Is Bitcoin a Bubble?

What is a bubble, exactly?

The phrase, “Bitcoin is a bubble” gets thrown around quite a bit these days. In fact, it’s an argument that detractors have been hurling at Bitcoin for over a decade. However, if we are to ever come to an agreement about whether Bitcoin is a bubble, it would help to have a clear definition of what it means for a financial asset to be a “bubble.”

There are numerous examples of bubbles throughout history. However, they all display three main characteristics: 

1. They have a single boom/bust cycle
2. They are relatively short in duration
3. The price crashes to zero, or to the pre-bubble level, when they pop

The trend of a typical bubble looks like the chart below:

So, what are some classic examples of bubbles throughout history? Let’s start with the bubble that you will most likely hear about first when confronted with the “Bitcoin is a bubble” argument: The Tulip Bubble.

Tulip Mania  

The Tulip Bubble, sometimes called Tulip Mania, began in November of 1636 and lasted roughly 6 months. By February of 1637 prices had risen by 20x before crashing all the way back to the November levels in May of 1637. This was a single cycle for tulips. 

Let’s take a look at what this bubble looks like on a graph:

Further Historical Examples of Bubbles

The Tulip Bubble is the most common weapon in the Bitcoin bubble advocate’s arsenal. However, in the many examples of bubbles occurring afterwards, the picture remains the same: single cycle, relatively short, and a crash to baseline. The table below outlines just a few of these bubbles and their characteristics (bubbles in real estate tend to be longer than bubbles in other asset classes, as you’ll see below): 

What do these bubbles look like when we chart their life cycle?

Is Bitcoin a Bubble?

If the argument is that Bitcoin is nothing more than an asset that is itself a massive bubble, then it would be unlike any other bubble we have ever witnessed before. Bitcoin has been going strong for more than 15 years now. It may be possible that a bubble could last over 15 years. However, that seems highly unlikely and would warrant sufficient justification by anybody making such a claim as to how it is that Bitcoin has pulled this off.

In addition to this, Bitcoin has had numerous boom/bust cycles in its history, four of them thus far. In each of those cycles, Bitcoin’s price has dropped by more than 75%. No other bubble in human history has ever played out this way. Even more important, in each of the boom/bust cycles that Bitcoin has gone through, its price has never crashed down to zero, or even close to the prior baseline for that matter. 

• In 2011, Bitcoin’s price dropped 94% when it went from $32 per bitcoin to $2 per bitcoin. However, $2 was still 40x higher than Bitcoin’s price before the first price cycle began.
• In 2014, the price dropped 93% when it went from $1,200 to $92. However, $92 was still 46x higher than the $2 price before the cycle started.
• In 2018, the price dropped 84% when it went from $19,000 to $3,200. However, $3,200 was still 35x higher than the $92 previous low.
• In 2022, the price dropped 78% when it went from $69,000 to $15,500. However, this was still 5x higher than the $3,200 previous low.

Below is a chart of all the cycles mentioned above to help drive the point home:

Therefore, to claim Bitcoin is a massive bubble, one would need to answer a very important question. What is so different about this particular asset that it can sustain such a long-term price rally with numerous boom/bust cycles while no other bubble in history could?

What IS Bitcoin Doing, Then?

What, then, explains Bitcoin’s seemingly erratic and volatile behavior?

Well, we have seen similar behavior before in other financial assets. Bitcoin is behaving totally normal for an asset that has a very high growth trajectory and very high underlying value. Just a few examples you may be aware of: 

• Facebook - Stock price has corrected by more than 40% at least three times; the largest of these being just over 74%.
• Apple - Stock price has corrected by more than 75% three different times.
• Amazon - Stock price has corrected by more than 50% at least four times; the largest of these being just over 94%.
• Nvidia - Stock price has corrected by over 67% at least four times, two of which were corrections of more than 85%. 
• Tesla - Stock price has corrected by 50% or more at least three times.
• Microsoft - Stock price has corrected by over 50% at least two times.
• Netflix - Stock price has corrected by more than 70% three times.

Even stock indexes and precious metals tend to behave this way. For example, the Dow Jones Industrial Average has corrected by more than 45% at least three times in its history, with the largest correction being 86%. The Nasdaq Composite Index has corrected by at least 35% three times, with the largest correction being 78%. Gold has gone through two price corrections greater than 44% while silver has gone through three corrections over 46% with one of those being as high as 90%!

There is no big mystery as to why these stocks, indexes, or precious metals act in this way. They go through these price patterns because the marketplace is trying to figure out how big of a deal each of them is, and how effectively the marketplace thinks that each company or technology or precious metal might be able to capitalize on that industry. All of them create uncertainties in the marketplace as to what their true value is. 

To demonstrate this point, let’s conduct a thought experiment where we go back to the very early days of the internet, before Google or other search engines began popping up on the scene. How big of a deal would you have guessed Google would be? How much value would you have placed on a search engine at that time? What about an online marketplace, like Amazon? How big of an idea was that? Would Apple’s iPhone be a big deal, or a really, really big deal? And what about Facebook? How important would social media turn out to be? These questions are incredibly hard to answer and take years for events to play out before we truly know the answers. In the meantime, though, prices of these assets can be volatile.  

The common ground with all of these assets is that each has an underlying value which ensures that, even after plummeting in price, often many times, their price will still continue to rise over time.

And so, if Bitcoin is a bubble, then it’s a very, very strange bubble that doesn’t act like any bubble we’ve ever seen. Although, if it’s an asset with an underlying and very high fundamental value, then it’s behaving exactly as you would expect - exactly like hundreds of other high-value assets have behaved throughout history. It’s either a mysterious, new kind of bubble, or simply another instance of a valuable asset that the market is working to price.

What is Bitcoin's Underlying Value?

We have thus far presented arguments showing how Bitcoin’s price action does not conform to that of other financial bubbles throughout history. However, at the heart of the argument that Bitcoin is a bubble lies the belief that it has no real fundamental value and, therefore, its price action is nothing more than speculation. After all, unlike gold, Bitcoin isn’t physical. You can’t build anything with it or use it in any type of production process. So it certainly seems very odd that something like this could be worth as much as Bitcoin is trading for today.

It’s important to point out that all value is subjective, and what one person finds valuable another may find rather useless. However, the fact that some people see no value in a good does not mean that good has no value to somebody else. That being said, this is certainly an important point and one that requires further discussion.

We argue that Bitcoin has four main properties that make it very valuable.

1. It is a medium for exchange
2. It is decentralized
3. It is secure
4. It is limited

Let’s look at all of these in a little more detail 

Medium for Exchange

By “medium for exchange” we don’t necessarily mean that it is used as a currency everywhere. This is obviously not true… yet. What we mean is that Bitcoin is a medium (a platform, a protocol, a network) that allows any two people anywhere in the world to exchange value. And the way it brokers this exchange is unlike anything else. Having a universal, borderless, and worldwide platform for the exchange of value is very valuable.

Decentralized

The Bitcoin network is made up of tens of thousands of nodes. Each of these nodes contains a full copy of every single transaction that has ever occurred on the network, and they ensure that the network remains decentralized, without a single point of failure. They allow the network to irrevocably process transactions between any two parties without counterparty risk or governmental approval. This type of decentralization allows Bitcoin to be an international medium for exchange that is permissionless, censorship-resistant, and confiscation-resistant.

Every other monetary network (USD, Yuan, EUR) is centralized and relatively provincial. You can exchange value between these networks, but it requires each jurisdiction’s explicit or implicit approval, and the transaction must pass through innumerable counterparties, each capable of terminating it and/or charging fees. In this way, these networks are not really a neutral medium for exchange. 

While most exchanges of value between centralized monetary networks do end up going through, they can be very costly, time consuming, and uncertain. Some exchanges are simply impossible under these networks. You cannot send $1 billion from an account in China to an account in the US in 10 minutes with final settlement, even if you could get the transaction approved. And worse, if you come under suspicion from the political establishment that controls that network, you could even lose your ability to transact entirely. As an example, truckers who protested Covid restrictions in Canada several years ago had their bank accounts frozen. And Russia had its USD reserves seized and used for Ukraine aid. This is not stating any kind of political opinion on the Canadian trucker protests or the Russian/Ukraine war. The point here is strictly to point out that the country that controls the monetary network you transact in fully controls the value you have stored in that network. This is not the case with a decentralized network like Bitcoin. And that is a highly valuable attribute to have in the digital age.

Secure

It’s beyond the scope of this discussion to go into too much detail about Bitcoin’s security model. But, for our purposes, suffice it to say that it is essentially as hard to hack a Bitcoin transaction as it would be to shut down the internet - the entire internet - because unless you can take control of over half the nodes on the network, the rest will continue to add blocks to the chain in a way that can’t be undone. Compare the difficulty here with hacking a transaction on our existing monetary networks. Each government-run monetary network depends on the interaction between the security model of multiple banking jurisdictions and fiefdoms.

But Bitcoin is not just secure from hackers. It’s secure from some of the largest bad actors of all - governments. When you hold your funds in a government’s currency, it’s trivial for them to confiscate them. However, it is near impossible for a government (or anyone) to confiscate your Bitcoin if it is properly secured. And before becoming too dismissive of this very important point about governments being bad actors, let’s first look at the big picture. You may trust your government officials or, at the very least, not consider them to be acting in bad faith. But what about somebody living in Russia, China, or even Brazil? What would you think if you were a member of the Canadian trucker convoy who had their bank accounts frozen? And if you are American, before hand-waving away nefarious financial acts by your leaders, remember that in 1933 the US federal government forced all US citizens to hand over their gold or face 10 years in prison! A perfect example of how, when faced with a large enough crisis, almost any government can turn adversarial.

If you can think of a government that you don’t trust, we can show you a large group of people who have their entire life’s savings fully dependent on that government’s monetary network. And when you truly think through the implications of that, you can quickly see the value people place on knowing that the network in which they store their wealth is absolutely secure.

Limited

The maximum supply of Bitcoin is 21 million. This is a hard limit built into the Bitcoin protocol. To be clear though, we are not saying that Bitcoin is valuable because it is limited. This strict limit on the supply only makes Bitcoin valuable if it is indeed a decentralized medium on which to exchange value, AND if it is secure. Therefore, IF Bitcoin is a completely non-government-controlled medium for exchange and IF Bitcoin is secure, then the fact that it is limited also gives it the potential to be a store of value - which is, in and of itself, very valuable. 

Now compare this with fiat. Fiat currencies are centralized and provincial. They are less secure, particularly from counterparty risk, and they are most certainly not limited. For all these reasons, they are not a great store of value. You can lose your fiat through fees, or you can lose the use of your fiat temporarily through delays or restrictions. You may even lose your fiat through breaches in security or government seizure. And you will definitely lose your fiat over time through inflation.

Bitcoin may be very volatile right now as the market comes to terms with the long-term value of a decentralized monetary medium for exchange. However, over the long term, Bitcoin’s scarcity ensures that its other value propositions are not gradually diluted. 

Summary

To conclude our discussion, let’s recap the main points presented. 

First, financial bubbles throughout history have consistently displayed three main characteristics. They are relatively short, have a single boom/bust cycle, and they crash all the way back to zero or the prior baseline when they pop. Bitcoin does not display any of these characteristics. Therefore, if Bitcoin is a bubble, it is not behaving like any other bubble in the entirety of human history.

Bitcoin is, and is behaving like, any other financial asset with a high growth trajectory and a very high underlying and fundamental value. This underlying value can be attributed to Bitcoin being:

1. A valuable medium for exchange 
2. Decentralized and International
3. Secure
4. Limited

Therefore, it should be obvious from this analysis that Bitcoin IS NOT a bubble.

Frequently Asked Questions

1. What is Bitcoin’s fundamental value proposition?

Bitcoin’s underlying fundamental value proposition is the ability to store value, over the long term, in a way that governments can’t debase or inflate away. The same is true for a very large percentage of the $16 trillion+ market capitalization of gold. This is just the value of gold that is the result of gold’s monetary properties, not its decorative or industrial uses, and Bitcoin’s monetary properties are much stronger than those of gold.

Bitcoin gives you the ability to opt out of the boom/bust economic cycles caused by the Federal Reserve.

Bitcoin also gives you the ability to transmit value as easily as sending an email, anywhere in the world, without arbitrary gatekeepers. It is censorship-resistant, seizure-resistant, and doesn’t require anyone’s permission.

Bitcoin gives you the ability to cross country borders, with value that cannot be confiscated. Gold is difficult and expensive to store, to move, and to authenticate to make sure it is really gold. Bitcoin is much easier, faster, and more secure if you want to move anywhere from $100 to $100B, instantly, to anywhere in the world, and nobody can stop it. And again, Bitcoin’s monetary properties and store of value properties are much better than gold.

There is enormous value in having a store of value that can’t be debased or inflated away by government money printing. It gives you back the option to save money without having to worry that those savings will be lost to inflation over time

2. So how do you value Bitcoin?

The two best resources in regard to valuing Bitcoin are the CFA (Chartered Financial Analyst) Institute and ARK Invest.

The CFA Institute outlines four (4) different ways of valuing Bitcoin. They are:

(1) Total Addressable Market Approach (TAM)

(2) Stock-to-Flow Model

(3) Metcalfe’s Law: Cryptoassets as a Network

(4) Cost of Production Model

• ARK Invest is one example of an institution that has put forward a Total Addressable Market Approach to valuing Bitcoin. It is as simple as deciding if you are pessimistic (on the left side), optimistic (on the right side), or somewhere in between (in the middle). ARK Invest’s pessimistic case, on the left side, is that each Bitcoin will be worth $258,000 by 2030. Their base case, in the middle, is that each Bitcoin will be worth $682,000 by 2030, and their optimistic case is that each Bitcoin will be worth $1.48 million by 2030. Determining whether Bitcoin is over- or undervalued is as simple as comparing those numbers to the current price, or comparing those numbers to whatever is your next best investment alternative between now and 2030. We doubt you will find any investment that outperforms Bitcoin between now and 2030.
  
  The following links provide further detail:
• (5) https://research.ark-invest.com/hubfs/1_Download_Files_ARK-Invest/Big_Ideas/ARK%20Invest_Presentation_Big%20Ideas%202023_FINAL_V2.pdf  (See Page 65)
• (6) https://blogs.cfainstitute.org/investor/2023/11/30/bitcoin-valuation-four-methods/ 
• (7) https://rpc.cfainstitute.org/en/research/reports/2023/valuation-cryptoassets 
• (8) https://rpc.cfainstitute.org/-/media/documents/article/industry-research/valuation-of--cryptoassets.pdf 
• (9) https://www.fidelitydigitalassets.com/research-and-insights/bitcoin-supply-demand 
• (10) https://fwc.widen.net/s/rxkbv87nwm/1033043.1.1-fidelity-digital-assets---valuing-bitcoin-03-05  (See Page 4 and 9 and 10)
  

3. Isn’t Bitcoin used by criminals for money laundering?

Research shows that the US Dollar accounts for 60,000% more money laundering than Bitcoin. Criminals strongly prefer the US Dollar for their nefarious activity, and that is backed up by 100% of the research. It’s also important to note that crypto scamming and hacking revenue both fell significantly in 2023, with total illicit revenue for each down 29.2% and 54.3%, respectively.

Citations

1. https://bitcoinmagazine.com/legal/eu-parliament-adopts-aml-laws-regulating-bitcoin-based-on-questionable-assumptions 
2. https://www.chainalysis.com/blog/2024-crypto-crime-report-introduction/ 
3. https://www.coindesk.com/policy/2024/01/18/crypto-crime-amounted-to-over-24b-in-2023-chainalysis/
   

4. Will some other technology replace Bitcoin, like Facebook replaced Myspace?

According to Fidelity: “No other digital asset is likely to improve upon bitcoin as a monetary good…” and “we believe it is highly unlikely for bitcoin to be replaced by an ‘improved’ digital asset”. To get all the details, read Fidelity’s research report titled: “BITCOIN FIRST REVISITED: Why investors need to consider bitcoin separately from other digital assets”. We agree with their thesis.

5. Isn’t Bitcoin too volatile?

Volatility is inherent to any asset that has a very strong underlying value and a very high growth trajectory. As Fidelity says, “Volatility is a byproduct of price discovery, and there is no other way for price discovery to happen in a free market.”

The volatility will go away over time as Bitcoin slowly becomes the new monetary system of the world. But until then, you should be thankful for the volatility, because it means we are still early. When there is no more volatility in Bitcoin, it means Bitcoin has been fully adopted worldwide, and at that point the volatility will be much lower, but so will the economic upside from holding Bitcoin.

Also, there has never been a time when the price of Bitcoin was lower than the price four years prior. Almost no other major asset can say that. Indeed, no fiat currency can say this either. Would you rather have short-term volatility with a continual rise in value or short-term stability with a continual fall in value?

The near-term volatility in Bitcoin exists because it is still very early in this asset’s adoption life cycle.

Closing

Throughout history, there have been people that questioned the value of the automobile, electricity, commercial flight, the need for average people to own a computer, and the value of the internet. Now they are questioning the value of Bitcoin. Time will prove them wrong, just like it did for the naysayers of all past great inventions.

Bitcoin may be many things, but Bitcoin is most certainly NOT a bubble.