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Wednesday, 18 October 2017 12:51

The Bitcoin Bubble - Doomed to Burst?

Bitcoin – it’s a hot topic right now, and more than a few of our clients have inquired about its legitimacy. Are cryptocurrencies, like the popular Bitcoin, experiencing a major bubble that’s doomed to burst? Or could they actually be a great investment on the cutting-edge of a new technology?

While we can’t see into the future, our gut tells us that in the long run, the value of these cryptocurrencies is going to collapse.

Inherent Problems with Initial Coin Offerings

An Initial Coin Offering is the process of creating a new cryptocurrency. While Bitcoin may be the one you hear about most often, there are actually over 1,110 registered cryptocurrencies – and counting! So how does a cryptocurrency come to life? Here’s a quote from the New York Times that we think illustrates the concept well:

“If you’re having trouble picturing it: Imagine that a friend is building a casino and asks you to invest. In exchange, you get chips that can be used at the casino’s tables once it’s finished. Now imagine that the value of the chips isn’t fixed, and will instead fluctuate depending on the popularity of the casino, the number of other gamblers and the regulatory environment for casinos. Oh, and instead of a friend, imagine it’s a stranger on the internet who might be using a fake name, who might not actually know how to build a casino, and whom you probably can’t sue for fraud if he steals your money and uses it to buy a Porsche instead. That’s an I.C.O.” – Kevin Rose New York Times September 15 2017

When looked at in this light, it is clear that there are some obvious risks with cryptocurrencies – and yet investor appetite only seems to grow.

Cryptocurrencies are Largely Unregulated

Right now, the regulatory environment for cryptocurrencies is largely unregulated in the United States – a direct opposite of traditional stock offerings, which are planned months in advance, occasionally even years. But this free-for-all anonymous payment style could end, depending on the US government’s next move. Much like Japan, who has protected Bitcoin as a legitimate form of currency, the US could take steps to follow in their footsteps.

But to think Bitcoin could overtake central bank issued money any time soon is a misguided belief. While our government could allow for small anonymous transactions using the virtual currency, it is highly unlikely that they would allow large scale payments. The anonymity of these transactions makes it incredibly difficult to monitor for criminal activity, and makes it much easier for tax evasion to occur.

Cryptocurrency’s Ripple Effect

As the Bitcoin bubble grows, a crash will have a greater chance of affecting investor feelings towards stocks, particularly in the financial and technology sectors. As it goes with practically any product that goes through a dramatic rise and fall, there is the potential for collateral damage. Companies who put a significant investment into altering their infrastructure to accommodate cryptocurrency will end up suffering.

Despite all these concerns, the reality is we’re only at the very start of the cryptocurrency boom, and no one truly knows what will happen. Cryptocurrencies could be the biggest valuation bubble since the dotcom era, and is already following in its footsteps. And while like the dotcom bubble burst, some key players could survive (after all, both Amazon and Google were born in the dotcom era), as of now there is no reason to believe cryptocurrencies will not experience a similar burst.  

LPL Financial does not offer trading in currency or cryptocurrency