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Is the Bitcoin Bubble About to Burst?

A closer look at the technicalities of this bitcoin rally reveals a soft underbelly


You might hear this rehashed ad nauseam in the coming days, but unfortunately there’s no way of escaping it: the craze is now showing all the trappings of a bitcoin bubble. The price of a single bitcoin crossed $1,700 on May 9, taking out new highs as 2017 continues shaping up as a dream year for all virtual currencies.

Is the Bitcoin Bubble About to Burst?
Source: Shutterstock

Bitcoin prices have surged 28% in May alone, nearly doubled in the year-to-date and almost quadrupled over the past 12 months. The market value of all virtual currencies currencies has jumped 80% over the past 30 days alone to $49.5 billion.

The rally means that bitcoin, for the first time in the digital currency’s eight-year lifetime, has surpassed the price of a single ounce of gold. Gold has not been anywhere near as spectacular as its digital cousins — prices have rallied a modest 5.9% YTD and facing major resistance around $1,300 per ounce.

The fever has spurred another kind of madness with one investor, who dreams of the currency zooming to $10,000, saying he intends to double down by taking out a huge equity loan on his house and investing the proceeds in bitcoin.

Are investors like these justified in their extreme enthusiasm, or is it just a matter of time before the bitcoin bubble comes crashing down?

Growing Acceptance for Bitcoin

Several factors at play are responsible for fueling the crazy rally in bitcoin prices. But basically, they involve growing acceptance of bitcoin and other cryptocurrencies as a means of exchange, and the hope that this trend will continue.

Japan became the first major world economy to embrace bitcoin after the Japanese cabinet passed bills in 2016 that elevated digital currencies to similar status as normal currency. On April 1, 2017, the Japanese parliament went a step further after it passed a law that recognized bitcoin as a legal method of payment.

Two large Japanese retailers have already announced plans to integrate bitcoin in a popular mobile payment platform that will clear the way for the currency to be used across 260,000 stores in the country.

Here in the U.S., the decision by the Securities and Exchange Commission (SEC) to revisit its rejection of the proposed bitcoin ETF has the markets excited at new possibilities. Two months ago, bitcoin took a shellacking, losing a massive 20% in value, after SEC denied the proposed Winklevoss Bitcoin Trust ETF.

SEC cited the possibility of fraud as the biggest reason for the rejection.

At a market cap of just $25 billion and daily trading volume of around $30 million, bitcoin has ways to go before becoming a mainstream currency. Approval of the Winklevoss ETF was expected to improve bitcoin’s liquidity through a number of ways, including making the currency attractive to Wall Street and equity investors. It would also have opened the doors for retirement accounts and pension funds to chip in, a market that is worth trillions of dollars.

More importantly, SEC’s approval would likely motivate foreign regulators to follow suit in their own jurisdictions.

Makings of a Bitcoin Bubble Burst

A closer look at the technicalities of this bitcoin rally, however, reveals a  soft underbelly.

A lot of bitcoin’s upward move is being fueled by the massive appreciation of the so-called “altcoins” — smaller bitcoin rivals such as Litecoin and Ripple. These altcoins are mostly denominated in bitcoin, meaning investors who wish to buy them can only do so using bitcoin. These alternative currencies have surged more than 600% in the space of two months, from $3 billion in early March to $23.5 billion currently.

This leaves bitcoin highly vulnerable to the individual trajectories of its smaller rivals.

There are also fears that the huge run-up could be as a result of manipulation by wealthy traders. In the current unregulated environment, it’s relatively easy for traders with large reservoirs of cryptocurrencies to use their heft in the marketplace to move prices to their advantage.

But ultimately the biggest danger to the rally could be if bitcoin and other cryptocurrencies fail to gain traction as expected.

It will take more than just Japan to truly open up the cryptocurrency space. Virtually nothing has changed since SEC rejected the first proposal for a bitcoin ETF, and it’s hard to see it suddenly changing its mind.

This rally might still have legs to run, but another negative SEC ruling would almost certainly bring the cryptocurrency party to a dreadful end.

Article printed from InvestorPlace Media,

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