We know money – those coins and paper notes and those account balances we see when we log into our bank or brokerage accounts. And we know how to use it. You want chocolate? You take those dollar bills in your wallet down to the supermarket and exchange them for that piece of chocolate. You get the chocolate and the supermarket gets your money. The supermarket than uses those dollars and replenishes the stock of chocolate by giving some to the chocolate manufacturer while keeping some as profits. The manufacturer than takes those dollar bills and pays the supplier of all the good stuff that makes up that fantastic product that you consume pretty much every hour. So we see how money works. But why would a supermarket be willing to accept paper (those dollars) and exchange them for something physical and real (chocolate)? Because the people of a country that issues that currency have collectively decided to put their trust in that currency and consider it to be a safe and secured medium for exchange. Those dollar bills for example are backed by the full faith and credit of the United States government. So those dollar bills are backed by the perceived strength of the United States as a country. And so are the currencies of the other major economies around the world.
But now we have bitcoin, a crypto-currency first brought about by Satoshi Nakamoto, an alias used by someone nobody knows about but now this pseudo-currency is being looked at as an alternative to a government issued paper as a medium of exchange. Or so is the hope. The underlying technology (blockchain) though on which bitcoin is based is extremely fascinating and promising and regardless of what happens to bitcoin, is here to stay and will likely revolutionize many aspects of the transaction economy. But why is everyone talking about bitcoin? Because everyone is enthralled by what the price of bitcoin has done just this year (up 300%). And had you invested a few hundred dollars when it first appeared on the scene, you would be a zillionaire now.
And if you are not familiar with how crypto-currencies work, you buy them with the currency of your choice like by exchanging US dollars and based on what the current trading price of bitcoin is, those dollars convert to x number of bitcoins. Now that’s the basics of it. But what’s been going on lately is that the price of bitcoin is going through some extraordinary cycles of volatility based on speculators bidding its price up and then down and then up. Real money is not supposed to do that. I read somewhere that there is this finite quantity of bitcoin that will ever be mined so there is this supply-demand imbalance at work causing the price of bitcoins to fluctuate like crazy. But who knows.
So is there a mania with the price of bitcoins? I am not smart enough to say that but just look at this price chart below.
Can you spot a bubble? Maybe I can’t but let’s go back in time and look at what happened to the price of tulip bulbs in 17th century Holland, a mania that almost took down that economy once that bubble burst. If you have not heard or read about the Tulip mania, this excerpt from this Investopedia piece should give you a feeler…
“The true bulb buyers (the garden centers of the past) began to fill up inventories for the growing season, depleting the supply further and increasing scarcity and demand. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs. Many Dutch persisted in believing they would sell their hoard to hapless and unenlightened foreigners, thereby reaping enormous profits. Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value – in one month!”
“Needless to say, the prices were not an accurate reflection of the value of a tulip bulb. As it happens in many speculative bubbles, some prudent people decided to sell and crystallize their profits. A domino effect of progressively lower and lower prices took place as everyone tried to sell while not many were buying. The price began to dive, causing people to panic and sell regardless of losses.”
Look familiar? What about the stock price chart of the South Sea Company? Was that a bubble?
Or what about Japanese asset prices in the 80’s? A qualified bubble for sure.
Or the US stock market in the 1920’s.
Or the Dot-com bubble of the late 1990’s or the real estate bubble of the 2000’s or the many bubbles in asset prices across the globe that don’t even register because they don’t affect a big enough swath of the global economy. Bubbles have existed in the past and bubbles will exist in the future because it’s us. We human beings are prone to irrational herd type behavior especially where profits and quick riches are involved.
Back to bitcoin, the bigger problem now is that the “success” of this pseudo-currency and all the publicity surrounding it has led to a variety of “me too” Initial Coin Offerings or ICOs here and elsewhere around the world where promoters dream up a fake new currency. I can create one if I want and call it fitcoin and tell you that fitcoin’s value will go all the way into the stratosphere but you can get in on the ground floor through this ICO by buying them for so many cents for each fitcoin. And guess what, within a year you will be a quadzillionaire. And that is the hysteria and the promise and the hype that is feeding this phenomenon worldwide. The danger as it is with all manias is that eventually they collapse. These are in many ways not any different than Ponzi schemes. I am not saying that bitcoin is a Ponzi scheme but the general thrust of what’s going on with the ICOs is at the very least a bubble but much more likely a Ponzi situation. And these manias get people excited who want to turn small amounts of money into huge wealth without doing anything other than being on the “ground floor”.
Again, I am not saying bitcoin or Ethereum or fitcoin or whatever new coin is in vogue today is a bubble but you have seen the data and you can be the judge.
So if I had issued fitcoin as a new currency, it would of course be bogus. It might look good for a while but then it would crash down to earth. And anybody who made money on fitcoins would be getting ill-gotten gains off the backs of other people. Think about that when a friend or a neighbor or someone at work, someone at church starts pitching you on the latest and greatest ICO. Your only job would be to run, run the other way.
Image credit: Basheer Tome, Flickr