These investors buy gold, not because of any fundamental economic insight or any analysis of value, but rather because they want to catch the train. They see the price rising and they assume they can buy gold, hold onto it as it appreciates, and then offload it to some greater fool before its value declines. In fact, the economic term for this sort of irrational belief is called “greater fool theory.”
Bitcoin is turning into a gaggle of greater fools. Retail investors are jumping into the market to buy bitcoin, in the expectation that they will be able to sell their investments for cash to some other sucker later on. In November, Bloomberg reported that “buy bitcoin” had overtaken “buy gold” as an online search phrase. In December, bitcoin platforms soared up the app charts. Coinbase, an online broker where people can buy cryptocurrencies, is now the top trending app in the Apple App Store. Two similar platforms to oversee cryptocurrency accounts, Gdax and Bitcoin Wallet, are now fifth and eighth on the trending charts.
For the people downloading these apps, bitcoin probably isn’t a philosophical bet on the future of money and society’s relationship to the government, says Christian Catalini, a professor of technology at MIT Sloan School of Management, whom I have spoken to often about bitcoin. “There is a speculative frenzy among retail investors who just want to make a quick buck and the App Store is pretty clear evidence of that,” he said.
There is another important feature of the bitcoin market that could both explain its high valuation and suggest an imminent correction. The crypto market is insanely concentrated. Approximately 1,000 people own 40 percent of all bitcoin in circulation, according to Bloomberg. Just 100 accounts control 17 percent of the market. Many of these accounts have held bitcoin for years because they believe fervently in its value. But if a handful of them sell even a small portion of their shares, it could dramatically move bitcoin’s price, potentially triggering a massive correction, as retail investors (who only bought in because the price was going up) try to sell en masse to avoid losing all of their money. There is an upside to this concentration, however, which is minimal contagion effects. If the bitcoin bubble crashes, it likely won’t spill out into the general economy, like the subprime mortgage crisis did one decade ago.
Smaller bitcoin bubbles have inflated and deflated before, without any macroeconomic effect. In 2011, the price rose from $1 to $30 and then crashed back to $2 all within the same year. “I wouldn’t be surprised with another crash, followed by another growth in line with transactions,” Catalini said. Indeed, the dot-com bubble was an unambiguous frenzy of speculation and financial malpractice. But 15 years later, many of the business propositions that flamed out spectacularly were reincarnated as successful companies. Chewy.com, essentially a modern incarnation of Pets.com, sold for $3 billion earlier this year.
Fifteen years from now, the blockchain, too, might be an integral infrastructure for the digital world. In this hypothetical world of 2033, bitcoin at $16,000 might be an absolute steal. But we don’t live in “hypothetical-world 2033.” This is still real-world 2017. And bitcoin’s last few weeks are the real-world definition of a speculative bubble.