cryptocurrency is a bubble

According to Nouriel Roubini, the professor of economics at New York University who is said to have predicted the 2008 global financial crisis, Bitcoin represents “the mother of all bubbles”. He’s the latest in a long list of economics and financial luminaries to have dismissed cryptocurrencies, from Alan Greenspan, the former chairman of the US Federal Reserve, to Jamie Dimon, the chief executive of JP Morgan.

It’s harder to find experts of equal weight who argue that cryptocurrency is not a bubble. That doesn’t mean it is one, of course, but the rocketing values of the last year or so point that way.

A ‘bubble’, in economic terms, is when the price of an asset far exceeds its intrinsic value. For example, the dotcom bubble of the early 2000’s was marked by companies that saw their share prices rise simply because they were in the dotcom industry, and without reference to their likely profits or chances of succeeding.

Bubbles are hard to spot in advance

Very often, in a bubble, prices are driven up because people are overly optimistic about an asset; sometimes, it appears that it’s simply a case of people rushing to avoid missing out as valuations keep climbing. Eventually, however, the bubble bursts and those who haven’t already sold up are left with nothing.

Cryptocurrency, according to the likes of Roubini, fits this pattern. Bitcoin rose by 900 per cent last year for example, and it’s not obvious what that value is based on, beyond the expectation of further increases.

Part of the difficulty of the definition is that bubbles are mostly identified after they have popped. Until that point, they are hard to identify. For example, in 2012 plenty of analysts were arguing that Apple shares were in a bubble as they hit $100 per share. At the time of writing, they are at $187. Six years and the bubble still hasn’t burst.

Cryptocurrency’s value is hard to determine

However, although lots of people seem to be holding (or “hodling” is the preferred phrase), their cryptocurrency as if it were a stock, it actually isn’t. That makes underlying its value harder to determine. Of course, it doesn’t really act like a currency either, which makes it hard to compare to currency valuations. That, say cryptocurrency enthusiasts, is because it is an entirely new thing. Like any new technology, it has been greeted with skepticism, especially from the sector it might potentially disrupt and, like any new technology, it has the potential to disrupt far more significantly than it has so far.

Complicating the picture is the growing number of cryptocurrencies. One might argue that the valuations of Bitcoin and Ethereum are not bubbles but that the bubble is represented by the flurry of new cryptocurrencies, each trying to attract a wave of buyers that hope to get in on the next big thing. In that sense, it bears some relation to the dotcom bubble. While Amazon was not a sign of a bubble, Pets.com, which went from IPO to liquidation in 268 days, most certainly was.

So is cryptocurrency a bubble? Ask us in 10 years’ time. Meanwhile, the dotcom bubble offers some sense of how to behave here. Don’t jump on a bandwagon because you fear missing out. Instead, evaluate your own attitude to risk and the value you are likely to get from your investment, and proceed accordingly.