09/01/2021
BITCOIN THE MODERN DAY TULIP MANIA
30.12.2020
By Laurence I. Sithole, Bachelor of Commerce (Honors) Banking & Investment Management, National University of Science & Technology, Zimbabwe
INTRODUCTION
A frequently asked question nowadays is when is the best time to invest in bitcoin? My answer every time is the same: when they were issued for the first time in 2008. Not that I would ever recommend it to anyone that they invest in bitcoin in the first instance. However, given the cryptocurrency's price trajectory, you would be forgiven for considering to add this novel investment to your portfolio.
Bitcoin has recently broken records with it's price reaching an all time high of US$27,936.94 as of today 30th December 2020. The first time that the cryptocurrency reached an all time high was in December of 2017 when it breached the US$20,000.00 mark before retreating to US$9,000.00 and then subsequently to US$3,500.00 in the year that followed of 2018.
It has since breached the December 2017 price level and has gone on to set new record highs. If an individual had bought bitcoin when they were first issued in 2008 and held them to date they would have made a massive fortune depending on how much they would have invested. The initial price of bitcoin was a mere US$.0008 a tiny fraction of a cent for a single coin. Now if you at that price had set aside US$1,000.00 at that price you would have bought 1,250,000 coins which today would be worth a mind numbing and staggering US$ 34,921,175,000.00! To put this is perspective an investment of US$1,000.00 in bitcoin around 2008 today would have made you as wealthy as: Sheldon Addelson the hotel and casino billionaire and in roughly the same league as Masayoshi Son the brains behind SoftBank. You would also be three times richer than Roman Abramovic and Aliko Dangote!
ORIGINS
The world owes the existence of bitcoin to a very obscure individual named Satoshi Nakamoto. I call him obscure because his identity has never really been confirmed however this character is widely credited with the invention of the cryptocurrency.
A loose definition of bitcoin is that it is a virtual currency design to revolutionize peer to peer transactions without the need for an intermediary like a bank or a credit card agency, the exchange of personal information and or transaction fees.
Central to bitcoin and any other cryptocurrency for that matter is blockchain technology which it uses to record transactions on it's network. A blockchain is essentially a publicly distributed ledger that records each and every transaction ever made on the block. When that block memory is full it is added in sequential order to the chain of blocks. This ledger is freely available on any computer on the bitcoin network and it validates bitcoin transactions, stores them on the blockchain and relays the transactions to the network of computers. The computers on the network are called nodes.
Because the blockchain database is said to be stored on a network of computers rather than on a server hacking or stealing bitcoin is said to be virtually impossible for would be cyber criminals. A hacker would have to break into a majority of nodes simultaneously which is highly improbable.
There is also said to be a predetermined number of bitcoins that can ever be created meaning that the cryptocurrency cannot be devalued in the future by any central bank issuing more units of the cryptocurrency but this also by implication means that cryptocurrency is not regulated.
For all the hype around bitcoin especially historically bitcoin was and is to large extent a notoriously difficult commodity to buy and sell so much that in it's early days the Winklevoss twins (the Facebook co-founders) had to resort to setting up a cryptocurrency exchange to be able to trade bitcoin. This move significantly reduced the lack of liquidity and ease of trade.
These are among some of the merits bitcoin proponents cite in favour of full scale adoption of the digital currency. The cryptocurrency in addition to having been on the upsurge in terms of price is can also be used to settle transactions for goods and services.
The investment case on the face of it for bitcoin seems to be strong with respectable financial news websites like Investopedia predict that bitcoin's price will rise to at least US$500,000.00 by 2030. Considering that bitcoin as of 30 December 2020 had a market capitalisation of US$516 billion and traded volume on that day of US$52 billion does not make the prediction 2030 predictions seem far fetched.
RISKS
Before we all conclude that bitcoin is a solid case for investment start piling in our investment dollars into the cryptocurrency there are some pertinent matters that we need to carefully consider. Due to the traceless nature of the cryptocurrency bitcoin has been used in criminal activities and the most prominent example being Silk Road the now defunct online store which criminals would use to trade narcotics and banned substances without ever divulging their identity settling their transactions through bitcoin.
Other risks include but are not limited to:
1. Volatile & fluctuating maker; there is no guarantee that after our invest in bitcoin that you will ever get your money back. Granted no investment is ever guaranteed but not all investments have the same level of risk as bitcoin. The price of bitcoin has swung from all time highs to lows in the space of mere months. This price volatility also stems from the fact that it is virtually impossible to appraise the fair value of bitcoin because it does not generate any cash flows to which you can apply discount rates. This means bitcoin does not have a net present value and or intrinsic value. There is consequently no way of telling at any price level if bitcoin is either under or over valued. Bitcoin price levels seem to be influenced only by pure and raw forces of demand and supply which can change at the drop of a hat.
2. Cyber theft; in spite of the earlier security merit, cryptocurrency is technology based and hacking is a serious risk. There have been many reports in the past suggesting that buyers of bitcoin have lost their investments on exchanges and in mining losses. Exchanges are likely to be hacked even if you have the protection of a smart wallet. It is imperative therefore that a prospective buyer carefully research cryptocurrency wallets before investing.
3. Fraud from fake exchanges; due to the lack of security and recourse in the event of deals and trades going wrong.
4. Little or no regulation; most governments do not have a clear stance on cryptocurrency which means that there is little indication from government policy on what is legally permissible in terms of trading and investing in bitcoin.
5. Technology reliance; thisnis both an advantage and a serious disadvantage at the same time given the fast paced changes in the technology space. Bitcoins are digitally mined and exchanged via smart wallet without this technology bitcoin is essentially worth nothing. In addition to this handicap there is no physical collateral to back up the value of bitcoin unlike in the case of shares, bonds, mutual funds etc. Bitcoin owners are more vulnerable than most to cyber threats and a system that can be shut down.
6. Limited use; bitcoin may be a step toward new monetary exchange however, there are few companies that accept it as a viable form of currency;
7. Financial loss; there are circles of individuals who believe that bitcoin is a ponzi scheme with those at the top benefiting from the ignorance of others. As more people buy bitcoin it creates a bubble economy. This is when the price of an asset rises beyond what can he fundamentally explained by its value. When the bubble bursts then the cryptocurrency will become useless.
CONCLUSION
Financial manias and crazes are not new to the world. All throughout the ages history is littered with them, periods of irrational exuberance where where rationality and sanity seem to be suspended in our affairs and dealing with money. All manias display strikingly similar characteristics.
Bitcoin and the Dutch tulip mania seem surprisingly contemporary.
According to Britannica, the Tulip craze or Dutch Tulpenwindhandel was a speculative craze/frenzy in 17th century Holland over the sale of tulip bulbs. Tulips were introduced to Holland from Turkey in 1550 and they delicately formed into vividly coloured flowers. They became a costly item and very soon demand outstripped supply. The prices of the rare variety of tulips began to rise to unwarranted heights in northern Europe.
By 1610 a single bulb was acceptable as dowry for a bride and flourishing brewery was exchanged for one bulb in the same period. The craze reached it's height in Holland in the years 1633-37. The trade had been restricted to professional growers but steadily rising prices prompted the middle class and the poor families began to speculate in that market. Homes and estates were mortgaged do that bulbs could be bought and resold at higher prices. Much of the tulip trade occurred without the tulips ever leaving the ground.
The crash came early in 1637 when doubts arose as to whether prices would continue to rise. Almost overnight the price structure for tulips collapsed sweeping away fortunes and leaving behind financial ruin for many ordinary Dutch families.
Does this story sound familiar? We are living through the first parts of the mania. The only difference is that in stead of trading tulips we are trading an incorporeal currency whose value cannot be fundamentally ascertained using modern financial techniques or any other techniques for that matter. The ending for bitcoin will not be any different from tulip mania.
Greg Herlean a columnist for Forbes magazine asserts that cryptocurrency is still a very novel technology. Bitcoin has been around for just over ten years. It is yet to develop into something solid. The technology upon which bitcoin is basedos fast changing and there is no telling how the market will evolve. The best way to approach this new investment is with caution and diligence.
