Bitcoin Balloons on Overheated Air – Bloomberg

Ever since the dot-com and housing bubbles popped in 2000 and 2008, spotting bubbles has become a national obsession. Investors have spotted bubbles in bonds, credit, equities, gold -- you name it -- over the last several years.

I wouldnt use the B-word to describe any of those investments -- yet. In fact, I wouldnt even nominate any of them for Most Likely to Bubble Over. I would give that distinction to a certain cryptocurrency that is quickly making its name and fortune: Bitcoin.

Bitcoin has all the attributes of a bubble in the making. First, its radically new. Its a digital payment system that allows users anywhere in the world to transact directly without interference from intermediaries, governments, regulators or central banks -- at least for now. Transactions are administered by a decentralized network of computers, much like the internet.

In his book about the 17th-century tulip bubble in Holland, "Tulipmania," British journalist Mike Dash points out, It is impossible to comprehend the tulip mania without understanding just how different tulips were from every other flower known to horticulturists in the 17th century. The same could be said about the internet in the 1990s and about digital currency today.

Second, Bitcoin is shrouded in secrecy. Buyers and sellers of Bitcoin can trade anonymously, which makes the digital currency a favorite of criminals and hackers demanding ransom. Its origins are shrouded in mystery. Its creator goes by the name of Satoshi Nakamoto, but it's unclear who that person is or if it's even one person. That, too, is reminiscent of another bubble. At the height of Englands South Sea Bubble in 1720, one company floated shares "For carrying-on an undertaking of great advantage but no-one to know what it is." Of course, that didnt stop investors from throwing money at the company.

Riding the Wave

In 1720, share prices of the South Sea Company rose 400 percent in three months and then collapsed just as quickly

Source: ICF working paper, New Evidence on the First Financial Bubble by Rik Frehen, Will Goetzmann and Geert Rouwenhorst Note: European date format.

Third, Bitcoin has no value other than what a buyer is willing to pay for it, which makes it susceptible to the argument that underlies all bubbles. Namely, that any price is appropriate. But theres already reason to worry that Bitcoin's price is excessive. An investment in Bitcoin has returned a breathtaking 351 percent annually since its inception in July 2010 through Tuesday. To put that in perspective, an investment of $100 in Bitcoin from the beginning would be worth close to $3 million today. Its not easy to justify that kind of return for any investment.

Digital Gold

The price of Bitcoin is up 3 million percent since July 2010

Source: Bloomberg

Bitcoin is similar to other currencies and commodities such as gold, oil, potatoes or even tulips in that its intrinsic value is difficult -- if not impossible -- to separate from its price. But there are governments standing behind currencies and reliable currency markets for exchange. And with commodities, investors have something to hold at the end of the transaction. Bitcoin feels more speculative because its just digital ephemera.

That isnt true for all investments. Stockholders are entitled to a share of a companys assets, earnings and dividends, the value of which can be estimated independent of the stocks price. The same can be said about a bonds payments of principal and interest.

This distinction between price and value is what allowed many observers to warn that internet stocks were absurdly priced in the late 1990s, or that mortgage bonds werent as safe as investors assumed during the housing bubble. A similar warning about Bitcoin isnt possible.

During the dot-com craze, Warren Buffett was asked why he didnt invest in technology. He famously answered that he didnt understand tech stocks. But what he meant was that no one understood them, and he was right. Why else would anyone buy the NASDAQ 100 Index when its price-to-earnings ratio was more than 500 times -- a laughably low earnings yield of 0.2 percent -- which is where it traded at the height of the bubble in March 2000.

Internet Gold

The NASDAQ 100 Index's spectacular rise and fall within five years embodied the dot-com bubble

Source: Bloomberg

Thinking back on investors credulity during the last two bubbles, I cant help but wonder if buyers of Bitcoin understand what theyre invested in. They would be wise to ask themselves that same question.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Nir Kaissar in Washington at nkaissar1@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

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Bitcoin Balloons on Overheated Air - Bloomberg