Bitcoin’s far from a bubble and here’s proof why

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Six months ago, a particularly brazen professor from Boston University veered from the herd to predict bitcoin would lose 99 percent of its value and fall below $10 by the end of June 2014. Well, it’s June 1 and bitcoin prices are hovering around $640. That prompted Coindesk to reach out to Williams for comment:

“In contrast to the Winkelvoss twins that prognosticated that Bitcoin would rise to a mind boggling price of $40,000, I am confident that the true value of Bitcoin is closer to my estimate than theirs.”

“I am not alone in the view that bitcoin is in a hyper bubble that will eventually pop,” Williams goes on to say. While I don’t agree that bitcoin’s currently in a bubble, I do believe it could evolve into a bubble one day. I expect bitcoin prices to be much higher than they currently are, though, before I’d concede we’re in a bubble.

Still, it’s helpful to look at the bears arguments against bitcoin so you’re not blindly investing in a commodity that’s set to crash.

First, let’s define a market bubble:

The over expansion of a market due primarily to excessive buyer confidence resulting in inflated values.

If anything, I’d say the bitcoin community has suffered from a lack of confidence. After prices spiked higher in December, they quickly collapsed to $400 on news of a clampdown in China. It’s taken six months for prices to climb back to half of what they were at the start of the year.

Hofstra University’s Dr. Jean-Paul Rodrigue has a helpful chart that shows the stages in a market bubble:

On his website, Rodrigue details the key characteristics of each stage in a bubble. To summarize:

  1. Stealth. Those who understand the new fundamentals realize an emerging opportunity for substantial future appreciation, but at a risk since their assumptions are so far unproven. So the “smart money” gets invested in the asset class, often quietly and cautiously. This category of investor tends to have better access to information and a higher capacity to understand the wider economic context that would trigger asset inflation. Prices gradually increase, but often completely unnoticed by the general population.
  2. Awareness. Many investors start to notice the momentum, bringing additional money in and pushing prices higher.
  3. Mania. Everyone is noticing that prices are going up and the public jumps in for this “investment opportunity of a lifetime”. The expectations about future appreciation becomes a “no brainer” and a linear inference mentality sets in; future prices are an extrapolation of past price appreciation, which of course goes against any conventional wisdom.
  4. Blow-off. A moment of epiphany (a trigger) arrives and everyone roughly at the same time realize that the situation has changed. Many try to unload their assets, but takers are few; everyone is expecting further price declines. Prices plummet at a rate much faster than the one that inflated the bubble. Many over-leveraged asset owners go bankrupt, triggering additional waves of sales.

If we can even say that bitcoin has reached any of the stages above, we’re in the “awareness” stage. As Rodrigue notes, a “mania,” which is the key characteristic of a bubble, requires that the general public get involved in bitcoin. Living in Ohio, I’m yet to meet a single other person who owns bitcoin, litecoin or any other cryptocurrency.

When you’re immersed in a community, it’s easy to slip into a trap where you think everyone else knows about it, too. I can assure you that’s not the case with bitcoin. Some of the most tech savvy people I know couldn’t tell you anything about bitcoin beyond the fact that it’s a digital currency. Once those friends and less tech-savvy buyers move into the space, then we’ll be at danger of being in a bubble.

My guess? We’re finally recovering from the first big sell-off detailed in Rodrigue’s chart. If a bubble (or “mania”) is on the way, it’s in front of us, not in the rear-view mirror.

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