When Will The Bitcoin Bubble Burst?

Check out our previous article for an introduction to Bitcoin.

The price of Bitcoin has soared over the past year raising serious concerns over the sustainability of this surge. A single Bitcoin is currently worth $6,200 (12/11) rising by over 500 % in 2017 alone. Attitudes appear to be changing as more retailers are now accepting the cryptocurrency and regulators have been closely monitoring its growth. Large financial institutions are taking cognisance of Bitcoin, although feedback has been mixed. The question remains, is this remarkable growth sustainable or is it merely a bubble?  Bitcoin’s price responsiveness makes it capable of collapsing as quickly as it rose. Bitcoin may become a ubiquitously adopted currency but this prospect could be hampered by regulators. The likely option is that it will become an asset class rather than simply a currency. The Bitcoin “fork” has also created significant problems for its growth. Alternatively, other external factors could cause the bubble to burst and the market crashing, taking all market participants down with it. This article will explore the likelihood of these possibilities as well as providing an insight into the current Bitcoin market and different perspectives of it.

Bitcoin’s future seems bright as corporations are now taking it seriously. Futures exchange operator CME announced plans to launch Bitcoin futures. Retailers such as Expedia and CeX already accept Bitcoin. There also speculation that Amazon could soon accept Bitcoin as it has opened up 3 cryptocurrency domains. The purpose of these is not yet known but this is encouraging news for investors. If it does become widely accepted by retailers this will inevitably buoy long term confidence and provide desperately needed price stability. The more prominent it becomes however, the more regulation will need to be introduced to protect consumers. The impact of regulation will be discussed later.

Bitcoin is most likely to become an asset class in its own right. Business Insider analyst Tom Lee predicts that Bitcoin could reach $25000 and replace gold as a safe bet for investors (Investopedia). Lee is positive about the growth and claims that millennials will adopt Bitcoin as their safe asset. Lee is accurate in claiming users will grow as its popularity continues to grow.  He is highly over-optimistic in his predictions as while the cryptocurrency may continue to grow, the fundamental appeal of buying gold is its price resilience compared to currency. This is why investors by gold during financial and political crises. Unless there is revolutionary change, Bitcoin will not be able to match this level of stability.

Many commentators in the financial world have however, been critical of Bitcoin. Few have been more vocal than JP Morgan CEO, Jamie Dimon. Dimon described the entire cryptocurrency as “a fraud” and those who trade it as “stupid”.  This is an overzealous disparagement of the Bitcoin community but his core points are somewhat accurate. Bitcoin’s value derives solely from confidence but there is absolutely no underlying regulatory support. If enough external factors cause investor confidence to dissipate then the cryptocurrency crashes and this model is highly unstable. The volatility of Bitcoin is why it lends itself more to an asset class rather than currency.

The Bitcoin “fork” is arguably the greatest threat to the survival of Bitcoin. Bitcoin developers fought over about the best way to upgrade the outdated operating system and so some decided to set up another strand altogether. On August 1st 2017, developers created a new cryptocurrency called Bitcoin Cash. Initially, investor confidence was surprisingly stoic to the news with minimal price drops. In November however, a vast number of investors sold Bitcoin and bought “Bitcoin Cash” instead, causing the price to plummet by over $1000 in just 48 hours. Many analysts claim that the fork is the beginning of the burst for Bitcoin but this is inaccurate. The sheer speed of Bitcoin’s price rise was indicative of its potential volatility and so price dips like these are inevitable. The hype surrounding the cryptocurrency has shifted it into the mainstream buoying investor confidence as demonstrated by its growing acceptance by retailers. As a result, the fork will bring volatility but will not kill the currency.

A crackdown by regulators could also send Bitcoin into freefall. The lack of centralisation is problematic for regulators. All major currencies are backed by central banks to protect consumers’ money from external shocks. Bitcoin wouldn’t be permitted to take over traditional banking as it stands because it does not have sufficient consumer protections. If protective regulations are introduced, they could potentially stunt Bitcoin’s growth as much of its appeal derives from the freedom it affords users. Furthermore, regulators do not need to ban cryptocurrencies in their entirety to cause its collapse. China recently banned initial coin offerings as part of wider crack down on cryptocurrencies , causing a 6% fall in price. Negative moves by regulators can shock the market and kill investor confidence.

Bad publicity could also lead to Bitcoin’s downfall. The WannaCry hackers who input DDOS software into IT systems worldwide, requested Bitcoin from victims as ransom. Now, some law firms have pre-emptively opened Bitcoin wallets in case of cyber attacks. The most notable criminal story however, was that of Silk Road, the illicit goods exchange. Created in 2011, users could anonymously buy and sell illegal goods using Bitcoin. The FBI shut down Silk Road in 2013 but most of the one million registered users were untraceable. The anonymity of Bitcoin users lends it to criminal activity and this is problematic. If regulators associate Bitcoin with illegal activity they could introduce restrictive regulations which could lead to its demise.

Taking all into account, Bitcoin’s bubble may not burst anytime soon. While there are many regulatory issues preventing it from overtaking traditional currencies and banking, it is capable of running alongside them. Bitcoin is likely to become an asset class and in this sphere its potential growth is limitless. The lack of centralisation however, fundamentally prevents the cryptocurrency from overtaking traditional banking. Central banks mitigate external shocks to currency, protecting consumers. A currency that can lose 20% of its value in a few hours (Jan 2017) and has no central body is simply not stable enough. The Bitcoin fork has exacerbated volatility but it will not crash the market. It is the regulators who can burst the bubble through stifling regulation, if it encroaches into traditional banking. Confidence in the cryptocurrency could diminish just as quickly as it developed, so its future really does lie in the balance. Bitcoin is edging its way into the mainstream but faces numerous issues potentially threatening its very existence. It will be interesting to see just how large the Bitcoin bubble can grow.

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