bitcoin bubble

The first Bitcoin transaction was for two large pizzas. In a post still archived on Bitcoin Forum, early Bitcoin adopter Lazlo Hanyecz offered 10,000 Bitcoins to anyone who would have a pizza delivered to his house. He valued the coins at around $25-$30. While the price of those pizzas has dropped a bit since Bitcoin’s recent peak, at over $77 million per pie, these remain the world’s most expensive pizzas. 1 While many have questioned Hanyecz over the years about whether he regretted the purchase—he’s always answered in the negative and says that the pizzas were delicious—there is a chance that the future will reveal that the pizzas were the wisest use of his coin. 2

What Caused the Bitcoin Bubble?

Bitcoin has gone through bubbles before. The first occurred in 2011, when the price soared from a few cents per coin to a high of $31.91. However, the currency dropped by over 93 percent over the next four months. Prices increased again in 2013, this time reaching over $1,000 per coin. The price again fell, this time to $0 per coin, when investors learned that bots drove the rise and that users could not withdraw their money from the massive MtGox exchange.

This time, the driver behind the steadily increasing price of Bitcoin seems to be simply the steadily increasing price of Bitcoin. A persistent feeling that those who do not act now will miss out continually drives the price higher through speculation. At any time, the tide may turn and investors may feel a need, all at once, to begin collecting their earnings. 3

When Will the Bitcoin Bubble Burst?

Many governments have taken a hands-off approach to Bitcoin so far. However, that policy is not likely to last. China has already begun to crack down on some uses of the currency. 4 With Bitcoin futures now trading on the Chicago Mercantile Exchange and the Chicago Board of Options Exchange, U.S. regulators are likely to take notice and begin issuing rules regarding the currency soon.

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At the time of this writing, enthusiasm for Bitcoin is already beginning to cool: the cryptocurrency is already trading for nearly $3,000 less than its peak price of $17,549.

Futures recently began trading and the prices on the January contract have already dropped significantly: the most recent price is $15,000, 25 percent lower than its $20,000 peak. 5

While there is a chance that the price will stabilize as more mainstream investment vehicles become available, the inherent instability of the currency leaves it perpetually vulnerable to manipulation and bubbles—not to mention insider trading and other scandals.

Why the Bitcoin Bubble Matters

Many investors look at Bitcoin and see opportunities to realize enormous and instantaneous gains. While the opportunity is there, the chances are better that those who engage in speculation will lose more than they win.

Thought leaders like Warren Buffett have long said that Bitcoin can’t be valued because it isn’t a value-producing asset. 6 Additionally, the wide fluctuations in price mean that many retailers will never accept it. Why take a currency that could double or halve in price by the time you close business for the day?

While Bitcoin prices have gone through rises and falls, it’s important to realize that any Bitcoin bubble could burst anytime. Just 1,000 people own about 40 percent of all Bitcoins. Most are early adopters, and it is likely that most know and correspond with one another. Because Bitcoin is not a security, it is perfectly legal for Bitcoin holders to collude with one another to buy up enough of the cryptocurrency to drive up the price and then cash out while it is high. Even with the other issues that plague Bitcoin as an investment, this persistent risk can significantly reduce the currency’s value at any time.

With all of this in mind, smart individuals would not seriously invest in Bitcoin. The potential gains are likely to be more than balanced by sudden and extreme losses.