Bitcoin, tulips and feathers
ARE YOU A BELIEVER? Investor frenzy’s never a great predictor of future returns, especially for those who are late to the party.
Bitcoin mania’s in full swing and investors globally are getting caught up in the hype. The lure of investment riches is so powerful, many speculators don’t apply rational investment principles when making decisions about bubbles.
A bubble occurs when there’s so much hype around an investment, that speculators drive the price beyond rational value. Economist Hyman P Minsky, says there are five steps to a bubble:
– when investors become obsessed with the latest “in thing” which promises to make them rich.
– prices rise slowly, then gain increasing momentum as more investors enter the market. The asset attracts widespread media attention, increasing the fear of missing what could be a ‘once-in-a-lifetime’ opportunity.
– valuations reach extreme levels. Bitcoin’s now selling for $2 514/Bitcoin (at the time of writing). Five years ago it was $5.
– smart investors realise it’s a matter of time until the bubble bursts. They sell out and bank profits.
– asset prices descend even quicker than they rose, as speculators start panicking. The tulip bubble ran from 1633 to 1637. At its peak, one tulip could be traded for an entire farming estate. In one month, the price of tulip bulbs rose 2 000%! Once the bubble burst, a tulip cost the same as an onion.
The ostrich feather boom started in 1890, driven by fashion. At one point, you could get more money for 1kg of feathers than 1kg of gold. The boom ended in 1914, blamed on the arrival of the first motor car. Ladies weren’t able to wear elaborate feather hats in cars with roofs, so the demand for feather hats collapsed.
What’s the connection to tulips and ostrich feathers?
There’s no doubt blockchain technology and cryptocurrencies could have a massive impact on all forms of business. However, this doesn’t guarantee that it’ll be the first choice as a store of value. It’s difficult for proper investors to consider an asset that can appreciate 180% in six months.
Similarly, bitcoin has lost over 80% on a few occasions, causing serious investors to allocate very small amounts of money to it and only as a form of speculation. In June 2016, bitcoin’s market share of all cryptocurrencies was 81%. It’s now 41%. This drop’s not due to bitcoin’s price decreasing – the price has skyrocketed since 2013 – but other cryptocurrency competitors growing more quickly. In comparison to younger cryptocurrencies, bitcoin is slower and more limited.
“We learn from history that we do not learn from history,” George Hegel said.
Warren Buffet says to only invest in what you know. Apparently, there are only a few hundred people globally who understand what Bitcoin is and how it really works. For many, it remains a mystery. If you don’t understand your investment and you’re buying when there’s a state of euphoria, tread carefully. You might be the last buyer at the highest price.