Rewind to December 2017. The price of Bitcoin was within touching distance of $20,000. Having risen from $1,000 at the start of 2017, many investors were enjoying being in significant profit in a very short space of time. There were various commentators saying that the virtual currency could go on to reach $30,000, $50,000, or even $100,000 within a matter of months. For those not invested in Bitcoin, there was a definite feeling of missing out.
Today though, Bitcoin is priced at just $3,400. It has endured an exceptionally disappointing period that has erased the profits of a significant number of investors, and left others deep in negative territory. How can so many investors have been so wrong about the cryptocurrency? And, more importantly, how can a repeat event be avoided in future?
Sentiment
Bitcoin’s success appears to have been built on the fact that global stock markets had enjoyed a decade-long bull market. This had caused investors to gradually move on from the challenges experienced in the financial crisis and, instead, become increasingly ‘risk-on’ in their approach to investing.
The potential to buy into a virtual currency which could apparently go on to replace traditional currencies was therefore highly alluring. And the fact that it lacked sound fundamentals didn’t seem to matter to investors. After all, they’d seen its past growth rate and thought it would last forever.
Fundamentals
Clearly though, that hasn’t been the case. As with a number of other assets that have experienced booms and busts in previous years, Bitcoin lacks sound fundamentals. Just as the price of tulips eventually bore no resemblance to their real-world value, and dot com companies which had zero sales were being valued in the billions, the virtual currency’s price isn’t linked to its intrinsic value.
Since it’s unlikely to replace traditional currencies due to its limited size and lack of infrastructure, it could be argued that Bitcoin’s real-world value is very limited. Although some investors had felt it could offer diversification potential due to its lack of correlation to the economy, its dependence on investor sentiment means that it’s difficult to see a reason to buy it. After all, its price is completely dependent upon investor sentiment, which is impossible to accurately predict.
Takeaway
The demise of Bitcoin may not yet be over. Even at $3,400, it could be argued that it’s significantly overvalued due to its lack of real-world usage potential. Yet it wouldn’t be a surprise for it, or some other asset, to become increasingly in-demand among investors.
Given a bullish outlook from the investment community over a sustained period, another bubble is likely to occur in the next decade. While tempting to buy into it, sticking with high-quality companies trading at fair valuations could be the most appealing means of delivering increasing wealth over the long run.