Many people claim that bitcoin is one of the greatest bubbles in human history. It has been compared to the Tulip Mania and other bubbles in the past. Despite claims that bitcoin is in a bubble, it has continued growing at an astonishing rate and it shows no signs of slowing down. In this article I discuss what a bubble is, explore the confusion around bitcoin’s intrinsic value and explain why bitcoin is not a bubble.
In order to explain why bitcoin is not a bubble we first have to define what a bubble is.
During a bubble, assets typically trade at a price, or within a price range, that greatly exceeds the asset’s intrinsic value (the price does not align with the fundamentals of the asset).
From Investopedia
According to this definition, an asset is in a bubble if its price trades significantly above its intrinsic value. This means, to know whether an asset is in a bubble or not we need to know its intrinsic value. It also illustrates that whether a certain asset is deemed to be in bubble territory greatly depends on ones definition of intrinsic value.
In order to establish if bitcoin is in a bubble or not we first need to explore what intrinsic value is and whether bitcoin has intrinsic value.
There are different economic theories of value. Adam Smith and Ricardo, two classical economists, assumed that labor gives things value. This is known as the labor theory of value.
(Portrait of influential economist Adam Smith)
According to this theory, goods have utility value and exchange value. Utility value is subjective and exchange value is objective. Smith and Ricardo believed that the specific amount of human labor that went into producing goods determines their exchange value.
Marx then built on this theory and argued that not the specific amount of human labor that goes into producing goods determines their exchange value but the average labor it takes to produce them. The labor theory of value is generally considered outdated today and few economists still believe that value is the result of human labor.
Economists from the Austrian school of economics pioneered the marginal theory of value which is based on the idea that intrinsic or objective exchange value doesn’t exist. All value is subjective and a result of marginal utility.
Different actors coming together in a free market, each with their subjective ideas of how much utility a good has for them, or in other words how much something is “worth” to them depending on their unique situation and needs, determines the price of goods.
Supply and demand is just a function of who is willing to part with certain goods at a certain price, and who is willing to acquire these same goods and what they are willing to pay for them. When a seller and buyer agree on a price, an exchange is initiated.
Economically speaking, neither consumer goods nor assets like real estate, stocks, bonds or bitcoin have any intrinsic value. But the fact that something has a price and is being exchanged means it has value for at least two market participants.
Given that people are selling and buying bitcoin for as much as $69,000 means that bitcoin has value for these people — enough value that bitcoin hardware wallets were developed, ETFs were launched, institutional investors piled in, incumbent banks started offering bitcoin to their customers and bitcoin’s market cap grew to $1 Trillion in record time.
Saying bitcoin has no intrinsic value is true, but the same could be said about any consumer good or asset.
Claiming that bitcoin has no value in general is false, since the market has decided that bitcoin is worth up to $69,000. The fact that it has a price, and people are buying and selling it, is empirical proof for its value.
In case every single market participant were to decide tomorrow that bitcoin has no utility whatsoever, then the price of bitcoin would go to zero.
The same would be true for Pokémon cards, jeans, laptops and housing. If every single market participant were to believe that these things have no utility anymore, their price would go to zero and they would cease to exist.
So what utility value does bitcoin have? While it’s easy to see why jeans, laptops and housing fulfill specific needs, the utility of bitcoin isn’t as clear —at least not to market participants who view it as a speculative bubble. We’ll explore the value proposition of bitcoin later in this article. But first, we have to take a closer look at the meaning of “intrinsic value”.
As you can see, the idea that assets have intrinsic value is not founded in economic theory. The term intrinsic value was coined by the investing community and is used in the context of fundamental analysis.
In fundamental analysis, investors look at the fundamentals of a company to assess whether the company’s stock price is underpriced, fair value or overpriced. The term intrinsic value is specifically used in conjunction with cash flow.
If a company has no cash flow and zero potential to generate cash flow in the future, in a free market, the company would go bankrupt and the stock would disappear, resulting in complete loss of investment in the company.
(Warren Buffet, the famous value investor who called bitcoin “rat poison” by Aaron Friedman)
This is why investors try to assess the intrinsic value of a company by looking at its balance sheet, current cash flow and future potential to generate cash flow. Using this data, they can decide if a particular stock is undervalued or overvalued.
Based on economic theory, this doesn’t mean the company or the stock has any intrinsic or objective value. The value of both the company and stock depends on human actors coming together to form a market and agreeing on a price through supply and demand.
Imagine for a second that an investor is stranded on an island with a suit case full of stock certificates of a company that generates cash flow. These certificates will have no value on the island. If the investor were to encounter a local tribe that hoarded lots of coconuts, they likely wouldn’t trade them for the suitcase full of stock certificates. The stock certificates won’t have any utility for the tribe.
They might not even know what stock certificates are. As far as they are concerned, it’s just worthless paper that can be used to light a fire. This is why it’s incorrect to claim that stock certificates, bond certificates and even real estate have intrinsic or objective value.
The idea of intrinsic value and cash flow might be helpful for investors who want to gain clarity when it comes to their own subjective evaluation of an asset. But the term is often misunderstood.
When investors use models from fundamental analysis to assess the intrinsic value of bitcoin, they of course don’t find any. Apart from the often overlooked fact that intrinsic value doesn’t exist from an economic standpoint, bitcoin is neither a company, nor a real estate property nor a bond.
But just because bitcoin doesn’t generate cash flow doesn’t mean it isn’t valuable. Value is subjective and based on marginal utility, not cash flow. This means to understand bitcoin’s value, we have to look at its utility.
Some people say bitcoin is a new investment class, but that is not true. Bitcoin is money, which means it is the oldest investment class there is. Money has existed for tens of thousands of years in various forms. Bitcoin is simply perfectly engineered, modern money.
This means bitcoin’s value proposition doesn’t come from cash flow, since its not a company, bond or a real estate property, but from its properties as money.
For a commodity to function as money, it must have certain properties:
Historically, different commodities have been used as money. Salt, cattle, stones and cigarettes are some examples. But not a single commodity has embodied these properties better than gold. This is why gold became the universally accepted and primary form of money around the world.
If you want a more thorough explanation of the history of money, you can read our article Hyperbitcoinization and the End Game of Central Bank Policy.
Most commodities are useful for certain things but have little utility as money. Some commodities have utility and also embody the properties necessary for money. For example, salt is an ingredient for cooking, cigarettes can be smoked and gold can be used in jewellery. At the same time these commodities are relatively durable, divisible, verifiable, fungible, scarce and portable.
This means they have two-fold utility: As a general commodity that people find valuable and useful, such as in the case of salt, cigarettes or ornamental gold, and as a commodity that embodies the properties necessary to function as money.
Bitcoin didn’t exist as a commodity before it was money, rather it was engineered and programmed to do nothing else than embody the properties of money. And it does this better than any commodity that ever existed, including gold. It can be seen as perfectly engineered, modern money. There is no commodity that is more durable, divisible, verifiable, fungible, scarce and portable than bitcoin.
Bitcoin’s value hence doesn’t come from its utility as a commodity like salt, cigarettes or gold, or from being a cash flow producing asset like stocks, real estate or bonds, but from its superior properties as money.
Bitcoin only does one thing: It claims to be the best money in the world. And as such, it solves one of the biggest problems in human history.
Apart from being a superior form of money, bitcoin has utility for several other reasons. Historically, money and tyranny have been closely related. Whoever has the monopoly on money production has the most control over society.
Given that 54% of the world’s population lives under authoritarian regimes, bitcoin is a monetary technology that enables freedom, censorship-resistance, pseudonymity and protects human rights.
It’s also a way for the unbanked population to send money back and forth and protect their wealth from confiscation by corrupt governments. The fact that bitcoin is decentralized means it cannot be controlled by a small group of people.
Virtual Private Networks and tools like The Onion Project (TOR) allow human rights activists, bloggers and dissidents to bypass Internet censorship and practice free speech. Bitcoin allows these same people to escape financial repression and wealth confiscation.
Many people take privileges like access to bank accounts, financial services, credit and investment opportunities as granted. But a large part of the world’s population is excluded from these services.
Increasingly more people live in sovereign nations where governments have debased the local currency to the point of heightened inflation or even hyperinflation. This is the case in Venezuela, Lebanon, Turkey and many other countries. For them, bitcoin provides a way to preserve wealth.
(Protestors in Venezela which is currently experiencing hyperinflation by andresAzp)
Again others escape their countries and become refugees. It’s often not possible for them to take their wealth with them in the form of bank notes, gold bars, stocks or real estate. Their only option is to leave all wealth behind and escape.
With bitcoin, anyone can preserve and transport wealth by remembering 12 words. In an extreme situation, someone could memorize their bitcoin wallet’s seed phrase, swim or run across a border, and once in safety, type the memorized seed phrase into a mobile phone or laptop and retrieve all their wealth.
Remittances are another use case for bitcoin. For example, in El Salvador a large percentage of the population works abroad and sends money back to their families through companies like Western Union. But these money transfers are slow and expensive.
With the Lightning Network, a secondary layer built on top of bitcoin, anyone working abroad can send money back to their families in a matter of seconds and almost for free. Bitcoin doesn’t have any intermediaries, it’s a trustless network that cannot be censored or exploited. Anyone with a smart phone or feature phone can tap into this global, decentralized payment system and benefit from its speed and low fees.
As more people adopt bitcoin, its utility and value increases. This is due to a phenomenon known as network effect.
Certain technologies are based on networks. This includes the telephone, social media sites and bitcoin. These technologies get more useful as more people join the network. For example, if only two people used telephones, the utility of telephones would be limited. You could only call one other person. But as the entire world adopted telephones and every household had one, the utility of telephones grew exponentially.
The same is true with social media platforms like Facebook. As more users adopt the platform, its network effect increases. With every additional user, the utility and value of the network grows for all existing users.
Bitcoin is being adopted at a similar pace as the Internet was and is experiencing one of the strongest network effects in history. With every additional user, bitcoin gets more useful and valuable for all existing users of the network.
One day, almost everyone will be plugged into the bitcoin network just like everyone has access to the internet.
We can summarize Bitcoin’s value as follows:
These are some of the reasons why bitcoin has value in the eyes of the market. But how do we know whether bitcoin’s current price is undervalued or overvalued?
Now that we’ve established that bitcoin has utility and value, the question is how we can quantify this value and make judgements about what price bitcoin should be trading at.
Ultimately, the market will decide what bitcoin’s fair value is since there is no objective or intrinsic value to bitcoin or any other asset. But there are still models we can use to evaluate if bitcoin is overvalued or undervalued based on its current price.
Bitcoin is often compared to gold due to its properties as money. Historically, gold has embodied the properties of sound money better than any other commodity. At the time of writing this article, gold has a market cap of $11.5 trillion.
Investors are still using gold as a hedge against inflation due to its great monetary properties. Bitcoin has superior monetary properties than gold but currently only has a market cap of $810 billion.
(Gold bullion held in a vault by National Bank of Ukraine (NBU))
If we compare gold and bitcoin and assume that bitcoin has superior monetary properties than gold, this would mean that bitcoin is significantly undervalued.
If bitcoin is digital gold, it should have a market cap at least the size or bigger than physical gold. Regardless if it completely demonetizes gold, or just steals a small part of its market cap, this would imply significant upside to the bitcoin price. If bitcoin were to grow to the same market cap as gold, its price would trade around $400,000-$500,000 per bitcoin.
Given the current price of $42,000, this would mean that bitcoin is undervalued and not in a bubble. Remember, according to Investopedia an asset is in a bubble if it is trading significantly above its “intrinsic value”.
While there is no such thing as “intrinsic value”, we can compare bitcoin to similar assets like gold and look at their properties and market cap. Based on this model, we can make a judgement about what bitcoin’s fair value might be. And if we treat bitcoin as digital gold, it’s trading approximately 1,000% below its fair value.
This is not only the opposite of a bubble, but an asset that is currently in deep value territory.
Comparing bitcoin to gold is a relatively conservative valuation model since bitcoin has more utility than gold.
For example, gold isn’t portable. It takes armies, large ships and airplanes to transport it around the world. Moving large quantities is risky, expensive and cumbersome. On the other hand, billions of dollars worth of bitcoin can be moved from one place to another in as little as 10 minutes and for a few dollars.
Gold is also less scarce, verifiable and divisible than bitcoin. Bitcoin’s total supply of 21,000,000 is known but nobody knows how much gold exists under the earth, in the oceans and on asteroids. Gold requires sophisticated tools to verify its purity. With bitcoin, the network is built to verify transactions mathematically. And while gold is divisible into coins and dust, each bitcoin is divisible into 100,000,000 Satoshis. Given these shortcomings of gold, bitcoin has more utility as money.
Finally, bitcoin is both money and a payment and settlement network while gold is only money. As a technology, bitcoin provides a safer and faster payment railway compared to the legacy banking system. Final settlement of payments takes as little as 10 minutes on the bitcoin base layer while it takes several days, weeks or months using the European SEPA or the United States CHIPS clearing system.
On the Lightning Network, almost instantaneous micropayments of less than $0.30 are possible. And they barely cost anything. This isn’t possible with the current banking system where payment processors have a minimum transaction size of $0.30 and upwards of 1.5% transaction fees. Bitcoin is a superior settlement system and the Lightning Network, a secondary layer built on top of bitcoin, is a superior payment system.
If we don’t just think of bitcoin as digital gold but as a revolutionary new settlement and payment technology, how much is that worth? If we use a more aggressive valuation model, bitcoin has the potential to demonetize a large part of the “store of value” market. In that case we are looking at a market cap between $100 to $400 trillion. This is a huge jump from where bitcoin is today, but it might reach such market caps in the event of hyperbitcoinization.
This would imply a price upwards of $5,000,000-$10,000,000 per bitcoin. Based on this aggressive valuation model, bitcoin is trading more than 10,000% below its fair value.
Regardless if we use the conservative model of comparing bitcoin to the market cap of gold or imagine what hyperbitcoinization would look like, bitcoin appears to be significantly undervalued. This is why bitcoin is not a bubble.
The only reasonable way someone could argue that bitcoin is in a bubble is by assuming everything is in a bubble.
According to William Quinn and John Turner (who falsely call bitcoin a bubble), the formation of bubbles requires three ingredients:
Marketability means that an asset must be easy to buy and sell. It has to be liquid and divisible. Furthermore, money and credit must be available through low interest rates. When the market is flooded with “free money”, such as has been the case since Greenspan and Bernanke’s time as chairs of the Federal Reserve, this fuels the formation of bubbles.
And finally, when people are buying overpriced assets with the sole goal of speculation, or in other words to dump the assets on the next “greater fool” in an attempt to make a profit, this is a sign of a bubble as well.
(Graph of the Tulip Mania which is often falsely used to describe bitcoin by Encik Tekateki)
The problem with this definition of bubbles is that almost everything can be seen as a bubble today. With the digitization of stock brokers and the introduction of derivatives, assets like stocks, bonds and real estate have become increasingly marketable.
Low interest rates have been prevalent since the late 90s and have led to the Dotcom Bubble, the United States Housing Bubble and the bubble in sovereign bonds. Central banks are addicted to low interest rates because they allow governments to borrow money almost for free.
If interest rates were to raise, the already unsustainable debt levels of sovereign governments would spiral out of control. If you are barely able to make interest payments at 1%, you’re guaranteed to go broke if interest rates increase to 5%-10%. That’s the situation most governments including the United States are in today.
This is why it’s impossible for the Federal Reserve to significantly increase interest rates.
Finally, speculation is present in every asset class to some extent. There will always be people who don’t see much value in the asset itself other than “flipping” it for a profit. This is certainly the case with stocks, real estates and bonds to varying degrees. In fact, the Federal Reserve acts as the ultimate “dumb money” buyer that investors can front-run.
With every Quantitative Easing program, the Federal Reserve has announced in advance how many government bonds they will purchase per month. This led to investors piling into the bond market and speculating on the prices of bonds on the secondary market.
Since central banks have flooded markets with “free money” for the last two decades, we have experienced a period of serial bubbles in stocks, real estate and bonds. As Graham Summers argues, we are currently in the midst of a bubble in the most senior asset class: Sovereign bonds.
Since sovereign bonds are the bedrock of the financial system and act as the risk-free rate against which all other assets are measured, the current bubble we’re in can be seen as the “Everything Bubble”.
So does that mean bitcoin is in a bubble as well? It depends what your benchmark for fair value is. Using different tools to assess fair value or intrinsic value, most stocks and real estate properties seem to be fair value at best and significantly overvalued at worst. Bitcoin on the other hand, using both conservative and aggressive models, appears to be significantly undervalued.
While all assets today are in a pro-bubble environment and thriving because of low interest rates maintained by central banks, not all assets are trading above their fair value. Bitcoin appears to be one of them.
There is another important difference:
Since the “Everything Bubble” poses a systemic risk, central banks cannot let it burst. They will likely have to resort to more and more extreme monetary policy in the future, including negative interest rates and nuclear levels of Quantitative Easing to keep the bubble inflated and prevent deflation. This would lead to heightened inflation or even hyperinflation.
As we have seen, bitcoin isn’t a new asset class. It’s the oldest “asset class” that has ever existed: Money.
While the US dollars will continue losing its purchasing power as a result of the Federal Reserve’s monetary policy, it will come under increasing pressure as world-reserve currency. Individuals, corporations and sovereign governments will start looking for alternatives to the US dollar.
(Banknote with face value of 100 Trillion mark during the Weimar Republic hyperinflation of 1923)
Historically, gold has served as a “life boat”. But given that bitcoin has superior monetary properties than gold, it is likely that bitcoin will become the preferred “life boat” for anyone who is looking to escape the collapsing US dollar.
Despite being relatively early in bitcoin’s history, long-term holders aren’t selling their bitcoin when the price drops. They are holding on to their bitcoins. While speculation does occur, it’s mostly new market participants that are attracted solely by bitcoin’s historic price increases and aren’t aware of the value proposition of bitcoin as superior money and settlement technology.
Those who understand the technology and have conviction aren’t speculating though. And with time, the number of long-term holders can be expected to increase while the number of speculators decreases.
Let’s return to Quinn’s bubble triangle one more time.
Bitcoin’s marketability is incredibly high but this is a sign of its superior monetary properties and not a weakness. All money must be marketable. In fact, money has to be the most marketable commodity in an economy. This is exactly what allows it to be money.
The low interest rates maintained by the Federal Reserve and other central banks simply lead to the economy being flooded with “free money”. Whenever new money is lent into existence, this causes inflation. As a result, the purchasing power of the circulating money drops.
Quantitative Easing, the way way central banks have been doing it since 2020, is inflationary as well: The total money supply has to grow in order to keep the “Everything Bubble” inflated and prevent deflation.
This debasement of the US dollar through low interest rates and Quantitative Easing will likely lead to more individuals, corporations and sovereign nations becoming aware of bitcoin’s value proposition. As the US dollar is debased, the utility of bitcoin increases relative to that of the US dollar.
Finally, the number of long-term holders of bitcoin is steadily increasing. These long-term holders aren’t selling their bitcoin for fiat currency even during market downturns. As more people become aware of bitcoin’s value proposition, we can expect this trend to continue.
With time, it’s likely that a majority of people trust bitcoin more than their own government’s fiat currency. Speculation in the sense of buying bitcoin and selling it for fiat currency when the price spikes will decrease as the value of fiat currency continues falling. People will realize that bitcoin is not a way to get more fiat currency but a life raft to escape from fiat currency.
This is in a nutshell why bitcoin is not a bubble.
