Bitcoin may be the new big thing in global currencies, but don’t count on it replacing the old, boring store of value, now or ever.
New paradigms often create market bubbles. They are a new technology or idea that will change the world and, along the way, offer investors unlimited profits.
Mania soon takes hold as prices detach from reality and people get rich, at least on paper. The mania soon fades, though, and before long prices fall, sometimes dramatically.
The cryptocurrency bitcoin is a good example of this new paradigm thinking. Bitcoin is a digital currency that is created and held electronically.
At its core is the blockchain, a super database that tracks all bitcoin transactions. Some of its fans think that soon bitcoin use will grow exponentially and offer unlimited profits to investors.
They think that bitcoin will become the gold of the digital era, a safe place to park cash whenever there is a financial crisis and which is beyond the printing press threat of paper currency.
Bitcoin proponents say that it is similar to the Internet in the 1990s and personal computers in the late 1970s. It is a disruptive technology about to go mainstream.
And as investors abandon paper currencies, a tsunami of money will chase bitcoins as a safe-haven global currency, sending prices for the limited number of bitcoins available soaring.
The bubble in bitcoin prices, which rose from $215 last summer to a high of $763 this summer, reflects the exuberance.
It could also show the impact that Chinese traders are having on bitcoin, as 90% of all bitcoin transactions happen in China, and much of bitcoin’s price volatility is due to China-based short-term traders.
In market bubbles, the mania phase eventually turns into the fourth and final blow-off phase. This is when paper fortunes and big gains disappear.
Since its June 16 high, bitcoin has dropped 24%, which we flagged as a possibility at around the same time. So, bitcoin has likely already started the blow-off phase, and lower prices could be on the way.
A new, more realistic view of bitcoin is taking hold. Bitcoin has become the realm of speculators, and isn’t a legitimate currency.
There are still a lot of obstacles to it becoming mainstream.
And last week’s news of hackers stealing $70 million worth of bitcoin from Hong Kong-based Bitfinex, a bitcoin exchange, also highlighted one of the biggest concerns about bitcoin: that it has a hacking problem.
The same day that news of the bitcoin hack/heist surfaced, global investment bank Credit Suisse released a report on bitcoin and its blockchain technology.