Is Bitcoin just a bubble?
Bitcoin and the Tulip Mania
Chances are, you have read articles like this one calling Bitcoin a bubble. Many of writers creating such pieces even go as far as comparing current Bitcoin market state to the Tulip Mania.
The Tulip Mania is a period of 17th century in the Netherlands known for extraordinary growth of tulip bulb price. Speculators bought new types of bulbs and sold them with profit on the next day. The price of bulbs grew constantly. The cost of certain types of bulbs could be 10 times bigger than the annual salary of workers! In the end, the prices crashed spectacularly. Here is a great video explaining the Tulip Mania:
Analysts criticizing cryptocurrency and Bitcoin in particular often use this example to prove that crypto will fail economically.
But can the value a decentralized P2P money remittance system be really compared to the value of a flower?
All a single tulip can do is to be beautiful. A single Bitcoin can do much more. It can be stored for as long as the system will exist. It can be sent to any other user of network, regardless of the location. It cannot be duplicated – unlike a tulip. By buying a Bitcoin, you are buying a near-indestructible digital asset. By buying tulip, you are buying a flower.
This fundamental difference between the Tulip Mania and the Bitcoin “mania” is the actual value, the usefulness of the assets in question. Because Bitcoin is much more useful than a tulip, the comparison of the Bitcoin market with the Tulip Mania is irrelevant.
Bitcoin has “died” many times
Apart from comparing bitcoins to tulips, there is one more thing cryptocurrency sceptics often do: declare it dead. Every time a market enters a large correction, Bitcoin opponents are eager to claim that the cryptocurrency is taking its last breaths. Do not believe? Here’s the list with majority of Bitcoin obituaries.
However, historically, Bitcoin price has always recovered, proving all the naysayers wrong.
So, is the Bitcoin bubble real?
Usually, when the economic bubble “pops”, the asset never regains or surpasses its all-time high price. Bitcoin, on the other hand, has surpassed its previous ATHs after 80%+ drops.
A bubble occurs when the market value of an asset is much higher than its intrinsic value – think of the Tulip Mania. It is hard to determine the intrinsic value of Bitcoin, but it may very well be lower than its market value (we’ll explain that later on).
As you can see, there is no evidence behind the claims of Bitcoin being a bubble. If anything, the facts are against this theory.
What gives value to Bitcoin?
Main factors giving value to Bitcoin
There are 6 main factors that make an asset, such as precious metal or fiat currency, valuable. Contrary to what Bitcoin critics say, the world’s largest cryptocurrency may have more reasons than traditional assets to be valuable.
1. Fungibility & uniformity
Every single Bitcoin is equivalent to any other Bitcoin. Same can be said for fiat currencies – every single US dollar in circulation is equivalent to any other dollar in circulation. Every amount of Bitcoin of the same denomination have the same value (1BTC = 1BTC).
A single Bitcoin can be divided into smaller parts. Satoshi, the smallest part of one bitcoin, is equal to 0.00000001 BTC. Bitcoin is far more divisible than the majority of fiat currencies. For example, if BTC would cost 1 million USD, then satoshi would be equal to 1 cent.
Worldwide, more than 15 000 merchants accept Bitcoin. There are both small local businesses among them, as well as some global companies, such as Microsoft and Overstock. Here is the biggest list of businesses accepting Bitcoin.
Of course, this is the area where fiat currencies are still far ahead. However, the general trend is that more and more merchants (both online and physical) start accepting digital currencies, Bitcoin included.
4. Limited supply
There will never be more than 21 million bitcoins in existence. Right now, It is set in the Bitcoin algorithm, which can only be changed if 51% of miners agree to do it. The possibility of this happening is almost non-existing.
What’s more, some bitcoins are likely lost forever, with their owners losing private keys. Here is a story of a man who reportedly lost 4000 BTC this way. And here is another similar story. Of course, such cases only make Bitcoin more valuable, because the actual supply of BTC decreases. According to this article, nearly 4 million bitcoins might be lost forever.
Now, compare it to fiat currencies and precious metals.
Former are printed by central banks. Governments decide when and how much USD, for example, to put into circulation. The system is not transparent and gives governments control over money.
As for the precious metals, they are being extracted from the ground all the time. No one can surely tell, how much there is left and what would be a final amount of a certain metal, for example. Once again, the situation is far from being transparent.
Once you have bought Bitcoin, it can be accessed from anywhere if you know your address and public key. It doesn’t even matter what type of wallet you use (read our guide to choose the best wallet for you!). In some cases you will only need to memorize a 24-word seed phrase. After you have done it, you will always have access to your bitcoins.
In comparison, fiat money and precious metals have to be stored somewhere physically. If, for some reason, you do not have access to this place or company, such as bank, you will lose your funds.
Bitcoins can be used for an unlimited amount of times, unlike gold or paper money which will eventually be unusable due to the damage. What’s more, every single bitcoin will exist for as long as the Bitcoin network will exist. Once again, paper money and precious metals do not have this property.
It is one of the largest P2P networks in the world
Bitcoin has no competitors when it comes to its decentralized network size. To understand just how big and powerful it is, keep in mind that miners are using more electricity than certain countries.
This fact contributes to the value of Bitcoin. It is the first of its kind and can be viewed as a massive global experiment.
BTC is censorship-resistant money
No one controls Bitcoin. The algorithm runs on tens of thousands of miners. Each of them has a copy of the blockchain. Because there is no centralized server, there are only 2 ways to censor a certain transaction:
- To shut down almost all the miners. This would be almost impossible due to several reasons. First of all, it is impossible to identify the exact location of every miner. What’s more, the shut-down process should be executed before the transaction gets enough confirmations.
- To perform a successful 51% attack. In order to do so, at least 4 largest mining pools would have to cooperate, which is extremely unlikely. Another option is to buy enough ASIC miners to have more hash power than the whole Bitcoin network. In order to do so, you would have to buy ASIC miners worth more than 300 million USD! Of course, such an order would be impossible to produce and would make the prices of mining hardware skyrocket.
As it can be seen, Bitcoin truly is censorship-resistant. People worldwide have been using it thanks to this quality. In countries with unstable economies, such as Venezuela, or countries with limitations for moving money abroad, such as China, BTC has become especially popular thanks to this “immunity”.
Demand and supply
The bigger the demand and the smaller the supply, the more valuable asset is. Just as simple. Here is what determines supply and demand of Bitcoin.
Although the current supply of Bitcoin increases constantly due to miners’ rewards, the maximum supply will never exceed 21 million BTC. This guarantees that once all the bitcoins have been mined, there will be no inflation.
The demand for Bitcoin has been consistently growing. There are several ways to evaluate it:
1. BTC price history. Long-term, the price of the world’s first cryptocurrency has always been growing. The demand was especially high during the bull runs, such as the one at the end of 2017. More and more people want to invest in BTC despite its inflation due to miner rewards.
2. Public interest. With Google being the leading global search engine, Google Trends can serve a good indicator of just how much the general public is interested in Bitcoin:
Interestingly, the data correlates pretty well with Bitcoin price:
Thiers’ law & Metcalfe’s law
Thiers’ law states:
“In the absence of effective legal tender laws, if given the choice of what money to accept, people will transact with money they believe to be of highest long-term value.”
In Bitcoin’s case, it means that unless the cryptocurrency is rendered illegal, it could slowly become more valuable than traditional money. Some experts, such as Max Keiser, are sure that Bitcoin can replace fiat currencies competely:
Another law worth mentioning is Metcalfe’s law. It states:
“The value of the network is proportional to the square of the number of connected users of the system.”
Here’s an example. In the early days of Facebook, only Harvard students were using the social network. At some point the website, called thefacebook back then, had exactly 10 thousand users. At the time of publishing, there are approximately 2.4 billion users of Facebook worldwide.
According to Metcalfe’s law, Facebook is now 57.6 billion times more valuable than it was back then. Considering that Facebook is worth more than 130 billion USD now, the law seems to work fairly well.
Some may argue that as a money remittance network, Bitcoin is far from ideal. And they would be right. With transactions sometimes taking hours to be approved, the value of Bitcoin as an everyday payment network is limited.
The problem here is the limited scalability of Bitcoin. As long as relatively few people use the blockchain, the transactions get approved fairly quickly. However, when the load on the network increases, the fees go up, and so does the wait time.
Thankfully, many developers are working on solving this problem.
Possibly the best solution to scalability is something called Lightning Network. It is a system that allows users to make transactions without using the blockchain. Here’s how it works.
Suppose you want to send your friend some Bitcoins. You open a so-called off-chain payment channel and send your coins to your friend. They get transferred without being approved by the blockchain. There can be many transactions between you and your friend; when you are done, you conduct a closing transaction. It is the only transaction that gets processed by the blockchain, which settles all the previous transactions between you and your friend.
Based on the same principle, the transactions can be made between you and someone you don’t know. To ensure that the stranger does not steal your money before the closing transaction occurs, you both make a deposit. This deposit gets frozen by the Lightning Network upon opening a new payment channel. Logically, the amount of the deposit is equal to or bigger than the amount of Bitcoins any of you sends.
You may ask: why isn’t Lightning Network still fully implemented? Well, the caveat here is that the wallets of both sender and receiver must support it in order for LN to work. While many of BTC wallets already support the network, the other ones are still working on it.
Once all the users will be able to make transactions via LN, the practical value of Bitcoin as everyday payment processor will increase.
As you can see, there is no reason to say that the value of Bitcoin is purely speculative. Despite being so innovative, Bitcoin is still a financial asset and can be evaluated as such. In some ways, its value is even more justified than the value of fiat currencies and precious metals.
More importantly, Bitcoin is clearly superior to gold and fiat when it comes to the technical backside. Both of those are just objects that have value. Bitcoin, on the other hand, is the world’s largest decentralized money transfer network. A PayPal competitor controlled only by the algorithm.
Of course, Bitcoin network is still not ideal. However, the developers are working hard to make transactions quicker, the fees lower, and the network more energy efficient. The situation has already improved since the late 2017 chaos and will continue to improve as solutions such as the Lightning Network become more widely adopted.
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