Mania is irrational. You can’t deny that whatever is happening before your eyes is indeed happening but shouldn’t be based on all known rules and limits. When ever a rule is being defiantly broken and leading to success and riches (without anything tangible of value being produced), you question your sanity and everything you come to know and hold dear.
Imagine yourself in the 17th century. There’s no reason a single tulip is worth the same or even more than a whole farm. But your neighbor took a massive loan on his farm and livestock just to buy that one tulip and flipped it at a nice profit… in a matter of days. Makes no sense, but it happened.
Imagine owning a small clothing business in the late 90’s. Your competitor down the block has inferior customer service, low quality merchandise, and is almost always near bankruptcy. But they buy a computer, get a kid to design a dinky webpage, and then they add “.com” at the end of their store name. Suddenly your competitor is considering going public. Might be worth millions if not hundreds of millions once its stock trades on the NASDAQ. Makes absolutely no sense… but it happened.
Bitcoin is currently in mania territory. But it is nothing like the tulips or the dot-com bubbles that it’s commonly compared to. But let’s do so nonetheless, and compare it to the most recent and tragic example of mania: the housing market bubble.
Houses were being bought at irrational prices every day, every week, every month, for years. And almost each purchase resulted in a successful sale at ever higher prices to what appeared like an endless pool of “greater fools” willing to buy and hoping to flip for a quick profit. Is this what’s happening to bitcoin? No. Let’s examine the mania more closely.
Asset bubbles form when more of the same limited number of product is bought and sold and flipped to a new buyer who becomes a seller who looks for another buyer who looks for another seller… and so on. But it’s the same product. When a person bought and sold a house, that same house exchanged hands at higher prices to newer fools. The physical act of buying a home drove prices higher than the rate at which they were being built. The solution appeared to be to build more houses, more condos, more apartment buildings. But since buying homes required borrowing from the banks, it didn’t matter that there was all this mania-driven demand to buy homes. Eventually, the lenders wanted to get paid so that they could pay their mortgage bond investors. The number of home sellers began to outnumber home buyers which began the crash in prices as sellers couldn’t recoup the amounts they borrowed from the banks. As mentioned earlier, buying a home did not contribute positively to the economics of the housing market. It simply shifted debt on to the next fool. Is this what’s happening with bitcoin?
The mechanics of buying bitcoin (which is pushing its price higher) follows different rules than in the previous examples of manic bubbles. Physically buying bitcoin has a positive effect on the network that makes bitcoin possible. Every time a person transacts with the network, either to buy or sell, they are forming an indirect relationship with the miners that maintain the bitcoin network. Miners are the backbone of the blockchain network. Every transaction, whether it’s to buy or sell, requires a complicated confirmation process executed by the miners. The miners incentive for processing your transaction is that when they do enough of these complex confirmations, they are rewarded with bitcoins of their own. The bitcoin protocol has limited the number of bitcoins to 21 million. There are currently 16 million in circulation. Since mining bitcoins gets more difficult every year, requiring more time and computing power, it is estimated that the full 21 million will be mined by the year 2130. Furthermore, each bitcoin can be broken into fractions of up to 8 decimal points behind zero. These are called “satoshis”, fractions of bitcoin.
Still with me?
The physical act of buying bitcoin follows the basic tried and true dynamics of supply and demand. As more people enter the network by buying and selling bitcoin, they provide an incentive for the mining network to keep mining. Since their collective mining power maintains the blockchain network of transactions, every transaction is verified and secured. This is the process that legitimizes bitcoin as a secure store of value (like digital gold). Since the supply is limited, it has value the more it is in demand. It’s limited supply also acts as a hedge against inflation. And since that supply can be broken into fractions, it is accessible to anyone in the world at whatever price they can afford: $1, $10, $50, $100, $5000, or the full bitcoin price of $9900 at the time of this post.
Participating in bitcoin follows the rules of Metcalfe’s Law which states that a network’s value increases the more users it has. Bitcoin is made possible by a network. That network is a decentralized group of miners around the world. They are the ones building and maintaining the authenticity of the blockchain network. As more users come in, the more valuable it gets. Currently, 0.01% of the world’s population is using bitcoin. Imagine where the price will be if we reach a full 1% of global population.
During the tulip mania, buying a single tulip didn’t contribute anything meaningful to the tulip market. It simply pushed the price higher, shifting debt to the last greater fool. During the dot-com bubble, putting your crummy business online didn’t really make the internet any better nor did it deliver profits to investors who pushed share prices to ridiculous levels. During the housing boom, buying property with bad credit didn’t make the housing market better with new home owners. It simply delayed the day of reckoning when the lenders wanted to get paid by whoever was the last person who borrowed money to buy it.
With bitcoin, there is no last “greater fool”. Not when bitcoin has yet to tap even 1% of all the people on earth. With bitcoin, prices are going higher because buyers have a direct effect of contributing genuine demand in the bitcoin economy, creating an economic incentive for the network to keep mining for more bitcoins to go out in circulation. Those bitcoins can be broken and sold into fractions, facilitating the ease of access for anyone in the world. Those fractional transactions are equally processed and confirmed by the miners like all the other transactions. Bitcoin mania is, for the first time in human economic history, completely justified to keep going, with no end in sight.
Am I wrong? Leave me a comment and say so. Thanks.