tl;dr: Bitcoins are like Beanie Babies. In 2014, both fanatics and critics will turn out right. If you want to play this, watch out for the mafiosos.
Bubbles are stubborn things. They make fools money and make those with common sense look like chumps. They never go up and down in any straight-line fashion. And, just after the last one bursts, a new one seems to appear somewhere.
If you recall, the latest gold bubble ended just before the Bitcoin craze began, and drew in not just Glenn Beck and the Tea Party, but some of the smartest financiers in the business, including David Einhorn and John Paulson.
So, when will the Bitcoin bubble end? As Henry Blodget writes, Bitcoin is the perfect asset bubble and “prices could keep rising for years.”
There is absolutely no way to value Bitcoin, which means there is nothing constraining its price other than supply and demand. As long someone new can be convinced to buy Bitcoin, its price can keep rising.
However, sooner or later, all bubbles get ahead of themselves, and Bitcoin will be no different.
So, when will the bubble burst?
Chances are, much after when the early critics would expect — likely no earlier than 2015.
With Bitcoin, the timing is actually relatively predictable, and depends on supply and demand.
On the supply side:
Bitcoin is already 57% mined. There are 12M coins out of 21M possible coin total. By end of next year, 63% of the Bitcoins will be mined, after which the supply will grow exponentially slower.
On the demand side:
Bitcoins’ demand is driven by just two reasons:
- they continue to rise in price
- they are non-traceable, aka you can use them to do illegal things
One important note: Bitcoins’ demand isn’t based on that they are a “universal” currency that can be used anywhere in the world. While hypothetically that’s true, in reality, Bitcoins involve much higher transaction costs than any other currency exchange. Using Bitcoins for cross-border transactions is a bit like hiring an English-to-Esperanto translator and an Esperanto-to-Spanish translator to get around Mexico City.
So, once the initial controversy and exuberance over Bitcoin wears off in one to two years in favor of the next shiny thing, Bitcoin prices will reach a plateau. Once that happens, the vast majority of the people interested in Bitcoins today will no longer have any use for them, making the price plummet.
How far will the prices plunge?
Likely not to zero. Could it be $500 (up from today’s $466)? $100? $10?
That depends almost entirely on the importance of the illegal, untraceable feature of Bitcoins, and how much cocaine the Winklevoss twins and their friends consume per year. Chances are, however, this demand for Bitcoins is much much lower than the “monetary base of Turkey,” which Second Market alludes to in their Bitcoin investor pitch.
With U.S., Japan, and Europe taking measures to disrupt illegal money laundering operations, the value of Bitcoin based on this will likely be quite low.
So, when can I start making money shorting Bitcoin?
Well, likely you can’t. Unless you hit a jackpot in your timing, the transaction costs alone will likely eat away your gains. The trick with bubbles is that “there’s a sucker born every minute”*. Bubbles inflate and crash in waves, making their paths very hard to predict.
Some spike and crash quickly, like gold in the 1970s-80s and NASDAQ in the 1990s.
Others pause for a while at the peak, like the the housing bubble of 2000s.
One thing that we know is that at the end, things will end up looking like they did after the Mother of All 1990’s Bubbles: