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Bitcoin: Is a bubble driving up the price?

Courtesy LDP  Audit – Advisory – Tax


Since November 2016, the value of Bitcoin has risen from $800 to over $15 000 at the time of writing. Bitcoin now trades on the Chicago Board Options Exchange and the Chicago Mercantile Exchange. These are futures markets and have contributed to the fast rising price of Bitcoin. As Bitcoin is getting more market acceptance, so the interest in this cryptocurrency has rapidly grown. One of the reasons why the value has grown so rapidly is there can only be twenty-one million Bitcoins in existence. As the price goes up investors hold onto them, anticipating further price increases. The supply shortage further drives up the price.

At some stage, a herd mentality takes over, fueled by greed and the price goes through the roof. In this stampede, no one stops to think – they have to jump in before the price rises even further. With all bubbles, at some point the price defies belief. Once this happens, the losses mount as fast as the price once rose until the asset becomes worthless.

But is it a bubble or not?

The hard fact is that no one knows for sure. If it is a bubble and you invest now, you could lose a fortune. If it isn’t and you don’t invest, you could lose out on a potential fortune.

Hindsight of course is 20/20. But by then it’s too late to do anything about it. The best advice is to be guided not by the herd mentality, but by your own research. If you do invest, the only prudent thing to do is to use money you can afford to lose.

All we can say for sure, is that Bitcoin is starting to exhibit all the characteristics of a bubble and at some stage there is the risk that the price will collapse.

If you are still not convinced, consider what happened to Sir Isaac Newton, an intellectual giant and one of the fathers of modern science. He initially bought into the South Sea Company and as prices rapidly rose, he sensed a bubble and sold out, making a very good profit. But prices continued to rise at a dizzying pace and he reinvested just in time to witness the collapse of the company. Newton was ruined by the South Sea Bubble.

The current situation with Bitcoin does not invalidate the concept of a digital currency which has the potential to do what banks do – be a credible third party between a buyer and seller and guarantee payment when the conditions of the contract are met. The big difference is that cryptocurrency uses blockchain technology and is much cheaper. It’s here to stay.