetary system in a drastic way. It received wide acceptance by various business entities and it also emerged as a new investing tool. It is generally agreed that the global financial system is currently expanding at a very high rate. However, the expansion of cryptocurrencies has alarmed various financial experts.
This has provoked critical questions such as: what is bitcoin? What is the value of bitcoin? Is this another bubble? Will bitcoin last in the financial platform?
In order to get the correct answers to these questions, it is important to first understand certain concepts and phenomena. One has to understand the concept of ‘money' so as to know whether bitcoin has reached the threshold for money. In addition to that, one must also understand how crypto currencies operate. These understandings will allow one to assess the validity of bitcoin and its growth in the financial markets.
The main issue discussed in this article is not about the validity of bitcoin. This article gives a critical financial analysis and it later explains whether bitcoin is really a bubble waiting to burst.
Is Bitcoin In A Bubble?
It is important to understand the concept of money and to get familiar with the regulatory institutions. Traditionally, anything that is regarded as a universal medium of exchange is considered to be money. The monetary system has evolved throughout history and various items have been used as money. During antiquity, money evolved from cowrie shells to precious metals like bronze, copper, silver and gold.
The current global economic system uses fiat money; paper money which is backed by precious commodities like gold. Most scholars argue that as time goes by, less value items are used as money and the only thing that gives them value is the confidence of the users. The confidence of the user is usually guaranteed by the central banks. Central banks are charged with the responsibility of regulating the supply of money.
The paper money is printed by central banks and they allows commercial banks to increase money supply within stipulated regulations. The case is quite different when it comes to bitcoin because it is not regulated by central banks at all. In addition to that, the supply of bitcoins is not regulated by standard measures. It is these realities that have evoked the questions of validity.
Fortunately, bitcoin is considered legal in many geographical entities; therefore, there is a growing confidence among its users. The announcement by NASDAQ in November 2017 to launch bitcoin futures in 2018 has further boosted the confidence of the users. Unfortunately, confidence does not answer the big question of the day.
The term “economic bubble” refers to a cycle within the four economic phases where a commodity, stocks or securities escalate rapidly based on positive news about the future. The economy usually has four phases: Expansion (boom/bubble), Peak, Contraction (burst/recession) and Trough.
In an economic bubble phase, the price of the commodity or stocks in question exceeds its fundamental value. It is usually caused by positive speculations which create redundant demand. It is normal for any stock to have a boom and burst phase; therefore, a boom phase does not make a stock or commodity a scam or illegal. These are just phases which reflect supply and demand of the commodity or stock in question.
The rising demand of bitcoin is a result of the acceptance it has received among governments and institutions. It should also be noted that countries like Japan which have legalized bitcoin only acknowledge it as an asset and not as a medium of exchange. This means that bitcoin is not yet a currency; therefore, it is bound to experience the bull and bear phase just like any other financial asset.
Bitcoin has increased from 449 in January 2016 to 18,000 in December, 2017. This has put the bitcoin in a very steep bull phase without any major correction phase. Any investor knows that the market conditions are usually a reflection of supply and demand and whenever there is a lot of demand the supply reduces and vice versa.
The price of an asset is determined by the supply and demand, in the sense that if the supply exceeds the demand, then the price go down and vice versa. In the case of bitcoin, the demand has been increasing ever since 2009 and this suggests that the supply ought to reduce. However, the supply of bitcoin is actually unregulated and depends on computer processes. The demand of bitcoin is actually caused by the underlying fundamentals which are based on acceptance of the crypto currency and speculations regarding its future.
Understanding the cause of the demand of bitcoin can help to determine whether bitcoin is actually a bubble or not. Since bitcoin is only regarded as an asset and not as a currency, it is bound to display certain development behaviors just like any other asset. In addition to that, it should also be noted that bitcoin is also traded in spot market. This means that speculators also determine the price movements of bitcoin.
These aspects openly suggest that bitcoin is within the known economic matrix; it can be subjected to either boom or burst phase by the underlying economic conditions. Therefore, it will be correct to point out that the current phase of the price range of bitcoin can be classified in any of the four economic cycles.
A closer Look at the definitions of the economic cycles show that the only cycle which perfectly fits the description of the current phase of the price range of bitcoin is the boom/bubble cycle. The rapid escalation of the price of bitcoin can be classified as a bubble and just like any other bubble in the history of finance, it is bound to burst.
The above analysis suggests that bitcoin is actually in a bubble phase. However, this does not mean that the bubble will burst tomorrow or in few days to come. The duration of an economic phase cannot be predicted because the variables which determine a business cycle are usually complex.
The price of an asset is usually influenced by mathematical programs as well as the psychology of the players. Therefore, a phase can last for a short period or it can extend for a very long time. The most important thing to note is that bitcoin is in a boom phase and just like any other previous bubble, it will soon burst. The end of the bubble phase will not mark the extinction of bitcoin but will actually mark the beginning of a new economic phase; a burst.