Is Bitcoin in a Bubble, or Is It Massively Undervalued?

Evaluating the current cycle of buzz


Tzogia Kappatou / Dreamstime

Bitcoin is all the rage again, and its major sustained price increase in recent weeks has prompted considerable interest and novice investment in the world's first cryptocurrency. Some people see this as a sign that bitcoin's end is near, but others argue that the infant e-money is actually massively undervalued in the long run.

As is common with any price peak and flurry of media chattering, bitcoin's most recent momentum has been met with predictions of boom and doom. A Wall Street Journal survey of economists found that an astounding 96 percent believe that bitcoin is experiencing a speculative bubble. The question for them is not whether the bubble will burst, but how badly, and how soon (if ever) it will recover.

It is true that the market shows signs of frothiness. Seasoned bitcoin users have found themselves inundated with questions from friends and relatives about how to cash in on this hot get-rich-quick scheme. When I talked to radio host John Batchelor about the bitcoin price increase last week, he told me he was reminded of the famous 1929 tale wherein famed investor Joe Kennedy quickly exited the stock market after his shoe shine boy deigned to give him investment advice. Contemporary anecdotes about people taking out mortgages to buy bitcoin fall into a similar vein.

Yet some have seized upon this investment flurry as sure proof that bitcoin's days are numbered—and running out. Former Federal Reserve Chairman Alan Greenspan told CNBC that he ultimately expects bitcoin to become worthless. Libertarian investor Peter Schiff likewise maintains that "bitcoin prices are headed to $0." The Nobel Prize-winning economist and apparent BitGrinch Joseph Stiglitz went a step further, arguing that bitcoin serves no social function and "ought to be outlawed."

But contrary to the now-predictable chorus of naysayers forecasting bitcoin's inevitable death, there are very good reasons to remain quite optimistic about the private currency's prospects. Even if the currency does see a short-term price correction, as is likely, the core value proposition at the heart of the bitcoin project continually proves to be vital and needed. The longer that the project succeeds, the better its future odds.

The bubble might not be as bubbly as it looks

In the short term, the recent record-setting prices did not spring from nowhere, but can be attributed to a series of technical and financial improvements that buoy bitcoin's future.

First, 2017 was a huge year in terms of the long-fought debate over how bitcoin can best scale. For about as long as bitcoin has existed, there were questions about how the currency could overcome the apparent trade-off between usability and security.

Fortunately for the bitcoin project, the network avoided a contentious hard fork in November and settled on a harmonious path forward based on two technical fixes. First, in August, bitcoin activated a change called "segregated witness," which will increase bitcoin velocity without compromising its security or decentralization. Then, in December, dramatic advances to the "Lightning network" project were made. This infrastructure development is designed to facilitate smaller transactions in a cheap and easy way without incurring high fees or slow confirmation by the bitcoin blockchain.

Additionally, 2017 saw impressive developments in financial maturity. By the end of the year, established Wall Street institutions such as the Chicago Mercantile Exchange, Chicago Board Options Exchange, and TD Ameritrade announced they would launch bitcoin futures trading on their platforms. This was good for the price of bitcoin in several ways. First, it signaled professional acceptance of the currency, which is always good for confidence. Futures trades also promised to smooth out some of bitcoin's famous volatility. And finally, it introduced bitcoin to a whole new subset of professional traders.

To the moon?

So the short-term picture might be a lot better than many outsiders assume. But there are good reasons to be optimistic about bitcoin's long-term future as well. Even if the price tumbles a bit in the coming weeks to correct for the recent frothiness—falling to "only" $12,000 or $14,000 or so after just recently breaking the $10,000 barrier two weeks ago—many bitcoin bulls see this as little more than a buying opportunity. To them, bitcoin is just going on sale.

A bit of context is needed.

If the first message that bitcoin's creator Satoshi Nakamoto broadcast in the "genesis block" is any indication—"The Times 03/Jan/2009 Chancellor on brink of second bailout for banks," a reference to that morning's headline of the Times of London—bitcoin was not intended to merely coexist in the current financial system, but supplant it. The problems endemic to poor government monetary management—debasement, inflation, cronyism, and boom-bust chaos—could be a thing of the past with a monetary system based on a censorship-resistant, hard digital currency.

The monetary economist Saifedean Ammous presents perhaps the most comprehensive case for bitcoin's potential as a sound monetary standard for global commerce in his forthcoming work, The Bitcoin Standard: Sound Money in a Digital Age. According to Ammous, bitcoin's real value "lies in it being a reliable long-term store of value, and a sovereign form of money that allows individuals to conduct permissionless transactions." He believes that bitcoin will one day serve the function that hard monies like the international gold standard or market-regulated free banking notes before it once served.

If this does prove to be the case, then bitcoin may be considerably undervalued indeed.

If bitcoin "hodlers" (people who hold onto bitcoins) are right, and the fundamental properties of a trustless, supply-capped digital currency are a significant enough improvement over the existing financial system, market players will gradually adopt the currency out of their own self-interest. Eventually, they believe that the financial system will switch to a totally bitcoin-based reserve economy, a flashpoint event known as "hyperbitcoinization." In that case, a single bitcoin would easily be worth millions of dollars. So "hodlers" are "hodling" for a very good reason in their view.

This may strike many as fanciful. After all, the existing system is not perfect, but it seems to do a good enough job. And it, well, exists. There are many entrenched and powerful players that are quite vested in keeping the current system going, even if it does come with the expensive baggage of regular global recessions, government financial mismanagement, and unfair taxpayer-funded bailouts.

Yet paradigm shifts always seem impossible before they become inevitable when viewed in hindsight, as the collapse of the Soviet Union demonstrates. And it's not just bitcoin believers who visualize this situation. None other than International Monetary Fund director Christine Lagarde herself publicly warned that bitcoin "puts a question mark on the fractional banking model we know today."

Of course, a lot can go wrong on the way to a sound post-state digital monetary system. But in the event that the stars align and things do go right, then the current bitcoin price appreciation will pale in respect with the future.