Is the SEC’s decision not to approve the first bitcoin ETF a sign that there is a bitcoin bubble?
Yesterday, the SEC issued a long-awaited ruling on the bitcoin’s worthiness for institutional investing. The SEC decided that because of bitcoin’s complexity and exposure to international markets and regulations, it is not yet suitable for listing on a U.S.-based stock exchange.
Some say that’s fine, bitcoin doesn’t really need the SEC or Wall Street money to keep moving. Other’s say that mainstream acceptance is key to stability and to assuage concerns that the bitcoin market is a bubble.
Background on the bitcoin bubble
To put this simply, there are two very distinct camps emerging when it comes to the bitcoin bubble talk.
This is an oversimplification, but I think that we could characterize camp A as traditional economists and investors that say the fundamentals of bitcoin don’t really make sense as a sustainable store of value.
They point out that bitcoin doesn’t really function as money (even though it was devised as a peer-to-peer payment system, that’s not really how it is used); and that the value is not really based on anything—it’s not tied to a commodity or any kind of assets—and that they whole system is one hack away (or one technical glitch) from collapsing at any time. (For a good explanation of this argument, check out the future money chapter in Naked Money).
There’s also the exposure issue: Since most bitcoin is held in international exchanges there is a concern that bitcoin markets can be manipulated.
For those in camp A, bitcoin doesn’t make sense and is a financial fad, or a bubble, that will never reach the establishment level it needs to be successful, and instead be relegated to a digital novelty.
Then there is camp B. In that group (again this is a huge simplification) we have technologists, venture capitalists, and proponents of personal freedom. This camp views bitcoin as a disruptive technology that is a new way of conducting financial business more transparently and efficiently.
The value of bitcoin is the blockchain, a new technology that doesn’t look to compete with government-backed cash but replaces it with a more secure and equitable system.
For camp B, bitcoin is not a bubble; it’s a massive opportunity.
But still, is bitcoin a bubble?
I guess the answer to the bitcoin bubble questions depends on where you fall on the camp A/camp B spectrum. But, for more reading, you should check out a piece that came out this week from Vikram Mansharamani, a financial thought leader who posts regularly on LinkedIn.
A couple of years ago, Mansharamani wrote a book called Boombustology: Spotting financial bubbles before they burst (which I have not read, but I think it’s important for context). In his post, he breaks down bitcoin according to the criteria he identifies as key ingredients to a boom/bust cycle.
The five bubble filters that Mansharamani identifies are demand, leveraged buying and debt, psychology, politics (or regulation), and potential.
Filter one—demand: This is slightly confusing, and probably more nuanced than I’m understanding, but the demand for bitcoin (especially during bullish trends) is not totally based on speculation. People are also using bitcoin as a hedge in unstable currency markets around the globe. In other words, there is a good demand balance, not just pump and dumpers.
Filter two—dept: Mansharamani makes the hallmark point of bitcoin evangelists, which in this context points to the underlying utility of bitcoin and can be used as contra-bubble evidence. He writes: “In addition, the fact that printing presses around the world continue to print more and more money implies that traditional currencies are being debased at an alarming rate. With a fixed algorithmic release of additional bitcoins into the market and a cap on the total number that will ultimately be issued, the crypto-currency represents a non-printable currency (similar in this respect to gold).”
Filter three—psychology: If you spend any time reading the cryptocurrency-related news you know that there is a frenzy of optimism about bitcoin’s potential. This is definitely bubble behavior.
Filter four—politics/regulation: The regulations surrounding cryptocurrencies are complex, but focusing on the SEC’s ETF decision is somewhat symbolic. If the SEC approved a bitcoin ETF it would have sent a signal that bitcoin was suitable and stable enough for mainstream investing, which would have introduced more streams of capital to cryptocurrencies and potentially eased some of bitcoin’s market volatility.
Filter five—potential: Bitcoin and blockchain are still in early days. As we seen in the headlines, there is just now an awakening happening to all of the issues that blockchain and be used to make more efficient—everything from real estate contracts to healthcare records, and accessible banking for the world’s poor to complex financial engineering. Put simply, blockchain and bitcoin still have a ton of untapped potential.
So, by using the criteria above, which is just a simple summary of Mansharamani’s more complex analysis, it looks like bitcoin exhibits some bubble behavior (many the frenzy and the lack of mainstream, institutional support) while also exhibiting some factors that could create good, long-term investment opportunities, such as the potential and the fact that cryptocurrencies like bitcoin are quickly becoming a digital alternative for fiat currencies that are in trouble.
It will be interesting to see in the coming weeks how much impact the SEC’s decision has on bitcoin’s steady march up and to the right.