Is Bitcoin A Bubble?

Time is working on the cryptocurrency’s side, keeping many waiting for its demise.

The price of bitcoin exceeded $48,000 earlier this week, as Elon Musk announced Tesla bought $1.5 billion of the digital currency and would soon start accepting bitcoin as payment for its products.  

Will it continue to surge, and possibly even replace fiat currencies? Or will it become a bubble, and crash like the unsustainable market manipulation that occurred with GameStop (GME)?

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Bitcoin is a digital currency that was created in 2009 that can be thought of as cash for the internet. It is the most popular of the digital currencies also known as cryptocurrencies. Cryptocurrency uses cryptography as security for transactions and to control the creation of additional currency.

Unlike conventional paper currency issued by governments, bitcoin has a limited supply that will not exceed 21 million bitcoins, at least in our lifetime. Such scarcity is one component to creating value. This is in sharp contrast to the trillions of dollars being printed by the U.S. government.

Bitcoin Solves A Problem

The blockchain technology behind bitcoin drastically lowers transaction costs by disintermediating traditional financial institutions. For example, when buying something from Amazon, the largest retailer on the planet, my credit card gives me 2% cash back, so I assume Amazon is paying more than this amount to the credit card company. By comparison, a bitcoin transaction would cost less than a dime.

Traditional financial firms have predicted the demise of bitcoin for some time. J.P. Morgan CEO Jamie Dimon slammed bitcoin as a fraud in September 2017, saying, "It's just not a real thing; eventually it will be closed." Dimon compared it to tulip mania—the contract prices for tulip bulbs that reached extraordinarily high levels before collapsing in 1637.

Dimon did not provide a specific time frame for bitcoin’s extinction, which is key to market “predictions,” which prevents him from ever being wrong. But his prediction isn’t looking so good right now, with the market cap of bitcoin approaching $1 trillion, currently at $867 billion.

Regrets: I Have A Few

I first wrote about Bitcoin in October 2017. In researching the cryptocurrency, I walked away with some respect. I even bought a little just to fact-check what I was writing on how one goes about buying bitcoin. Three and a half years later, I have a 1,100% return. My regret is that I didn’t have two or three extra zeros behind my tiny $200 purchase.

But if I’m really going to torture myself, in 2010, the price was $0.07 per coin according to BuyBitcoinWorldwide.com. If I had invested that $200 back then, I’d have made over $137 million. Here I go again. Back in late 2017 and early 2018, bitcoin had a surge and my brain was on bitcoin.

This surge is much larger, and the release of dopamine—the brain chemical that gives a “natural high”—is triggering my thoughts of huge financial gains if I invest more. The emotional side of my brain debated with the logical side back in late 2017, and the logical side won out … I didn’t buy any more. Now my emotional brain won’t let me forget it, and keeps saying, “I told you so!

Should You Own Bitcoin?

As interesting as bitcoin is, it is also full of risk. From a behavioral perspective, people chase performance, particularly when there is volatility. And bitcoin volatility makes the stock market look boring.

I think Matt Hougan, chief investment officer at Bitwise, basically has it right in these key points: 

• There’s a good likelihood it will emerge as a significant nonsovereign digital store of value, akin to or in rivalry with gold
• There’s a small likelihood (like a cheap, out-of-the-money call option) that it becomes the transactional backbone for Finance 2.0
• There’s a low or zero likelihood that it's used as a currency to buy things like coffee or lunch

Though I might disagree on the first point, there is certainly a good possibility it becomes a goldlike store of value. So I’m not against telling people they can have 1 to 2% of their portfolio in the digital currency.

But I do have an aversion to buying something after a spectacular surge. It typically doesn’t end well. And, of course, another digital currency could emerge as the standard, making bitcoin the MySpace of social networking.

How Should You Own Bitcoin?

Bitwise and others have filed to launch a bitcoin ETF and, along with the others, have been turned down by the SEC. Yet there are ways to buy bitcoin ETFs, as noted by Drew Voros, ETF.com editor-in-chief.  One could invest in companies betting on the future of bitcoin, such as Tesla.

Personally, I think if I were to buy more bitcoin, I’d buy it long term and not pay any manager an ongoing fee. In my mind, the purpose of an ETF is to get diversification, though it’s certainly easier to buy an ETF that would also automate the tax reporting.

Conclusion

Only time will tell whether bitcoin will continue to surge or go the way of tulips.

But, for now, the reports of the demise of bitcoin have been greatly exaggerated.

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.