Cryptocurrencies: Interesting concept, but the bubble will burst
Decentralized, democratic, tamper-proof global accounting systems on which no governments or financial institutions can arbitrate fees, value, or supply? You can almost hear the satisfied nods of approval from libertarians everywhere. However, current iterations of cryptocurrencies carry the hallmarks of what Nouriel Roubini (the economist who predicted the 2008 financial crisis to a T) calls the “mother of all bubbles,” and they will crash sooner rather than later. Here’s why:
The value of cryptocurrencies
As the idea of an economic “bubble” refers to situations when the price of an asset far surpasses its fundamental value, it’s easy to see why the term would be applied to cryptocurrencies. Bitcoin, for example, just dropped to around $8,000, and even that is less than half its December 2017 peak value.
The intrinsic value of cryptocurrencies is pretty much tied up in their utility as media of exchange. Given their mass rejection by most of the top S&P 500 tech companies and that no nations have adopted them (unsurprising, as corporations and governments are exactly the groups that the success of cryptocurrencies would undermine), let’s just say they have an uphill battle to stay relevant. Cryptocurrencies in their current state will, in all likelihood, vanish before they can topple any banking systems, as they show every indication of being in full-blown bubbledom.
The stages of a bubble
Bubbles share the same general pattern, as economist Hyman P. Minsky identified in his 1986 book, “Stabilizing an Unstable Economy”: displacement, boom, euphoria, profit-taking, and panic. Cryptocurrencies have gone through four of those phases.
1.Displacement: Investors go in full throttle on a new paradigm (like technological innovation–think Dotcom Boom. Or cryptocurrencies).
2.Boom: Initially, prices increase slowly, then gather momentum as more people get involved. Media attention spikes, bringing FOMO to more participants and causing more speculation. (This should sound familiar.)
3.Euphoria: Asset prices go through the roof, caution goes out the window, and the “greater fool” theory takes everyone’s reins. During this phase, new metrics and theories are presented as justification for the rise in asset prices. (This should sound familiar, too.)
4.Profit Taking: The savvy players get out while they’re ahead, everyone else holds out for the next big peak. (This is around where we are now.)
5.Panic: Asset prices collapse as quickly as they shot up, investors sell at any price, and supply far outpaces demand.
This is not to undercut the blockchain technology that makes cryptocurrencies possible, but rather to illustrate that the technology and concept will not ultimately achieve much this time around. There are, of course, plenty of case studies of bubbles other than cryptocurrencies that illustrate these five steps. Recognizing bubbles in hindsight is super easy and not very helpful, except to inform us what they look like for when we’re experiencing another one.
I’m going out on a limb and asserting that the vast majority of cryptocurrency investors are, ironically, capitalists to the core, and have no faith in actual cryptocurrencies. They have faith in the convulsive dollar amount associated with them. Once the dollar value declines enough, the panic will begin. You can’t have a decentralized form of currency if it’s inextricably tied to the value of the primary centralized currency of the world. It’s like bringing a kickball to a baseball diamond and telling everyone you’ve invented an entirely new game. Take that kickball to a desert with no infrastructure and make up your own game.
The real value that cryptocurrency brings to the table lies in the technology it sits on top of. Read more about blockchain technology here.
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