If bitcoin is a bubble, the 'panic' stage is near: economist

Posted by jbrumley on May 31, 2018 4:01 PM

- The smart money will soon head for the exits, if the typical pattern emerges -

By Aaron Hankin, CNBC

It isn't uncommon for crypto-skeptics to look a bitcoin chart and, without much analysis, label it the tulip bubble of the 21st century.

But economists note that bubbles are complex things, with a life cycle of their own.

According to the late Hyman Minsky, the U.S. economist whose theories on financial fragility came to the fore during the 2008 financial crisis when a surge in private debt accumulation led to the collapse in the housing market, an asset bubble has five stages; displacement, boom, euphoria, profit-taking, and panic.

Using this framework, Joost van der Burgt, a policy adviser at the Federal Reserve Bank of San Francisco, said that if bitcoin is indeed a bubble, it's likely at the beginning of the profit-taking stage, which means panic might be around the corner.

The displacement phase of the bubble came in the years after Satoshi Nakamoto, the person or people credited with creating bitcoin, released the white paper on the first digital currency. In the early years, bitcoin was ruled by its hard-core proponents, known as bitcoin evangelists, and the lack of notoriety was evident in minimal trading volume and the price; a single bitcoin didn't trade above $100 until 2013.

However, the second phase has been less of an enigma. "The subsequent 'boom' phase is characterized by prices rising slowly at first, but then gaining momentum as more and more participants enter the market, fearful of missing out," wrote van der Burgt.

That fear, often referred to by the acronym FOMO, saw companies add coin- or blockchain-related terms to their names, hoping to capitalize on the booming interest in the industry. Furthermore, celebrities jumped on the bandwagon, launching or endorsing their own cryptocurrencies. However, as many of these companies have been exposed, these 'new' cryptocurrencies have blown by the way side-often with legal ramifications.

Now, even as price volatility subsides, the hype remains. Van der Burgt argues that the bitcoin bubble is now entering the euphoric stage, one with direct parallels with the period leading up to the 2008 financial crisis.

"The euphoria phase is also when people start to borrow extensively to finance their investments," said van der Burgt. "According to a recent survey, 18% of active bitcoin investors have financed their investments by credit card, and 22% of this group indicated that they have not yet paid off their credit card balance."

Which brings us to now: the price of the world's biggest digital currency has lost more than half its value since peaking in December 2017 and van der Burgt believes the market is entering the profit-taking stage, a phase where so-called smart money begins to head for the exits, leaving only one step left before the bubble pops.

"The subsequent 'panic' phase, should it come to that, commences when reality sets in and bitcoin's price would substantially crash," wrote van der Burgt.

However, like most bitcoin debates, the argument comes with a caveat.

"Then again, maybe bitcoin is different than anything we have seen before, and maybe a decade from now its market capitalization will be sky-high as it attains the status of a new global currency," van der Burgt said.