Is Bitcoin a bubble, and what will cause it to burst?
Don’t get me wrong, I wouldn’t mind if I bought some Bitcoin a few years ago to have now. However, the high volatility of the market points to trends that can change within a day, a month, or year, which is a familiar sign of a looming bubble. It seems every decade or so we develop a bubble, and in 2018 it’s the Bitcoin Bubble. The bubble will burst from the inside when some heavy pocket holders start selling off coins. Watchers will view this as a sign of the market and everyone will follow, selling their supply and plunging the market.
In my opinion Bitcoin is a digital bubble, and it’s important to understand why this bubble is different. If it burst yesterday and we looked in retrospect, we’d see it wasn’t easy to hold a short position on Bitcoin. “Short Position” is when an investor anticipates the value of a stock will decrease in the next few days or weeks and in a short sell transaction, the investor borrows the shares of stock from the firm to sell to another investor. The options to short bitcoin are mostly through unregulated exchanges and given bitcoin’s volatility, very risky. When buying stocks for example, you need a minimum investment to open an account. In this bubble, you can buy one “Satoshi” named after Satoshi Nakamoto, the inventor of Bitcoin. A Satoshi is the smallest fraction of a Bitcoin: 0.00000001 BTC, that is, a hundredth of a millionth bitcoin. It hasn’t exactly been a good year for bitcoin given the 10-fold price surge.
Of course, one could argue that all bubbles are digital in nature however, somewhere, someone was holding the papers for it. This is the first bubble where no one holds anything: no financing, funding, or financial backing seen in previous bubbles. Even if past bubbles were indirectly related to the financial markets and funding, in dire times one could raise capital to back it. Other than the desire of having Bitcoin, there are no other similarities to other investments. The only reason to buy Bitcoin is to make more money but other than that, it does not create future value. With Bitcoin, no one will do a round of fundraising to back it up. When stocks crash they may become worthless for a time and other markets may suffer consequences, but if the bitcoin market collapses no other investments will be affected. Some markets associated with Bitcoin where it’s used in trade may generate at best, a trickle effect.
I doubt banks or financial system at large will care because while it may affect wealth distribution in the world, that’s about it. If the public doesn’t use large amounts of savings investing in Bitcoin, the collapse may not have widespread consequences. It isn’t clear where the burst will come from as there are no base facts, market conditions, etc., other than the system itself to estimate odds.
In many ways it’s like a casino, but at least in a casino you can calculate your chances.
Sales will ignite the collapse.
As stated above, the facts here are different than a normal bubble. Bitcoin is unrelated to financial markets, which suggests a lower level of investor sophistication. It’s less likely to be regulated due to lower daily volume where anyone can invest, limit many buyers to short term small transactions and possibly effecting the value. Other investments are more transparent because information is publicly available, and you can see the biggest stakeholders. Bitcoin’s transaction volume is less than 20% of all bitcoins, meaning the biggest digital wallets are not involved in any transactions.
Once one of the bigger digital wallet holders starts exercising their options in Bitcoin(in this case, redeeming Bitcoin in exchange for cash) it may ignite market collapse. This is exemplified by the Winklevoss twins who are likely the largest digital wallet holders in the world. They invested in 2013 with money received in a settlement with Marc Zuckerberg for their involvement in growing Facebook. In April 2013, the brothers claimed they owned nearly 1% of all bitcoin in existence at the time with Bitcoin holdings worth over $1 billion. Which means that as soon as they start selling their options – we will know.
Is it too late to control the enormous resources needed to mine Bitcoin?
The answer is yes. It’s too late and impossible to stop the burst from happening due to the enormous resources needed to “mine” the coin. Bitcoin mining is the process that verifies transactions and adds them to the public ledger (known as the “block chain”), and the means through which new bitcoins are produced. Anyone with access to the internet and hardware can participate in mining Bitcoin.
Bitcoin uses a lot of energy verifying the blocks in the chain. Today its averaging out to 215 kilowatt-hours (KWh) for each Bitcoin transaction, currently averaging 300,000 transactions per day. The average American household consumes 901 KWh per month meaning each Bitcoin transfer is enough energy to run a house and everything in it for a week. This process includes not only electricity, but microchips and other equipment. In 2009 verifying 50 Bitcoins was worth about 15 cents and today, the worth is paid the same for 12.5 Bitcoins ($250,000). If in the past people were mining Bitcoins, it’s because of money. The higher the price, the more incentivized people are to buy electricity itself and convert it to mining Bitcoin. Instead of mining gold, find places where electricity is the cheapest to mine Bitcoin and, since there are no transportation costs it’s the best competition that can be created.
It’s worth asking ourselves hard questions about Bitcoin’s environmental footprint. Bitcoin’s electricity consumption since 2015 has been high compared to conventional digital payment methods due the price of Bitcoin being directly related to the amount of electricity that can be used to mine it. As the price rises miners add more computing power to chase new Bitcoins and transaction fees making it impossible to know exactly how much electricity the Bitcoin network uses. Its estimated the minimum energy Bitcoin may be using worldwide if all miners are running the most efficient hardware could power 821,940 average American homes.
How do we get out? How do we stop it from happening?
The bad news is right now there’s no way that we can stop the bubble, nor can we stem the energy resources used to mine Bitcoin. Even if Bitcoin will be worth $100,000 and the cost of resources to mining it will reach tens of billions per year. The good news is that this wild ride may be over by 2032 when the cap for Bitcoins production is reached When Bitcoin was first invented and issued, mining Bitcoin was designed so that by the year of 2032 we will reach the cap of 21 million Bitcoin issued. From that point on the compensation will be based on the commissions on trading in it. Maybe if all the coins were issued in the beginning or shorter time frame we could at least have realistic speculation – but we could have saved enormous amount of energy resources.
Will it stop earlier than 2032?
Without international concentrated effort of governments, I don’t see how. The Bitcoin pioneers and advocators offer ways to get out of this complicated energetic problem first by changing Bitcoin’s protocol. The mining companies will have to support moving the a less expensive system, which is unlikely consider they are probably way too invested in current systems.
Another solution is to create competition in an additional form of virtual coin that doesn’t need resources that Bitcoin requires. People will understand the ability to conserve resources and increase sustainability, realize that other form of currency is better and move to using that. Clearly, this solution is not well liked by the mining companies and those who count on revenue from Bitcoin.
In conclusion, in my opinion Bitcoin is here to stay. The bubble will probably grow, and burst, but eventually will even out on a much lower value.