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Bitcoin is all the rage, again. Last week, the price rose above $10,000 for the first time. Following a Friday announcement by the Commodity Futures Trading Commission, the Chicago Mercantile Exchange, the CBOE Futures Exchange, and the Cantor Exchange appear poised to launch Bitcoin futures or other derivatives contracts, with Nasdaq likely to follow. Portfolio advisers are encouraging cryptocurrency diversification. In London’s Metro, advertisements assure potential investors that “Crypto needn’t be cryptic.” And, as skyrocketing prices gain headlines, less sophisticated investors are diving in (Ms. Scott bought a few hundred dollars’ worth).
The danger is that investors will interpret the surging price itself (and the associated hullabaloo) as a sufficient signal to buy, fueling an asset price bubble (and, eventually, a painful crash).
No one can ever say with certainty when an asset price boom is a bubble. In theory, a bubble occurs if the price of an asset becomes completely detached from any fundamental value. In the case of an equity, for example, imagine that the price surges because of momentum. That is, investors buy solely because they see the price rising, without any change in the discount rate, in risk tolerance, or in the projected dividend stream―the three fundamental drivers of equity value from the classic dividend discount model.
In practice, people can disagree greatly about projected dividends (or about the appropriate risk premium). So, even in the ill-fated tech stock boom of the late 1990s, when stock prices surged for many companies that never earned a profit, advocates usually found (invented?) other metrics to substantiate their belief that “This one will be the next Microsoft.” And, tech bears could go broke shorting those stocks long before their warnings that “this time is not different” came true. Indeed, even long after an asset price boom goes bust, the ex ante relationship to fundamentals can remain in dispute (see, for example, Peter Garber’s study of the 17th century Tulipmania).
Nevertheless, as Jamie Dimon suggests, it makes sense to ask what fundamental services Bitcoin provides. More specifically, have the prospects for those services improved sufficiently over the past year to warrant the 10-fold increase in price that has vaulted Bitcoin’s market capitalization into the range of the top 50 U.S. firms?
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