Let’s Talk About Bitcoin

 In Blog Articles, Commodities Corner, Investments

Everywhere you look, there is talk about Bitcoin. Oddly though, the media seems more interested in emphasizing its exponential tear upwards than explaining the underlying technology. Bitcoin, simply put, is a completely virtual currency. Originally created to be a decentralized medium of exchange, it first took off as the finite supply of coins appealed to investors who distrusted Central Banks’ growing influence in the global economy, and the essential rise of fiat currency, i.e. money with no value behind it such as gold or silver. It was created to be a dependable form of decentralized currency, unable to be manipulated by central banks or governments.

Is Bitcoin Overvalued or Undervalued?

When we talk about whether or not Bitcoin is overvalued or undervalued it is important to note that we are not making comment on the future or usefulness of the underlying blockchain technology that has been brought to the spotlight through the prevalence of Bitcoin. In fact, there is likely to be a very promising future for blockchain technology, and even cryptocurrencies in general, however that does not mean that Bitcoin is fairly valued.

At its current levels, Bitcoin appears to be overvalued. As we mentioned earlier, the original intent with Bitcoin was to create an online currency that could be used as a medium exchange. As it gained mainstream attention, people began buying it not to use as currency, but as a speculative asset to be flipped onto the next person in order to make a quick buck. While specific data is not available, it would seem that the average person buying Bitcoin today is not purchasing it to use as a medium of exchange, but rather, to speculate. Due to the fact that Bitcoin has largely become a tool for speculation, it is unlikely that the current price accurately reflects the true value of Bitcoin as a unit of exchange.

The key is to remember that in buying Bitcoin, you are not investing in blockchain technology; in fact you own nothing except for the electronic documentation stating you have a Bitcoin. The mania surrounding this new technology seems to eclipse this fact. A better potential investment would be allocating money to companies that look to harness blockchain technology to create an actual profit, rather than something that just utilizes it with no underlying business. However, this too has created problems in the market.

The Hype of Blockchain

As it turns out, investors and company operators alike, are already on top of the idea. A simple name change of a company from ‘Long Island Iced Tea’ to ‘Long Blockchain Corp.’ resulted in a more than 200% rally in the share price. While this represents the right idea, to invest in something tangible that can capitalize on the technology, the company itself is clearly taking advantage of the mania. Other examples of companies mentioning blockchain or changing their name to incorporate the technology saw similar exorbitant gains in share price, without any real proven business model behind it. The eagerness of investors to hitch their wagon to anything remotely referencing Bitcoin and the technology is surely a sign of the speculative nature of this feeding frenzy.

The future is difficult to predict, and while there may be a future for blockchain and cryptocurrencies in general, that does not mean that Bitcoin is rationally priced or even the particular crypto that will end up being widely adopted for permanent use. The speculative nature of those currently buying Bitcoin, with no intent to use it for its created purpose, is indicative of an irrational market. People are not making investments, but rather looking to sell to the next speculator who comes in to try and make the same quick gain. Going forward, I expect to see  the meltdown from the highs that has begun, to continue. As the gains slow, Bitcoin drains from the headlines. The hopes of getting rich off the quick flip of an extremely volatile crypto begin to fade and speculators move on to the next thing. As these short term holders begin to leave the market the price will begin to bottom out and stabilize. We believe that when the volatility in Bitcoin begins to fade it will indicate that those left holding it are the actual investors, the ones who intend to truly use it as a currency. It is lost on us that one of the major characteristics of any currency is that it must be a reliable store of value. As speculators leave the market, perhaps Bitcoin will actually become useful again for its true purpose.

To learn more about how to protect your assets from irrationality in the market read our blog Market Bubbles Are Inevitable; Portfolio Bubbles Are Not.

Michael Canale

Michael Canale

Michael Canale, Investment Research Associate, has been practicing investment analysis in myriad forms since he opened his own real money portfolio during sophomore year of high school. Michael has worked as a Senior Analyst and Portfolio Manager of the Minutemen Equity Fund along with experience as an Investment Management Intern – Quantitative Strategies at MassMutual Financial Group. He is in his final semester at University of Massachusetts – Amherst, pursuing a bachelor’s degree in economics and finance.
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