Over the last two years, it’s been impossible to ignore the cryptocurrency mania. The success of Bitcoin has spurned copycats and attracted money hungry entrepreneurs into the sector, looking to cash in on the craze. Five years on since Bitcoins first surge in price and its momentum continues to build. Despite some setbacks along the way it always comebacks soaring. With the vast amount of millions being pumped into cryptocurrencies, it’s no doubt a bubble is forming. Major currencies such as Bitcoin and Ethereum will eventually collapse but the blockchain will survive and thrive. Remember the tulip mania collapsed horribly but tulips remain big business in Amsterdam today.
What differentiates fiat money from cryptocurrencies is what we perceive as trust. We have a familiarity bias with regular fiat currencies. We’ve used them for years and they have retained their value, so we trust them. People don’t always trust something new, especially an asset that resides only in digital form (oddly, and almost ironically, the great strength of cryptocurrencies is in the trust and legitimacy of the ledger). Those concerns have not stopped the absolute frenzy of new traders investing into the sector. More experienced investors remain cautious because they have lived through numerous bubbles such as the US housing market and the dot-com era. It’s almost impossible to guess when asset bubbles will crash but when do something new comes along to replace it.
If you don’t remember the definition of a bubble from Econ 101, these are the five phases:
- Displacement – something new and exciting.
- Boom – acceleration as more people get into the asset.
- Euphoria – mind-boggling price movements with no particular reason. The risk is not even considered, just constant buying.
- Profit Taking – institutions and veteran traders scaling out slowly, selling higher at crazy valuations to new entrants.
- Panic – slow down in an upward momentum, dramatic and massive selloffs, people get rid of the asset to recoup whatever money they can. The price sinks faster than the titanic.
So what phase are we in now? Let’s take a look at a daily chart of Bitcoin.
At a glance, we could see a number of ways to interpret what phase we are currently in. The most important factor in the bubble though is the massive inflow of new capital and market participants. That is a factor that can not be ignored. The image above shows one interpretation of this crypto bubble. The numbers below correspond to the numbers on the chart.
- Displacement – A clear uptick in volume and increase in price, new participants enter the market.
- Boom – massive quick and frenzied rallies with no concern for the downside.
- Euphoria – more participation, more buying, all dips in price are immediately bought sending the asset soaring.
And not to get too technical, but there is another important piece of this chart that should be reviewed carefully. And that is the slope or angle of the rise of Bitcoin.
One of the ‘fathers’ of technical analysis, WD Gann, was specific about angles. Rises in price at a 22-degree angle or lower are normal. When prices exceed that, especially over 45 degrees in the case of Bitcoin, that means the price has moved way too fast and is bound to have a quick reversal at some point.
Because Bitcoin is still very new in relation to other financial instruments, we can only really analyze the current phases with the data available to us now. Some might argue that we are in a profit-taking phase. Others will think we are still in a boom phase. What no one will argue is that we are reaching the peak. It only takes a small catalyst for bubbles to implode and millions to be lost overnight. Too many people are investing in a digital asset that they don’t understand and will sell at the first sign of panic. People new to the cryptocurrency investing, are building a portfolio of different altcoins hoping to find the next Ethereum. Some might hit the jackpot but 99.99% will fail.
Hundreds of new ICOs (Initial Coin Offerings) are hitting the marketplace in 2017. They are essentially the cryptocurrency equivalent of regular stock IPOs. Initial Coin Offerings operate in the same way as IPO’s, except there are relatively few regulations on the initial investors. In stocks, you are prohibited from selling your shares for quite some time. Who would trust a company that goes public, reaches a high valuation in a short time, and then the original owners start selling? The suckers buying the IPO lose big time. Those restrictions provide incentives to the early shareholders to make the company successful. There is no protection similar to this within ICOs. The lack of regulation is frightening, every day a new ICO is launching, claiming to be the next Bitcoin. There is nothing stopping anyone from creating their own altcoin and advertising to the public to enrich themselves.
In August, The Hill reported that the SEC is becoming concerned about ICOs and the inherent dangers with them. In fact, one of the most infamous scammers of all time, Jordan Belfort, has called attention to this. ICO’s are the new penny stock pump and dumps! He’s been joined by prominent figures such as Jamie Dimon of JP Morgan Chase in their criticism of cryptocurrencies. China, most recently, banned ICOs and is becoming increasingly antagonistic towards them in general. Other nations governments will soon follow suit.
As with any free market mechanism, unfortunately, there are going to be bad actors taking advantage of others. Unless regulation is introduced to protect people from this craze, millions will lost. The average person on the street shouldn’t be investing in an digital asset they don’t fully understand. The immediate future of cryptocurrencies certainly promises to be as exciting and risky as it’s beginning. My educated guess is that cryptocurrencies will continue to rise for the 9-12 next months and then crash. Only invest if you have a massive appetite for risk and can afford to lose all your capital.