By Constantin Gurdgiev
There is a much-discussed in the crypto-sphere chart making rounds these days, plotting bitcoin price dynamics against the historical bubbles of the past:
The chart is striking, albeit simplistic.
On price dynamics alone, bitcoin /zigman2/quotes/31322028/realtime BTCUSD -0.97% looks like a sure bubble — a disaster waiting to happen. But bitcoin dynamics are basically not suited for any empirical analysis of any significant accuracy.
As noted by some commentators, bitcoin had numerous 80% to 90% and larger drawdowns in the past, given its immense volatility. It keeps coming back from these. Some claim this to be the evidence that bitcoin it not a bubble. Which is neither here nor there: bubbles are generated by exuberant expectations of investors, not by actual parameters of price processes. Causality does not flow from dynamics to bubbles, but the other way around. So to identify a bubble, one needs to identify exuberance.
In the case of bitcoin fans, there is clearly such.
No investor or serious analyst has been able to provide a fundamentals-based valuation model for bitcoin.
A disclosure in order here: myself and a graduate student of mine have looked at the fundamental modelling for bitcoin over the summer. We found no tangible relationship between any economic or financial parameters tested and bitcoin price dynamics. In another piece of research, myself and two co-authors are currently looking at empirical dynamic and fractal properties of bitcoin. Again, we finding nothing consistent with a behavior of an asset with fundamentals-derived valuations.
It is white-powder-under-the-nose and empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.
Absence of evidence is not the same as evidence of absence. But, taken together with the general lack of credible fundamentals-linked modelling of the crypto-currency, this means that, at this point in time, bitcoin price can be potentially driven solely by expectations held by its enthusiasts, plus the incentives by the predominantly China-based investors to avoid extreme risks of capital controls and expropriations. If so, both drivers would make it a speculative bubble.
The only quasi-fundamentals-linked argument for bitcoin has been the blockchain one — the promise of bitcoin serving as a key tool for data aggregation, recording and transmission. This argument, however, no longer holds. Blockchain technology has migrated from public blockchains, like bitcoin, to either open blockchains, like Ethereum or, increasingly more frequently, private blockchains. It is the latter that currently hold the promise to serve as viable platforms for data economy.
As a libertarian, I should like a private currency system that supports anonymity of transactions. As an economist, I should like the innovative nature of bitcoin. And, put simply, I do. Both .
But as an investor, I do not have the stomach for bitcoin’s valuations and volatility, as well as for its higher moments behavior (in particular worrying are kurtosis, co-skews and co-kurtosis, which severely complicate empirical dynamics analysis, see Note 3 below). And I have even less enthusiasm for the crypto market that is sustained increasingly by undertakings, like BitMEX — a purely speculative platform trading some $35 billion in bitcoin derivatives with leverage up to 100 times to the amateur speculators who, put frankly, have zero idea what they are buying and at what price. The vast majority of bitcoin investors have no clue what a butterfly option looks like and how it can be valued. And the vast majority of financial markets analysts and professionals won’t be able to price a butterfly strategy for bitcoin, given its painfully twisted moments. Yet, within a month of starting trading, BitMEX reached one-third of the market capitalization of bitcoin. This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.
Another worrying issue with bitcoin is the argumentation of its main supporters.