Financial Insights

Is Bitcoin A Bubble?

Bitcoin has taken the market by storm. As most readers are likely aware, Bitcoin has cruised through $10,000, $14,000, $15,000, $16,000 up from only around $1,000 to start the year and mere pennies just a handful of years ago.  The market has become euphoric about Bitcoin’s future and speculation is rampant. The euphoric and mindless buying isn’t rationale or based on a fundamental structure of support. Bitcoin’s future is likely to be exceedingly volatile. Still, Bitcoin is likely here to stay, short of massive government intervention. There is value in Bitcoin and blockchain technology. So the question remains. What is Bitcoin worth?

If you want to learn more about Bitcoin there are some links at the end of this text to provide a simple backdrop for this commentary.

Despite my opening thoughts on Bitcoin, I’m not a Bitcoin hater. In fact, I’ve personally owned Bitcoin throughout the past several years, although I recently sold my position. At the time that I purchased Bitcoin, I viewed it as a very speculative play on the future of cryptocurrencies and blockchain technology.

My rationale for owning Bitcoin for the past few years had been one of risk/reward. The risk was that the asset would decline to a value of zero, but the reward, the prospect of mass appreciation was very real. Today, however, that risk/reward balance is less clear because of Bitcoin’s tremendous appreciation.

The market capitalization of all cryptocurrencies has soared to over $400 billion with Bitcoin making up well over half of that total. At the time of this writing, there were over 1,300 cryptocurrencies in existence with more being created each week. Those currencies, excluding Bitcoin, are worth about $150 billion alone. The opportunity for fleecing people in this highly unregulated market is enormous and there are likely to be many victims in this storm. (This is not unlike the 19th century before the Fed when every bank issued its own paper money, financial panics occurred frequently and many banks failed each time.) Most people who own these currencies have little idea of what they are buying. This market is quite similar to 1999 when dot coms were booming everywhere and everyone was talking about what they were buying. My barber told me to buy eToys when it had an IPO. But even in 2000 when many of the dot coms were declaring bankruptcy, many others survived and went on to become highly successful companies.

Bitcoin itself has some issues that it will need to work through if it’s going to survive and succeed. Just mining Bitcoin, i.e. creating new Bitcoins requires a tremendous amount of energy. Also, Bitcoin also has a low transaction capacity or the number of transactions that it can process. Bitcoin mining today already consumes more energy than about 160 countries in the world, including more than the country of Ireland and+ about 0.15% of all of the energy consumed in the world. If you want to keep track of this usage, this is a nifty link:

There have been attempts to try to address some of these issues by releasing amended currencies and making other improvements, but none have yet come close to addressing the energy demand problem.  This doesn’t mean that Bitcoin will crash and burn, but it does mean that it will need to evolve in order to survive.

Still, when cryptocurrencies are compared to other asset classes it quickly becomes clear how far they have appreciated in such a short period of time.  Like Bitcoin, gold is a decentralized way to attempt to store value; it is not controlled by an individual government.  While gold does have functional uses, a majority of gold is owned as a way to hold value or to speculate and protect against a market decline. In these ways, it is similar to Bitcoin. But humans have been mining gold and using it for currency for thousands of years starting around 700 BC when Lydian merchants produced the first coins. Gold has had centuries to refine its perception of value and has had years of cultural integration. Bitcoin has no such cultural history. Nor is it a stable form to store value whereas gold was one of the few assets classes that actually increased in value during the Great Recession.

If we measure all of the gold that has ever been mined in the history of the planet Earth it would fill a cube that is approximately 68 feet long, wide, and deep. The value of this incredibly heavy cube of gold would be about $7.5 trillion. With cryptocurrencies currently valued at over $400 billion, cryptocurrencies are already worth over 5% of the value of all gold that has ever been mined! But this very growth is also likely to be Bitcoin’s Achilles’ heel. The exchanges used to buy and sell Bitcoin are not well established, as yet.  The most popular exchange in the US, Coinbase, was backed by private equity to provide an illusion of security, trust, and safety. But Coinbase has already struggled to keep up with Bitcoin’s growth. Average response time to emailed questions lasts into the weeks, if not months if they respond at all. Online reviews of Coinbase have been so weak that they make Cablevision look good. This isn’t as noticeable as a problem when Bitcoin is appreciating in value, but when it declines and there are constraints on selling, problems could spiral. Coinbase actually limits the amount per week that can be pulled from an account and this has the potential to cause mass hysteria and calls for regulation.

I’m not suggesting that Bitcoin is doomed. In fact, I think that Bitcoin and other cryptocurrencies have a reasonable chance at succeeding unless governments shut them down, something I view as a realistic risk. I am just suggesting that this asset class is setting up for a potentially painful and exceedingly sharp level of volatility where owners will have little support to turn to. Indeed, many of the 1,300+ cryptocurrencies are likely to be wiped out. With phrases like, “Buy bitcoin on credit card” soaring on Google trends,, this is not an asset class for the faint hearted.

If you are a Bitcoin owner and you do sell some shares, you should declare those gains (or losses) to the IRS at tax time. The IRS will unquestionably follow Bitcoin’s meteoric rise to ensure they get their slice of the appreciation. Bitcoins are now viewed as assets that are legally subject to long term or short term capital gains or losses. Just a few weeks ago, a California federal court ordered Coinbase to turn over identifying records for users who transacted more than $20,000 in their account between the years 2013 and 2015. It is highly likely that the taxation enforcement will grow in the subsequent years given Bitcoin’s meteoric rise. In the future, it wouldn’t be surprising for these exchanges to ultimately be responsible for reporting gains and losses much in the same way that custodians such as TD Ameritrade, Fidelity, and Charles Schwab are obligated to do today.

Nonetheless, Bitcoin may continue to appreciate sharply, especially if the constraints and problems with Bitcoin can be solved. The percentage of the world that owns Bitcoin today remains very small. It is difficult to know exactly how many own the cryptocurrency, but there are around 20 million blockchain wallet users, which strongly suggest that only a minority of the world owns any cryptocurrencies. If Bitcoin indeed becomes ubiquitous in culture, it may have multiples of appreciation left to go. But this is a large hurdle.

As an investment Bitcoin is about as speculative and close to an outright gamble as it gets. Is it a bubble? Possibly, but far from certainly. Cryptocurrencies are a complex and brand new asset class. History suggests that the market tends to overreact to both the upside and the down and along the way the volatility and euphoria will lead to a lot of carnage. But just as eToys became obsolete very quickly the dot com boom also gave rise to Amazon and Google, among many others. Facebook didn’t exist when the dot com world exploded and it’s entirely plausible that we haven’t yet seen the cryptocurrency that will become the winner. The fact that cryptocurrencies feel very much like the Wild West does not mean it will remain that way indefinitely or that they will fail as an asset class. The internet when it first started was equally chaotic. And cryptocurrencies are already maturing rapidly. One way or another it appears that cryptocurrencies are here to stay.

What is Bitcoin?

A simple explanation:                                           

A more thorough discussion:                            

A more comprehensive discussion on Bitcoin:

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.


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