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Bitcoin and other Cryptocurrencies - Are we in a 'Bubble' primed to pop?


 

 

 

 

 

 

 

By Avinash Shenoy, UK

The Cryptocurrency Universe is experiencing a ‘Bubble’ not unlike what the stock market experienced in the recent past. This Bubble has been fueled by poor growth in traditional investment areas, low-interest rates, unstable local currencies, the lack of understanding and the uniqueness in this arena to name just a few. And like all Bubbles this one will pop.

Ever since the publicity received by the Security and Exchange Commission (SEC) in the USA taking into consideration the Winklevoss Twins' Bitcoin Exchange Traded Fund (ETF) proposal early this year, it seems the 1,100+ Cryptocurrencies or ‘Altcoins’ in the marketplace have gained public attention and are being invested in without a full understanding of what they actually are.

A prime example is the Cryptocurrency Ethereum. Investors are unaware that it is unusual among cryptocurrencies in that it's intended to work less as a currency and more as an enabler of programmable functions. Developers buy "ethers" for the right to run their code on the Ethereum network. This has even led to ether as being widely referred to as "fuel" and not a digital currency.

Therefore without understanding what it actually is, they pumped the price of Ethereum from $11 to $50 as the 'go to currency' when the before mentioned Winklevoss Twins' Bitcoin ETF was rejected, that too in a very short duration of time. Then as Ethereum was submitted for ETF status with the SEC and as they awaited the SEC’s decision on whether it will get ETF status, it was ‘pumped’ to an all-time high of about $245 per Ethereum in Jun 2017. The price rose to just above $400 before a crash recently for reasons which involved other factors which we will cover below.

With regarding the Ethereum ETF, on September 1, 2017, NYSE Arca has now withdrawn the proposed rule change (Aleman, 2017).

Another feature that demonstrates that we are in a middle of a Cryptocurrency ‘Bubble’ is when we can see the number of Initial Coin Offerings (ICO’s) being produced, which are similar to the ones that the Stock Market Bubble produced in the form of Initial Public Offerings (IPO).

The current ICO bubble on the Ethereum Network is comparable to the excessive speculative investments seen in IPO's that caused the dotcom bubble to crash in 2001.

Similar to the IPO's during the dotcom bubble, an ICO allows token based companies to raise a substantial amount of money without having ever made a profit—or, sometimes, realised any material revenue whatsoever.

What is unsettling is that anyone can write a ‘whitepaper’ explaining the benefits of their project and start an ICO. This is one of the reason the number of ‘Coins’ listed on since the beginning of the year of about 700 has gone up exponentially to over 1,100 to date.

The ban on ICO’s by China (Reuters, 2017) on Friday September the 8th had a significant impact on the prices of Bitcoin and Ethereum, as they are the primary cryptocurrencies used in buying tokens for ICO’s. This ban was put into effect because of a fear of a ‘Dotcom like Bubble’.

A partner at a Shanghai capital fund, who wanted to remain anonymous said: “This is not unlike the dotcom bubble of 2000". “There are a lot of companies raising a lot of money for not very good ideas, and these will eventually be weeded out. But even from the big dotcom bust, you still have gems." (Reuters, 2017).

In another surprising interview this is what Mr. Vitlak Buterin, the co-creator and founder of Ethereum had to comment about ICO’s and his fears about a Bubble forming:

“I indeed think that we are in a bubble because all the cryptocurrencies are rising and people have a feeling that they will always continue to rise. A lot of projects are raising more money than what they would be able to in the normal VC market, and sometimes there is no match between the necessity and usefulness of the project and its ability to raise money. Additionally, this market is still young and people still don’t know how to differentiate between projects that will exist in the long term and those that won’t. This thing is growing at a rate that makes it hard to control. I, for example, don’t participate in most ICOs because I think they are done at too high valuations.”

“If most ICOs fail, that is a risk (to Ethereum itself). We need to avoid over-publicizing these projects. The way to evaluate them is mostly by the résumé of the people in charge because there is no real way to judge such new projects. That is why there are projects that declare they are linked to this or that organization or even me – even if I am not linked to them. In the long run, the market will need to find a way to judge which projects make sense and what their appropriate worth is. It is not clear how things will look in a year or two. In the end the market will need to cool down. A lot of projects will fail and people will lose money.” (Mizrahi, 2017)

A further shock to the cryptocurrency ecosystem was felt when China decided to ban exchanges from trading cryptocurrencies within its borders (BBC, 2017). A flash Crash in the price of Bitcoin and all the currencies was experienced on Friday, September the 15th when this news was announced. There was about a 40% devaluation in the value the price of Bitcoin within minutes.

It will be interesting to see whether token based companies can keep up value over the coming years.

In conclusion it is hard not to notice the volatility both in Bitcoin and the Altcoins recently. For example a couple of weeks ago if you had bought Bitcoin at about $5000, it dropped to $4200 over the course of a week and then on Friday the 15th of September in a ‘flash crash’ fell to just under $3000 in minutes. Ethereum lost value from $400 to just under $250 also. Those drops were pretty fast.

The day after the ‘flash crash’, Ethereum rose from $230 to $280, and Bitcoin resumed its upward trajectory to $4000. That again was fast.

Anyone who felt the impact of the dotcom boom in the 2000’s will be familiar with the signs that this market is displaying.

It is important to recognise that there will always be bubbles. There are many reasons given why these occur ranging from ‘The greater fool theory’, to a simple attraction to a rising price without a thorough ‘fundamental analysis’ undertaken. However, when people see money being made seemingly from nothing, in the case of Cryptocurrencies, the curiosity and attraction is definitely great, which fuels runaway pricing.

In contrast, with the stock market, you can always conduct a thorough analysis of the stock and see if there are any problems with it being under or overvalued. With this new and unregulated Cryptocurrency market, unfortunately there is no real proven time-tested ‘science’, in which one can apply to understanding the real underlying value of the asset or coin in which he or she is investing in.

The best thing we can hope for in the near future is more rigorous investor research into what they are actually purchasing, full transparency in information provision by ICO and Token providers and finally a rigorous Legal and Regulatory framework to protect those adversely affected by this enticing market.

Only then can we hope to meet balance, harmony and stability in a young and growing market and avoid the mistakes of the past.


Works Cited

Aleman, E A (2017, September 6). Retrieved from www.sec.gov: https://www.sec.gov/rules/sro/nysearca/2017/34-81538.pdf
BBC (2017, September 15). Retrieved from www.bbc.co.uk: http://www.bbc.co.uk/news/business-41276348
Mizrahi, A (2017, September 11). Retrieved from www.financemagnates.com: https://www.financemagnates.com/cryptocurrency/news/ethereum-founder-vitalik-buterin-ico-bubble/
Reuters (2017, September 12). Retrieved from www.fortune.com: http://fortune.com/2017/09/12/cryptocurrency-china-initial-coin-offerings/

 

Avinash Shenoy Archives:

 

Comment on this article

  • Andrew, USA

    Sun, Oct 1 2017

    Hi Avi!

    Thank you for sending me the link and congratulations on a great article (including the archived one!). Definitely let me know when you get more published!

    Yours Sincerely,
    Andrew.

    DisAgree Agree [3] Reply Report Abuse

  • Avinash Shenoy, UK

    Mon, Oct 2 2017

    Hi Andy!

    I am glad you read and enjoyed the article! I will ensure that I keep you I the loop with regards to any future publications.

    Kind Regards,
    Avi

    DisAgree Agree [1] Reply Report Abuse

  • M A RAHIM, Mangalore

    Sat, Sep 30 2017

    Very good and informative article. Look forward for more such articles and latest developments on cryptocurrences in the world and India in particular.
    Warm regards

    DisAgree Agree [4] Reply Report Abuse

  • Avinash Shenoy, UK

    Sat, Sep 30 2017

    Your positive feedback is much appreciated.

    Warm Regards,
    Avinash

    DisAgree Agree Reply Report Abuse

  • Anita, Mangalore

    Wed, Sep 27 2017

    A really excellent and relevant article. Looking forward to reading more about this new subject!

    DisAgree [1] Agree [10] Reply Report Abuse

  • Avinash Shenoy, UK

    Thu, Sep 28 2017

    I appreciate your comments and look forward to writing more in the near future!

    DisAgree [1] Agree [3] Reply Report Abuse

  • Melwyn, Melbourne

    Tue, Sep 26 2017

    Very informative . Thank you!

    DisAgree Agree [12] Reply Report Abuse

  • Avinash Shenoy, UK

    Thu, Sep 28 2017

    Thank you for your kind feedback!

    DisAgree Agree Reply Report Abuse

  • Kareem, Manipal

    Tue, Sep 26 2017

    Very well researched and written article. It provides a brief idea of a concept which is difficult to grasp for a person not having the related knowledge. Thank you Mr Avinash Shenoy for a wonderfully written article.

    DisAgree [1] Agree [13] Reply Report Abuse

  • Avinash Shenoy, UK

    Wed, Sep 27 2017

    Dear Kareem Sir,

    Your professional opinion is highly valuable for me.

    Thank you for the same.

    Best Wishes
    Avinash

    DisAgree Agree [1] Reply Report Abuse

  • Satya, Mangalore

    Tue, Sep 26 2017

    Nice article!

    DisAgree [1] Agree [14] Reply Report Abuse

  • Avinash Shenoy, UK

    Wed, Sep 27 2017

    I am glad you enjoyed the article. Your positive feedback is encouraging and provides me with much motivation.

    DisAgree Agree Reply Report Abuse

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