Is Bitcoin the digital version of the tulip bubble?

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The tulip bubble

The most infamous of all was the Dutch tulip bubble that gripped Holland in the early 17th century.

“Tulips, which were seen as a luxury item and status symbol, first boomed in popularity when a virus infected them, causing the petal colours of the flower to suddenly change into multi-coloured patterns. In 1634, speculators began to enter the market and saw how the new rich and middle class in Holland’s Golden Age were willing to pay extraordinary sums of money for a single bulb, and by 1636, stock exchanges were established to trade in bulbs and their future options.

“Eventually though, in 1637, the market for tulips collapsed as people could no longer afford to purchase even the cheapest bulbs. This saw a tremendous drop in value and sparked a financial catastrophe for many,” says Sameer Singh, research analyst at Old Mutual Wealth Private Client Securities, adding that while the flower still remains popular in Holland, the story should serve as a reminder that markets can be extremely irrational at times.

More attractive for speculation

While Bitcoin has increased in acceptance, Singh notes that it still falls well short of mainstream fiat currency and the price movement over the recent past makes it quite unpredictable as a store of value. “Perhaps over time it could stabilise and gain mass appeal as a means of exchange. However, for now its volatility makes it more attractive for speculation than for facilitating trade.

As such, Singh says that those investing in Bitcoin as a currency should adopt an opportunistic trading strategy, pay attention to price action, analyse momentum indicators and utilise buy/stop orders regularly over short periods of time.

“The alternative is to hold Bitcoin for the long term with the faith that its price will stabilise, its acceptance (as a means of trade) becomes more widespread and its purchasing power slowly increases over time. This, unfortunately, is still yet to be exhibited,” he adds.

However, Singh believes that purchasing Bitcoin as a collectible because it was the first cryptocurrency, has a slightly better footing and similarities to being used as a store of value, as is the case with gold. “Within its code, Bitcoin was designed to reach a maximum number of units, 21 million Bitcoins to be exact. By most calculations, the total number of Bitcoins will reach their zenith in the year 2140.”

Digital gold

This brings about two consequential implications, he explains “Firstly, Bitcoin is scarce and, secondly, as a result, increasing demand should realise a higher value. Additionally, owing to the blockchain existing outside of the financial system, it could serve as a store of value, a digital gold, for those seeking an alternative to the status quo of central banks, financial regulation and industry middle-men.

“However, as it stands, the regulatory environment around Bitcoin remains a source of much uncertainty. Critically for purchasers, as with any investment, the price paid will be a defining element of the potential for future returns,” he adds.

So what does the future hold? This is the real “million Bitcoin” question, says Singh. “Blockchain as a technology and platform, we believe, is here to stay. There are numerous advantages that the platform maintains over traditional transaction networks which have seen organisations from central banks to private banks utilising the technology and creating their own closed loop networks for internal transactions.

“These advantages coupled with the increased adoption of artificial intelligence portend an exciting future where, at the very least, the cost to transact (being measured in both time and money) should decrease.”

Opento disruption

Singh says that the future for Bitcoin, however, is somewhat more uncertain. “As we know, there are many more cryptocurrencies in circulation, most are quite similar in nature while others are quite different, such as Ether. The issue for Bitcoin, specifically, is that it is the first cryptocurrency and has benefitted from this advantage.

However, this leaves it open to disruption from new superior entrants, he concludes. “With the state of technology continually in flux and improvements in efficiency and productivity gains being the eternal pursuit, it would be bold to think that Bitcoin is the cryptocurrency to rule them all. Most importantly, when the next evolution of cryptocurrencies rises to the fore, astute investors and traders would be mindful not to get caught up in the hype, understand the critical aspects of the underlying technology involved and manage their expectations accordingly.”