TechCentralTechCentral
    Facebook Twitter YouTube LinkedIn
    Facebook Twitter LinkedIn YouTube
    TechCentral TechCentral
    NEWSLETTER
    • News

      Floods blamed as gov’t falls behind in set-top box roll-out

      24 June 2022

      Vumacam announces big Jo’burg expansion drive

      24 June 2022

      Eskom crisis spirals: stage-4 power cuts this weekend

      24 June 2022

      Illegal strike at Eskom could make load shedding worse

      24 June 2022

      State capture probe ends but South Africa remains ‘broken’ by corruption

      23 June 2022
    • World

      Amazon has a plan to make Alexa mimic anyone’s voice

      24 June 2022

      Apple, Android phones hacked by Italian spyware

      24 June 2022

      Zendesk nears buyout deal with private equity firms

      24 June 2022

      Crypto crash survivors could become ‘tomorrow’s Amazons’

      23 June 2022

      Tether to launch a stablecoin tied to the British pound

      22 June 2022
    • In-depth

      The great crypto crash: the fallout, and what happens next

      22 June 2022

      Goodbye, Internet Explorer – you really won’t be missed

      19 June 2022

      Oracle’s database dominance threatened by rise of cloud-first rivals

      13 June 2022

      Everything Apple announced at WWDC – in less than 500 words

      7 June 2022

      Sheryl Sandberg’s ad empire leaves a complicated legacy

      2 June 2022
    • Podcasts

      How your organisation can triage its information security risk

      22 June 2022

      Everything PC S01E06 – ‘Apple Silicon’

      15 June 2022

      The youth might just save us

      15 June 2022

      Everything PC S01E05 – ‘Nvidia: The Green Goblin’

      8 June 2022

      Everything PC S01E04 – ‘The story of Intel – part 2’

      1 June 2022
    • Opinion

      Has South Africa’s advertising industry lost its way?

      21 June 2022

      Rob Lith: What Icasa’s spectrum auction means for SA companies

      13 June 2022

      A proposed solution to crypto’s stablecoin problem

      19 May 2022

      From spectrum to roads, why fixing SA’s problems is an uphill battle

      19 April 2022

      How AI is being deployed in the fight against cybercriminals

      8 April 2022
    • Company Hubs
      • 1-grid
      • Altron Document Solutions
      • Amplitude
      • Atvance Intellect
      • Axiz
      • BOATech
      • CallMiner
      • Digital Generation
      • E4
      • ESET
      • Euphoria Telecom
      • IBM
      • Kyocera Document Solutions
      • Microsoft
      • Nutanix
      • One Trust
      • Pinnacle
      • Skybox Security
      • SkyWire
      • Tarsus on Demand
      • Videri Digital
      • Zendesk
    • Sections
      • Banking
      • Broadcasting and Media
      • Cloud computing
      • Consumer electronics
      • Cryptocurrencies
      • Education and skills
      • Energy
      • Fintech
      • Information security
      • Internet and connectivity
      • Internet of Things
      • Investment
      • IT services
      • Motoring and transport
      • Public sector
      • Science
      • Social media
      • Talent and leadership
      • Telecoms
    • Advertise
    TechCentralTechCentral
    Home»Sections»Cryptocurrencies»How low will bitcoin go? History provides some clues

    How low will bitcoin go? History provides some clues

    Cryptocurrencies By The Conversation10 December 2018
    Facebook Twitter LinkedIn WhatsApp Telegram Email

    Nearly 170 years before the invention of bitcoin, the journalist Charles Mackay noted the way whole communities could “fix their minds upon one object and go mad in its pursuit”. Millions of people, he wrote, “become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first”.

    His book Extraordinary Popular Delusions and the Madness of Crowds, published in 1841, identifies a series of speculative bubbles — where people bought and sold objects for increasingly steep prices until suddenly they didn’t. The best-known example he cites is the tulip mania that gripped the Netherlands in the early 17th century. Tulip bulbs soared in value to sell for up to 25 000 florins each (close to R500 000 in today’s money) before their price collapsed.

    The bitcoin bubble surpasses this and all other cases identified by Mackay. It is perhaps the most extreme bubble since the late 19th century. In four years, its price surged almost 2 800%, reaching a peak of US$19 783 in December 2017. It has since fallen by 80%. A month ago, it was trading at more than US$6 000; it is now down to US$3 500.

    To begin to answer this question, we need to understand what creates the values that drive speculative price bubbles

    That’s still a fantastic gain for anyone who bought bitcoin before May 2017, when it was worth less than $2 000, or before May 2016, when it was worth less than $500.

    But will it simply keep dropping? What makes bitcoin worth anything?

    To begin to answer this question, we need to understand what creates the values that drive speculative price bubbles, and then what causes prices to plunge.

    The above chart shows the magnitude of the bitcoin bubble compared with the price movement of Japanese property and dot-com bubble from four years prior to their peak until four years after.

    We typically think about bubbles in financial assets such as stocks or bonds, but they can also occur with physical assets (such as property) or commodities (like tulip bulbs).

    A bubble begins when the price people are willing to pay for something deviates significantly from its “intrinsic value”.

    Theoretical

    The intrinsic value of an asset is theoretical, based its “fundamental” value. Fundamental value includes: the ability to generate cash flow (for example, interest or rental income); scarcity or rarity value (for example, gold or diamonds); and potential use (for example, silver and platinum are used in both jewellery and industrial operations).

    A house may have fundamental value owing to the scarcity of land, its use as a home, or its ability to generate rental income. A tulip (or bitcoin) has none of those things; even the presumed scarcity does not exist when you consider all of the alternative flowers (or cryptocurrencies) available.

    Initially, most investors tend to be cautious and ‘rational’ about a new technology

    A bubble tends to occur after a sustained period of economic growth, when investors’ get used to the price an asset always increasing and credit is easily accessible.

    To these conditions something more must be added for a bubble to form. That is typically a major disruption or innovation, such as the development of a new technology. Think of railways in the 19th century, electricity in the early 20th century and the Internet at the end of the 20th century.

    Initially, most investors tend to be cautious and “rational” about a new technology. For instance, early investment in railways took advantage of limited competition and focusing on profitable routes only. It was gradual and commercially successful.

    This creates higher growth and profitability, leading to positive feedbacks (from greater investment, higher dividend payouts and increased consumer spending), which raises confidence further.

    If conditions allow, this develops into a period the economic historian Charles Kindleberger described as “euphoric”: investors become fixated on the ability to make a profit by selling the asset to a “greater fool” at an even higher price.

    That is, they are attracted not by “fundamental” motives — the benefits from potential cash-flows such as dividend or rental income — but by “speculative” motives: the pursuit of short-term capital gains.

    More speculation

    Higher prices attract a greater number of speculators, pushing prices higher still. Uncertainty around the significance of the new technology allows extreme valuations to be rationalised, although the justifications seem weaker as prices rise further.

    The virtuous cycle of ever-rising prices continues, often fuelled by credit, until there is an event that leads to a pause in price rises. Kindleberger suggests this can be a change in government policy or an unexplained failure of a firm.

    When asset prices stop rising, investors who have borrowed to finance their purchases realise the cost of interest payments on their debt will not be offset by the capital gain to be made by holding onto the asset. So they cut their losses and start to sell the asset. Once the price starts falling, more investors decide to sell.

    Bitcoin’s bubble

    Observers of the cryptocurrency market will find this story familiar. Bitcoin emerged following one of the longest economic expansions in history, with easily accessible credit, and global interest rates at their lowest levels in 5 000 years of civilisation.

    The surge in price attracted speculators into the bitcoin market, helped by intense media attention. There are cases of individuals paying for bitcoin by using credit cards or by remortgaging their homes. The rationale for higher prices became more fantastical, with claims the price could rise to $100 000, despite more sober warnings.

    The possible triggers for a pause in bitcoin price rises included concerns about increased government regulation of crypto-assets and the possible introduction of central bank digital currencies, as well as the large theft of assets and collapse of exchanges that have dogged bitcoin’s short history.

    Going down

    In liquid markets such as stocks (where it is inexpensive to buy and sell assets in large values) the price decline can be steep. In illiquid markets, where assets cannot easily be sold for cash, the fall can be brutal. Examples include the mortgage-backed securities and collateralised debt obligations that led to the global financial crisis.

    Bitcoin is particularly illiquid. This is due to a large number of different bitcoin exchanges competing; often substantial transaction costs, and constraints on the capacity of the blockchain to record transactions.

    The aftermath

    The aftermath of a bursting bubble can be brutal. The stock market crash of 1929 was a prelude to the Great Depression of the 1930s. The collapse in Japanese asset values after 1989 heralded a decade of low growth and deflation. The dot-com crash of 2000/2001 destroyed $8-trillion of wealth.

    The effect of a crash depends the size, ownership and importance of the asset involved. The effect of the tulip crash was limited because tulip speculations involved a relatively small number of people. But sharp declines in property values during 2007 led to the worst financial crisis since the Great Depression.

    The effect of a crash depends the size, ownership and importance of the asset involved

    Bitcoin is more like tulips. The entire market valuation was about $300-billion at the peak. To put this into context, the US stock and housing markets are currently valued more than $30-trillion each. Relatively few investors own the majority — it is estimated that 97% of all Bitcoin are owned by just 4% of users. This suggests the effects on the wider economy of the bitcoin crash should be contained.

    The true value of cryptocurrencies is widely debated. Bitcoin entrepreneurs suggest a much higher price is justified. Others, such as Eugene Fama (a Nobel Prize winner) and Warren Buffett believe it is close to worthless. The Bank of International Settlements has described it as “a combination of a bubble, a Ponzi scheme and an environmental disaster”.

    Obtaining a realistic estimate of bitcoin’s intrinsic value is tricky because it is not an asset that generates a periodic cash flow, such as interest or rental income.

    For such an asset, value ultimately depends on what others are willing to pay for it. This often relates to scarcity.
    This does not provide a positive story for bitcoin. Though the total number of bitcoins is limited, there are many competing, virtually indistinguishable cryptocurrencies (such as ethereum and ripple).

    Bitcoin also fails to meet the criteria of a currency. Its price movements are too volatile to be a unit of account. The transaction capacity of the blockchain is too limited for it to be a medium of exchange. Nor does it appear to be a good store of value.

    Since it produces no income, has limited scarcity value and few people are willing to use bitcoin as currency, it is even possible that bitcoin has no intrinsic value.The Conversation

    • Written by Lee Smales, associate professor of finance, University of Western Australia
    • This article is republished from The Conversation under a Creative Commons licence
    Bitcoin Lee Smales top
    Share. Facebook Twitter LinkedIn WhatsApp Telegram Email
    Previous ArticleMeet the CEO: BitCo’s Jarryd Chatz
    Next Article Google+ suffers another major data leak

    Related Posts

    Floods blamed as gov’t falls behind in set-top box roll-out

    24 June 2022

    Vumacam announces big Jo’burg expansion drive

    24 June 2022

    Eskom crisis spirals: stage-4 power cuts this weekend

    24 June 2022
    Add A Comment

    Comments are closed.

    Promoted

    Watch | Telviva One: adapting to the requirements of business

    24 June 2022

    Huawei P50 now available for pre-order in South Africa

    23 June 2022

    Calabrio paves way for SA’s cloud contact centre WFO journey alongside AWS

    23 June 2022
    Opinion

    Has South Africa’s advertising industry lost its way?

    21 June 2022

    Rob Lith: What Icasa’s spectrum auction means for SA companies

    13 June 2022

    A proposed solution to crypto’s stablecoin problem

    19 May 2022

    Subscribe to Updates

    Get the best South African technology news and analysis delivered to your e-mail inbox every morning.

    © 2009 - 2022 NewsCentral Media

    Type above and press Enter to search. Press Esc to cancel.