Ideas & Debate

Why it’s a matter of time before Bitcoin collapses

The current market capitalisation of Bitcoin is eight times that of all firms listed on the Nairobi bourse. FILE PHOTO | NMG
The current market capitalisation of Bitcoin is eight times that of all firms listed on the Nairobi bourse. FILE PHOTO | NMG 

As a follow-up to my last week’s article, ‘‘Clear tell tales of Ponzi scheme in the making’’, I would like to end the series with a few thoughts on the asset-in-question: Bitcoin. No doubt, this red-hot currency is exploding.

Over the weekend, the total market capitalisation for all cryptocurrencies exceeded Sh30 trillion for the first time.

Of that amount, Bitcoin’s market cap represented the lion’s share, accounting for about Sh16 trillion. To put that in perspective, that is eight times bigger than total market capitalisation of all listed companies at the Nairobi Securities Exchange (NSE).

The move comes as its price surged to nearly Sh1 million according to the CoinDesk Bitcoin Price Index (BPI), bringing its year-to-date performance close to 1,000 per cent.

Now, call it what you want, but in my book—this is a clear bubble. And for today’s article, I would like to explain this bearish bias. 

First, while there may be good reasons for buying Bitcoin, the dominant reason at the moment is that it is rising in price. People are buying Bitcoin because they expect other people to buy it from them at a higher price; the definition of a greater fool theory.

But here’s the problem; at some point when the market reaches astronomical highs, this will happen, everyone will try to realise their Bitcoin wealth for millions, the market would dry up and the price would crash. Human psychology is still the same. History repeats itself.

Second, getting Bitcoin’s “true” value is difficult. Traditional methods for valuing currencies - balance of payments, budget deficits, interest rate differentials et cetera – do not apply. Use of Bitcoins transactional activity and user adoption are the only indicators albeit rather unreliable.

This is because most transactions are generated by automated systems and don’t represent economic activity. But if we assumed reliability, comparing bitcoins underlying activity and its price, reveals a glaring gap.

Bitcoins value far exceeds its use value in transactions. This means one thing: a substantial part of its value is supported by sentiment. In other words, there is too much “air” in the price. And here’s the problem; sentiments are fickle. Once they change, the “house of cards” falls. 

Third, although Bitcoin has a fixed supply (21 million), it’s foolish to imagine that its price will remain elevated. Consider gold.

An asset with similar characteristics – finite supply, store of value, medium of exchange, portability et cetera – but has suffered multiple corrections over the years.

Take for instance, in between 1970-1980, it surged over 1,400 per cent but eventually lost a third of its value in 1981 and went on to lose over 50 per cent in the next 20 years.

It’s currently down about 25 per cent from its 2012 highs. What’s my point? Bitcoin’s deflation is only a matter of when not if. It’s not immune to corrections.

Look, I believe Bitcoin is legit. Potential real life applications are many. But for its price, it a different story. Nothing lasts forever. Every party must come to an end.