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Cryptocurrency and the History of the Bitcoin Bubbles

Editorial and Content Intern, TRANSFIN
Feb 16, 2021 5:14 PM 5 min read
Editorial

Cryptocurrency is making the rounds again and Bitcoin, the world’s first decentralised crypto developed by pseudonymous Satoshi Nakamoto, is at the centre of it. It touched the $40,000 mark in early January before dipping. This was followed by an all-time high of $44,000 after Elon Musk’s Tesla announced an investment of $1.5bn in the digital currency. Come February and it is approaching $50,000. Dogecoin has attracted just as much interest from the billionaire who has been vehemently tweeting about it and investing in it for his son. When one of the richest people in the world takes cryptocurrency seriously, one can’t help but take notice.

Perhaps, taking notice is what Mastercard has done. The company announced that it would allow users to carry out transactions in certain cryptocurrencies on its platform. While the world seems to be opening, things in India appear to be falling backwards with the imminent introduction of The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 in this Budget session, expected to ban all private cryptocurrencies and introduce a state-sponsored one regulated by the RBI!

Digital currencies have been around for a while now. Even though they are typically considered risky investments, they have their fair share of perks. So, what explains the bubbles witnessed by this asset?

 

 

Double, double Bitcoin and trouble

Bitcoin has seen three bubbles in its 12-year history, two of which took place in 2011. Whilst it can be particularly difficult to recognise a bubble while witnessing it happen. And while it may seem obvious when it has burst, a post-bubble understanding can also be complex.

 

February-April 2011

Back when it began in 2010, Bitcoin was worth only pennies. That’s when it was mentioned on Slashdot, a news aggregator. As interest grew, so did the price. On February 10th, 2011, it touched one dollar and this day came to be known as Dollar Parity Day. This led to yet another post on Slashdot attracting more attention. Growing popularity brought with it an increase in perceived value, peaking at $1.06 on 14th February. 

This bubble followed a simple mechanism that still remains fundamental to Bitcoin: Blockchain. Miners add a data block to the chain which is essentially a bundle of data that communicate with one another in a way that each block knows what is contained in the chain. Freedom is offered by the self-policing mechanism. The result is that there is a system of fast, trusted exchange of data without governmental intervention or supervision.

 

This technological or infrastructural development in the form of blockchain pushes the price upward. The price generates a self-propelling function where it pushes itself further. However, this form of rise in prices is less sustainable and the concept of a bubble creeps in. Thus, technology drives the price growth which then drives itself. Subsequently, the price fell to $0.67. It may not seem like a significant rally, and yet this period is typically classified as the first bubble owing to the comparative rise leading to an eventual fall.

 

June 2011

On 8th June, following a two-month rise, Bitcoin hit an all-time high of $31.91. There was great excitement when the currency picked up the pace. Enthusiasts expected it to touch $1,000 and become mainstream. However, this was followed by a crash to $10.25, which eroded 93% of its value over the next four months. 

Soon it was noticed that Bitcoin was moving to the darknet. $1bn worth was seized by the Department of Justice from the online black marketplace, Silk Road, which was then shut down. Surprisingly, just a month later, the price stabilised and started clawing back to almost $5. But this bubble did bring out serious concerns around the cryptocurrency’s tendency to attract the wrong kind of crowd in the absence of mainstream legitimacy. 

Think of it this way, for something to be a store of value and have an economy, it must be inherently valuable. Therefore, if crypto cannot serve as a mainstream medium of exchange and thereby serve a practical purpose, it will cease to be a store of value. 

Like the currencies we use on a daily basis, crypto is not backed by either a precious metal or similar commodity. Its fundamental value is if it becomes a valid medium of exchange. In the absence of that, all one has on the plate is sheer speculation and fringe activity (like Silk Road).

But over time Bitcoin’s “economy” has become more decentralised making it more resistant to sudden market changes. What was initially a centralised ecosystem relying on certain providers now hosts many more businesses, thus allowing more resilience. It also became possible to short positions in this market to check sudden upticks and facilitate stability.

 

2017-2018

John McAfee, the founder of McAfee LLC was quoted saying in December 2017 that Bitcoin was not a bubble. Valued at $16,600, it was not going to crash. But only a few days later after peaking at $19,511, the currency began its journey downhill. The drop eroded 92% of the asset’s value. There was no obvious reason why the value rose so suddenly and then fell all over again. It has been attributed to a combination of herd mentality, poorly informed investors and downright speculation.

Critics claimed that not enough measures had been set in place to address the fraud and manipulation that occurred in the digital space. This has been regarded as the biggest bubble to date. 

 

Are we in the midst of yet another bubble?

In January 2021, Bitcoin crossed $40,000 for the first time which was followed by a 20% drop. Analysts suggest that if the price doesn’t go back up, the momentum will slow and traders will exit. Fears have arisen that this rally is a repeat of 2017. But believe it or not, this is different. 2017 was fuelled by irrationality, to a certain degree. Today, it is mellower, so to speak. Bitcoin has become institutional with several corporates buying into it. Moreover, Fintech companies have made it easier to invest in the crypto. 

Even with central banks talking of regulation, it points towards the trend that cryptocurrencies are here to stay. More institutional investors may translate to higher volumes of transactions for a longer period. What the COVID-19 vaccine, Joe Biden’s government in the US and India’s economic recovery spell for the cryptocurrency market is anybody’s guess.

 

A Close Watch

The history of  Bitcoin and cryptocurrencies, in general, make for fascinating reading. Love ‘em or hate ‘em, you sure cannot ignore them. The current trends are sure to go places as they unfold. And as they do, you can be sure that we’ll be keeping an eye out for them.

 

FIN.

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