Economists have long said that volatility of cryptocurrencies checks all the boxes of a market bubble, but in recent weeks, there’s been debate about when that bubble could burst.
Hundreds of billions of dollars were shaved off the total market cap of cryptocurrencies in the 24 hours leading to Friday afternoon, according to data from CoinMarketCap.
One of the economists who predicted the 2008 global financial crisis, New York University professor Nouriel Roubini, told Bloomberg TV on Friday morning that Bitcoin was “the mother of all bubbles,” as its value fell 15 per cent to below US$8,000, continuing its spiral downwards from over $10,000 at the beginning of the week and from almost $20,000 at the end of 2017.
Other major cryptocurrencies are also on the decline. On Friday alone, Bitcoin fell over 17 per cent, Ethereum fell more than 32 per cent, Ripple was down 38 per cent, and Bitcoin Cash was down over 27 per cent, according to CoinMarketCap.
The question on everyone’s minds is: If cryptocurrencies are a bubble, is it bursting?
No one knows what its real value is
According to experts, the real value of Bitcoin is difficult to determine because of two reasons: The currency is incredibly volatile, and trading practices may manipulate behaviour in unregulated exchanges.
Joshua Gans, the Jeffrey S. Skoll Chair of Technical Innovation and Entrepreneurship at the University of Toronto, argues that the Bitcoin bubble isn’t going to burst — because it already has.
“It’s down 60 per cent from December. This is already a burst bubble. And it could burst some more, all the way down to zero,” he said.
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He explained that Bitcoin’s market value can be classified as a bubble because its value isn’t based on anything real.
“A bubble is built on essentially nothing,” explained Gans.
An economic bubble is traditionally defined as trade in an asset at a price that exceeds its real value, otherwise known as a speculative market. Because Bitcoin and other cryptocurrencies are so volatile, it’s impossible to know their real value.
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“This is not even regular volatility for cryptocurrencies,” he continues. “And we think a market bubble is bursting when a stock drops 10 per cent.”
As Bitcoin climbed higher and higher near the end of 2017, defenders of the cryptocurrency began to tout the platform’s potential to replace gold as the new safe-haven play for investors. Gans retorted, however, that this is incredibly unlikely.
“People predicted that Bitcoin was going to burst when it was $100. Essentially, every economist will predict that it will burst, because the only scenario in which it doesn’t burst is that Bitcoin replaces gold. Gold has a very long history, it is very hard to replace gold and gold hasn’t disappeared.”
He concludes that the Bitcoin bubble will finish bursting when its investors panic about its plunging value and try to pull out.
Andreas Park, an associate professor of finance at the University of Toronto agrees that Bitcoin is a bubble, but argues that because the digital currency has been assigned value in an unregulated exchange, it became one the moment the enterprise rose above zero.
He also explained that since the trading practices of Bitcoin are unregulated, the market is often subject to nefarious activities.
“There’s 60, 70, even 100 exchanges where you can trade cryptocurrencies of many different kinds. You could open one yourself. In contrast to the financial world, there is absolutely zero regulation,” Park said. In addition, there is a small group of people with a lot of stock in Bitcoin and other cryptocurrencies.
This, he said, often leads to a practice called “manipulative behaviour,” which refers to artificially inflating the price of an asset for personal gain.
He reiterated that stability is key.
Bitcoin miners, investors argue that the market simply needs to mature
At this point, regulators have warned consumers that cryptocurrencies are highly speculative, and dangerous investments. Those who work in the space, however, argue that comparing the cryptocurrency marketplace to the mainstream financial exchanges isn’t fair.
“No, it’s not the mother of all bubbles. What people have to understand about this marketplace is that it’s a maturing marketplace,” said Cole Diamond, the CEO of Canada’s top cryptocurrency exchange Coinsquare.
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According to Diamond, the worldwide market cap of digital currency is approximately five per cent of gold. “It’ll at least hit gold if it establishes itself as a currency, and it will surpass the gold market.”
What we’re seeing with the wild dips and spikes in the value of cryptocurrencies is the market correcting itself, he says.
“It’s healthy correction,” he said. “Markets have volatility and this market will have more volatility because it’s still maturing.”
In response to the warnings of regulators and economists, Diamond retorts that the rapid increases are only natural for a fledgling market.
“It’s not a bubble because it started at zero and it has to increase over time.”