The value, development and future of Bitcoin: It’s not a tulip bubble, but there may still be speculative frenzy

The recent surge in Bitcoin prices is very abnormal.

Of course, being abnormal is part of Bitcoin’s appeal. Bitcoin has redefined money, creating the concept of scarce digital assets that have never existed before. So it’s hard to maintain the standards of a “normal” asset.

But as someone who has decades of experience watching financial markets, through repeated booms and busts, I’m very uneasy about Bitcoin’s latest surge, which saw it jump 20% over the weekend, 60% in two weeks and a staggering 900% so far this year.

Record gains are irrelevant. The more important question is: “What to compare Bitcoin to?” Comparisons within the same asset class are particularly tricky, and cryptocurrencies have no precedent for establishing a benchmark of value, making them difficult to value.

The difficulty of valuation puts us in a difficult position. Investors must at least try to record the value of the assets they buy in numerical form. By definition, any rational assessment of the value of something must be compared to the value of other things. Value is a relatively intrinsic concept.

Comparison Tulip Bubble

This is a value comparison worth thinking about.

Three weeks ago, when Bitcoin was worth just $7,000, Convoy Investments noted that the only other asset to outperform Bitcoin’s price performance in history was the Netherlands’ infamous Tulip Mania of 1619-1622.

As most finance students know, the tulip mania did not end well.

While the tulip bubble analogy cited by many Bitcoin critics is a somewhat hackneyed one, I think many Bitcoin bulls would instinctively laugh at them for citing it - it's often a simple parallel.

Last week, William Mallers fiercely refuted financial blogger John Lothian's criticism of CME's plans to introduce Bitcoin futures.

The problem is that this rebuttal is often based on critics misunderstanding Bitcoin’s far-reaching social potential, missing the point and seeing it as something as useless as tulips.

The problem with the tulip bubble wasn’t that the tulip bulbs had no value at all, but that a cycle of mania, speculation, and FOMO drove prices far beyond their true value. There could be a strong case to be made that a similar phenomenon is driving the price of Bitcoin far beyond its unproven potential.

In my first article about Bitcoin four years ago, I also cited the tulip bubble comparison as the Bitcoin price was as high as $1,200 at the time. This proved to be prescient, as the price fell to around $200 not long after, and it took three years to get back to the highs. But by then I didn't care. Now writing this column has made me understand cryptocurrencies more deeply.

So I changed my mind, wrote a book about Bitcoin, and eventually left the Wall Street Journal to join the Digital Currency Initiative at the MIT Media Lab.

This keeps me from being like Jamie Dimon who ignorantly references the tulip bubble. I firmly believe that what matters in cryptocurrency is that its core value is a superior, more powerful and universally acceptable form of money.

It’s just that I think it’s right to separate the hard-to-quantify, intrinsic aspects of its fundamental value and humanity from the specific, ephemeral, quantifiable expressions it finds in the marketplace.

The investment frenzy

What worries me most is the fanatical investment mentality of the investor group, shouting the slogan "Run to the Moon" and simply justifying price performance.

For example, the intrinsic scarcity of Bitcoin will drive its price higher indefinitely; the long-term prospects of the fork: although there is no technical improvement to Bitcoin Core, it provides investors with a wide range of options in the future.

If they find these forks more attractive — and who’s to say there won’t be better ideas? — it doesn’t matter because there are only 21 million bitcoins in existence.

The problem with Bitcoin’s immature investment culture is not that it will adjust to the market. It limits its use of technology to replace more fundamental social values.

Speculation is inevitable, and it can even lead to innovation. But if Bitcoin is to change the lives of billions of people, it needs to become a more mainstream asset class that is connected to the real world. As much as we may all like such eccentric, abnormal "money honey badgers", Bitcoin needs to become more normal.

It needs to be more stable and it needs to be a two-way market.

Financial professionals are about to bring us two-sided markets. These people will appear at CoinDesk's "Job Consensus: Investing" investment conference on Tuesday. Meanwhile, venture capitalists and hedge funds are creating investment vehicles to actively invest in bitcoin and other crypto assets; investment banks and exchanges are creating infrastructure to let other institutions invest in them.

The Future of Bitcoin Futures

For bitcoin bulls, they welcome CME Group’s plan to launch bitcoin futures contracts by the end of the year as a simpler way for institutional investors to invest cautiously in the industry.

Fund managers who trade these quarterly contracts and chase ROI don’t have the same faith in Bitcoin as any long-term Bitcoin holders do. Now they can short the market in futures contracts.

They will gladly act to drive the price lower if it makes sense to do so. People on Wall Street are pragmatic, self-interested, and obsessed with short-term trading. They will not hold Bitcoin for the long term.

It is unclear how much of a direct impact this will have on futures trading in the bitcoin spot market, where CME’s contracts will be settled in cash, meaning neither party will actually own the underlying asset. Investors only use the bitcoin market as a reference.

But as futures markets gain liquidity, and as cross-market hedging strategies mature further, CME futures prices could become a driver of spot market prices. This is likely to happen because of this imbalance between institutional and retail market sizes.

The fact is: this is welcome. By reducing volatility, two-way institutional participation will increase Bitcoin’s impact on the world.

This is an important step towards achieving Bitcoin’s goals. But it also means delaying Bitcoin’s price “rush to the moon”.