By Stephan Goss
December 4, 2017

Is Bitcoin a huge bubble? Based on what many investors have been saying lately, you’d certainly think so. While this stance isn’t technically wrong, I can say with certainty it’s built on unsound logic.

Bitcoin is backed by $0 worth of assets, so based on this criteria, yes, a valuation of $11,000 per coin (as of 12/4) certainly qualifies as a bubble. But with this logic, even if Bitcoin’s value were $1, it would still be a bubble. If you are working with a model that deems something overvalued at any price other than $0, odds are your model is bad.

Bitcoin prices are driven by demand for a limited commodity. There are currently about 16 million coins in existence, and based on Bitcoin protocol, there can never be more than 21 million coins, ever. It’s truly Econ 101. There is a finite supply, and since Bitcoin has become a mainstream brand name, demand has increased, therefore driving up the price. By default, a non-asset backed currency trades purely on hype. That’s the beauty of a decentralized system, and it’s the thesis at the core of Bitcoin’s success.

If you are looking to draw a parallel to traditional assets, do not use currencies like the USD. Fiat currencies are backed by assets and the economic power of the issuing country. If a country’s economy sees outsized growth, its currency will appreciate. If the economy slumps, it’ll devalue. Since there is no economy behind Bitcoin, that model won’t work.

Instead, compare Bitcoin’s valuation to the fine art market. Like Bitcoin, a great painting has no asset-backed value, but it is a scarce resource. Even my finest work is worthless because there is no demand for it. When an auction house estimates the value of a Picasso, it doesn’t do a fundamental analysis of what the paint, the canvas, etc., is worth. Instead, it attempts to predict the demand for the painting, which is the key driver of how much someone is likely to bid. The value is entirely backed by the demand for the painting. If the demand wanes, the price goes down. If the demand waxes, the price goes up.

If you want to figure out if Bitcoin is a bubble, first off, start treating it like the high-risk, speculative commodity it is. The price 50 years from now will depend entirely on its future demand, so ask yourself the following questions:

Will currencies and assets be based on distributed ledger technology in the future? I think the answer is a fairly resounding “yes,” and if you think this is a “no,” you need to do more technical research.

Will the currency of the future be asset-backed or demand-backed?

This is where things get tricky. Currently, a clear majority of cryptocurrencies are demand-backed. Little work has been done on the asset-backed side because it is much more challenging to launch an asset-backed currency, as it requires a large upfront investment to purchase the assets.

 

If you think demand-backed currencies are the future because perfect decentralization (which cannot be achieved if there are underlying assets) will make up for the downside of high volatility, your next question should be: Will the Bitcoin brand be strong enough for it to remain the dominant player in the space, or will its technical challenges erode its hold on the throne and allow a company like Ripple, Litecoin, or an entirely new player to win? I doubt there will be more than a handful of currencies out there 50 years from now, since there is really no point for more than a few.

Long story short: Forecasting or evaluating Bitcoin prices based on fundamentals is silly since it doesn’t have any. When looking at demand-backed currencies, you are playing a game of forecasting hype. You have to consider the whims of the market and potential technology growth.

Bitcoin may be a bubble, but please stop saying it is because of fundamentals. You will have to make a stronger case if you want to convince me.

Stephan Goss is CEO of Zeeto, a questions-based data discovery company.

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