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Is bitcoin a bubble?

Daniel Lane

Daniel Lane - Fidelity Personal Investing

“What do you think about bitcoin?” is the question I seem to be running into a lot recently.

It has surprised me because the people asking it are those who would never normally talk to me about currency or investing, and the people who don’t quite know what I do for a living: friends and family, naturally.

But it really shouldn’t surprise me; the digital currency ranks among the nation’s top ten most Googled terms in 2017. So far this year the crypto rockstar has grown around 2,000%, definitely enough to get investors and non-investors talking.

However, I have found conversations tend to ignore the actual revolutionary blockchain aspects of the currency and instead veer towards how to get rich from it. For me that’s a worry.

We’ve all heard stories about selling as soon as the taxi driver gives us stock advice, or the security guard flags a sure thing but is this a sign that bitcoin is in the same league now?

Bubble trouble

We normally spot asset bubbles through rapid price increases fuelled by ill-informed, or just irrational, decisions made by investors. The problem is that we’re great at spotting these after it’s all collapsed. When we’re in the middle of all the excitement we rationalise our own choices one at a time and gradually replace our initial solid convictions with shaky new ones.

The tulip mania of the 1630s is a classic example of this, with an incredible amount of speculators taking leave of their senses and paying up to ten times a craftman’s annual income for a single tulip bulb.

Madness? Yes. But think back to the dot.com bubble around 17 years ago and it’s clear we are still as fallible nearly 400 years on. The rhetoric around internet stocks at the time sounds eerily familiar, with extraordinary price rises being justified and fuelled by phrases like, “It’s different this time… It’s a new paradigm… The rules are being rewritten.”

None

Source: Fidelity International & Wall Street Journal, December 2017

Five year performance (Table to be inserted when availeble in text component)

(%)

As at 13 Dec

2012-2013

2013-2014

2014-2015

2015-2016

2016-2017

Nasdaq

34.3

22.0

10.7

34.5

20.8

Past performance is not a reliable indicator of future returns

Source: FE from 13.12.12 to 13.12.17, total return with income reinvested in GBP

Of course, the proponents of the internet were right - it has revolutionised our world - but the fanfare overshadowed the fundamentals at the time. Companies’ valuations detached completely from their earnings as investors bought in, terrified of missing out on the new hot trend.

Bitcoin could genuinely change the way we use money but for it to do that we will need to learn from the past and stop using it as a commodity, instead using it for its intended purpose, currency. With most hanging onto it in a bid to sell it to the next enthusiast at a higher price, we’re quite far away from that point yet.

Who’s the greater fool?

The psychology around market bubbles is fascinating and there’s no better time to see our behavioural biases in action. Instead of realising that something is impossibly overvalued, we tend to suggest that there should be a new way of valuing it. Arrogance and hope in equal measure. Arguably, we’re seeing that in the crypto space more and more.

Our behaviour starts to matter much more than the intrinsic value of the asset and when the collective delusion starts to wane, panic sets in quickly. If you want to sell and the market stops offering to buy there’s only one direction the price can go.

The music might not have stopped yet with bitcoin and if you’re kicking yourself that you haven’t taken part yet, just remember Neil Woodford eschewed internet stocks in identical circumstances. In fact, I wouldn’t be surprised if the smart money left the crypto world a long time ago.

Any price rise fuelled by shallow research and a generally thin understanding should be treated with caution, even if it is the future of currency.

So, is bitcoin on the way to greatness or is it all a bubble? I’ll tell you if it pops.

Important Information

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