How Strained is the Bitcoin Bubble?

The cryptocurrency market is currently in a frenzy of speculation. As the first successful cryptocurrency, early Bitcoin users will likely be unaffected should it all come crashing down. Those who entered the market late are the ones who risk losing financially.

This is not simply a prediction. Ron Insana of CNBC has spent over thirty years reporting on speculative ventures. In a recent article he traces the rise and fall of numerous disruptive innovations, from the South Sea speculations of 18th century Europe to our recent real estate crisis. He reaches the same conclusion regardless of commodity or innovation: “excessive optimism” and irrational expectations lead to bursting bubbles.

There is no doubt, according to Insana and numerous others, that Bitcoin is in bubble stage. Bitcoin’s value has become significantly inflated as more speculators place their stakes in the cryptocurrency. But is the speculation irrational or overly optimistic?

Insana says yes. He bases his conclusion by Bitcoin’s lack of ability to stand up to a simple currency test. The test is comprised of three requirements. It must be a “storehouse of value.” It must be a “unit of account.” And finally, it must be “a medium of exchange.”

Though Bitcoin is a medium of exchange, the number of users is far less than other currencies, namely the U.S. dollar. Bitcoin is an innovative unit of account, in that its fundamental technology is blockchain, which is an open ledger account. However Insana points out that it isn’t clear who, or what entity, is performing the accounting. Finally, it will only take a bursting bubble to determine whether or not Bitcoin has stored value.

Since Bitcoin falls short on the currency test, speculators have no way of making rational decisions regarding its behavior. Bitcoin is unpredictable. Its value is suspect and someone who invests heavily in this feverish speculation is liable to lose it all when it comes crashing down.

Insana concludes with a final observation. Despite Bitcoin’s inevitable crash, it has been disruptive and transformative. And whatever follows Bitcoin will likely learn from its mistakes.