Dec 18, 2017

Why Bitcoin is a Bubble in Making

The rise of cryptocurrency and Bitcoin took Wall Street by surprise with many industry leaders stepping forward to give their opinions what they think of this new technology that can potentially disrupt the role of banks.

What is cryptocurrency? It is a form of digital currency that can be used to purchase goods and services and is limited in quantities, much like gold. However, unlike gold, cryptocurrency can be transferred through the internet, across the borders, without the need of going through customs nor banks. This creates a burning problem for governments in the form of illicit money flow which can be used to finance illegal activities and threatens the central banks abilities to control money supply, which is one of the key tool for economy management. Read more about cryptocurrency.

Bitcoin Bubble in Making?

As a form of currency, the value of a cryptocurrency such as Bitcoin, is based on its function as a unit of exchange. As the value of Bitcoin shoots through the roof, with its price tripling with a month, the owners of Bitcoin become less and less reluctant to use bitcoin to buy goods and services as they expect the value to rise more in the future.

The question is, what's the value of a good (in this case, a medium of transaction) if it loses its primary function it is suppose to fulfill? Normally, the value of the good (example is a broken cup which cannot contain water) will fall, as it becomes useless to anybody. However, if the price rises instead and the value of the good exceed that of its intrinsic value with no rational reason, it becomes a bubble. This is what is happening to Bitcoin right now. As a medium of exchange like cash, Bitcoin needs to have its price fluctuates around a stable value, much like how modern currencies fluctuates. Imagine the the SGD rising 100% in a month? That will wreck havoc on the banking system with deep implications on trade and all companies dealing with export and import. With Bitcoin prices shooting up 10% on a daily basis, its value as a medium of transaction has become limited as owners choose to hoard them like an asset, rather than use them to buy goods and services.

This is similar to the Tulip mania that occurred during the 17th century in Netherlands whereby the value of tulip shot up two hundred folds within a year. The basic function at that point of time functions as a decorative status item, and as the value of tulips start to soar, speculators start to hoard their tulip bulbs as long as possible before selling it, causing tulips to be traded as a speculative asset rather than for its value as a decorative item. Soon after, a futures market is started for tulips (A bitcoin futures is started recently) and not long after, the tulips bubble burst and the price fell back to its intrinsic value.

The general consensus among most financial experts is that Bitcoin, is indeed in a bubble stage now, but when will the music stop? There are no short and simple answers and only time will tell. Even though the Bitcoin bubble will eventually burst, the technology behind Bitcoin - blockchain is here to stay. Blockchain, similar to the mobile application revolution, will bring about another big disruption in the kind of jobs and skills that will be needed in the near future and companies that can harness these technologies may be the next Microsoft or Google.

Soo.. How do I buy a Bitcoin?

If you think Bitcoin will go to $300,000 , check out the article written by fellow financial blogger Budget Babe on the step by step guide to buy your first Bitcoin or attend a cryptocurrency course conducted by Dr Wealth.

Before you buy your first bitcoin, you better think twice if you think you can cash out when the bitcoin market starts to crash. Why? Because Bitcoin is a relatively illiquid investment and when many people are squeezing to get out of an illiquid investment, things will get ugly very quickly. How bad can it get? Check out this article: Bitcoin’s illiquidity is going to be a huge problem when the bubble bursts.

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