Chapter 10: Is Everything Just One Big Bubble?

If you read about cryptocurrencies, and especially Bitcoin, in the past, you almost certainly heard the claims that it’s nothing less than one of the biggest bubbles in human history. Even if you believe the opposite, how can you be sure that all of us won’t end up with nothing more than virtual dust? As always, it is important to form your own opinion. This is crucial, as you will have to deal with the consequences, whatever they may be. No one can predict the future, but we can always learn from the past. Our history can teach us valuable lessons about the future, even if some people may think otherwise. Why Bitcoin could be more than just a huge bubble is something we will focus on shortly. At first, let us take a look at the hash rate of the last year.53

The screenshot above may be not very well readable, but there is something you will notice almost instantly. Over the course of the twelve months, from January 2017 to January 2018, the hash rate was constantly rising. This is especially interesting if you keep the Bitcoin price chart in mind. You will realize that the decrease in the price of Bitcoin did not affect the rise of the hash rate. It even spiked to a new ATH not long ago. Let’s have a look at the second graph:54

What you can see is the total number of transactions in a linear fashion since the start of the network in 2009. You can see the steady rise of transactions in the Bitcoin network over the years. Both charts help shed some light on the possible crypto bubble if we consider the so-called Metcalfe’s law: “the value of a communications network is proportional to the square of the size of the network.”55

This law from Robert Metcalfe, the inventor of Ethernet, is often used as a possible explanation of the growth of modern-date networks.56, 57 For a network like Bitcoin or any other cryptocurrency, the network of people using it is often referred as the driving force behind valuation.

As you can see in the figure above, the number of active user addresses (equal to the number of users in this equation represented by the black line) meets the Bitcoin market cap in USD (grey line) quite well.58 Following Metcalfe’s law, the Bitcoin overall market cap should see a high increase in valuation in the upcoming years. It is important to notice that this won’t be free from short-term corrections though.

There is another law often referred to when it comes to Bitcoin: “The number of transistors in a dense integrated circuit doubles about every two years.”59

It’s called Moore’s law and is named after Gordon Moore, the co-founder of Intel. Dennis Porto, a Harvard academic and Bitcoin investor explained the law: “Any technology that is growing exponentially (i.e., ‘following Moore’s law’) has a doubling time.”60

Following Moore’s law, Bitcoin is primed to hit $100,000 in early 2021. Those laws can give you an idea what the upcoming years could have in store for Bitcoin. The key word here is could. No law, past event, or person can really predict what’s in store for Bitcoin. That’s why it is only of moderate informative value to compare the price charts of past bubbles to networks like Bitcoin.

There are some charts to put this whole topic in perspective. Once again, always try to think about the bigger picture. <Howmuch.net> is a great resource for amazing visualizations and information about anything related to cost and money. Take a look at the first graphic.61

Even though the represented data may be outdated at the time of your reading, it still provides us with a great impression of the overall market conditions. In the media, Bitcoin is often referred to as digital gold. At the time of writing this chapter, gold is still around 65 times more valuable than Bitcoin. So Bitcoin has a lot of room to grow. There is also an interesting side fact. The valuation of the available physical money exceeds the valuation of gold by far.62 This is pretty interesting, isn’t it? Especially if you keep in mind that the paper money that we use every day has no intrinsic value and should be backed by something, which has this value. In terms of physical money, this should be gold. As this is clearly not the case anymore, this is only one point that makes Bitcoin important. One interesting approach to visualize the stages of a bubble can be seen below.63

This is a very common visualization of the possible behaviour of the market and the possibility of a bubble. You may recognize the stages of the market sentiment described earlier. In short, the course of the bubble can be simplified and expressed in four major phases:64–66

  • The Stealth Phase: This first phase can be broken down to the fact that only a small number of people realize the possible potential (sometimes referred to as “smart money”) of investing. That happens mostly without any notice from the general population.
  • The Awareness Phase: The second phase is characterized by a slow increase in price as more investors notice the potential while the media begin to pay attention.
  • The Mania Phase: This third phase is the most important one. At a certain point, the behaviour of the general public becomes illogical and irrational as everyone wants their piece of the cake. Driven by greed, no one thinks about a possible price decline. People take out loans to buy in; right at the same time, many early investors are begin to cash out.
  • The Blow-off Phase: The last phase in the cycle is characterized by some kind of trigger or event, which leads to a general shift in the market. The overall sentiment becomes bearish, with fear and panic being the leading emotions. As everyone wants to exit the market as fast as possible, a setback even below the mean is possible. This represents a great buying opportunity.

Now let’s have a look at the Bitcoin chart once again.67

That is an astonishing resemblance isn’t it? As perspective is everything, take a look at the next chart as well.

As you may already recognize at this stage, that is the 2014 price correction.67 At that time, it was considered to be a huge crash. Without knowing what the future was holding, it indeed was. Hence, it’s quite helpful to have a look at the major bubbles of the past to evaluate Bitcoin’s potential outcome down the line.

  • The Tulip Mania: The Dutch Tulip Bubble (1636–1637) is often referred to as the first known speculative asset bubble. The price of tulips increased immensely, peaking in early 1637. The price of one tulip was more than ten times higher than the yearly salary of a skilled craftsman at that time. Following the burst, the price decreased by nearly 99 percent.68-70
  • The South Sea Bubble: This event is most likely the precursor of the term bubble, when referring to a financial crisis. Centered around a British stock company founded in the year 1711, a nearly ten-fold rise in mid-1720 led to a country-wide buy in. The burst of the bubble shortly afterwards led to an economic crisis.68, 71, 72
  • The Dot-com Bubble: When it comes to the potential Bitcoin bubble, the Dot-com bubble is mostly the one used to draw similarities from. Dot-com companies experienced a meteoric rise in the late 1990s. The huge spread of the Internet led to a high interest in Internet-based companies. The bubble burst in the year 2000 after investors got greedy and irrationally poured money in nearly every company with a “.com” ending.73, 74

Those are only some of many bubbles of the human past. You can be certain that as long as there is a human factor in trading, there will be new bubbles in the future. Some may even be bigger than anything we’ve experienced yet. But it is still uncertain whether Bitcoin is a bubble, has already popped, or is going to do so. No one will be able to tell you, even if they want you to believe otherwise. The future of Bitcoin and cryptocurrencies is still uncertain. There will always be price corrections on Bitcoin’s path. But even if it turns out to be a huge bubble, your funds won’t necessarily evaporate instantaneously. The most important thing is to develop a feeling and general understanding of the market and to form your own opinion. That is the only way to really start making money.