A deep dive into the three bubbles Bitcoin has faced during its existence, and how the BTC halving phenomenon impacts the price.
This is Part Two of a multipart series that aims to answer the following question: What is the “fundamental value” of Bitcoin? Part One is about the value of scarcity, Part Two — the market moves in bubbles, Part Three — the rate of adoption, and Part Four — the hash rate and the estimated price of Bitcoin.
The market moves in bubbles
In recent months or even years, there’s been a lot of talk about the bubbles developing in the bond markets. Newspapers — both financial and non-financial — talked about it, with specialized television stations and prestigious “macroeconomists” from all over the world discussing how today’s world debt has negative interest rates.
It is financially counterintuitive to have to pay or lend money to someone, even if that person is a state. We are experiencing an absurd situation that has never happened before in the financial market landscape. The main cause is linked to the enormous liquidity injected into the markets by central banks, which they use as funding to avoid their own bankruptcy, only to then, prudently, reverse it back onto the states (they themselves in difficulty).
After all, John Maynard Keynes’s famous phrase reads:
“Financial markets can remain irrational for much longer than you can remain solvent.”
In actuality, this absurdity has made it possible to avoid the bankruptcy of the financial system, so it is welcome, even though it feeds irrational phenomena, such as bond markets with negative yields (and therefore senseless bond prices) and stock markets touching (not all, but most) new highs day after day.
One phenomenon that isn’t actually fueled by central bank money, that everyone labeled a meaningless mega bubble in 2017, is Bitcoin (BTC). The price of Bitcoin rose to a high of $20,000 in December 2017, coinciding with the launch of Bitcoin futures by the Chicago Board Options Exchange and the CME Group, the two largest commodities exchanges in the world, and then hit a minimum of around $3,100 in 2018, effectively losing over 80% of its value.
Does it represent the bursting of a bubble? Sure. Does it represent the end of Bitcoin? Certainly not. Could there be more Bitcoin bubbles in the future? Of course.
As always, we would like to approach the problem as analytically as possible. We reconstructed the table created by the founder of bitcoin
Inflation
The U.S. dollar (and all currencies in the world, truthfully, including the euro), due to inflation, is worth less and less over time. We can better understand the phenomenon if we think about the value of assets. Buying a car 40 years ago cost about 13 times less than it does today, so a nice car that cost $10,000 in 1980 would cost $130,000 today.
This phenomenon is called inflation, and it is induced by a rule that links the total value of goods in the world to the total currency in circulation. If the number of U.S. dollars in circulation doubles, the same goods will tend to cost twice as much. It “will tend” because currency is not a linear phenomenon, and it may take some time to happen.
In the 1970s and early 1980s, inflation in the United States reached rates close to 12% per year, creating many difficulties for those who didn’t have the knowledge and the means to counter it.
Deflation
Bitcoin was created with a deflationary logic, more similar to commodities such as gold and silver. This is why it’s considered by many to be the new digital gold, as it has preservation of value characteristics and not those of impoverishment, like the dollar or the euro.
Related: Is Bitcoin a store of value? Experts on BTC as digital gold
Let's see how it was possible to create, and what the effects resulting from these choices are.
Nakamoto decided that the maximum number of Bitcoin created and available should be 21 million. (The number 21 will occur many times. It is the Greek letter phi, which we will also talk about later). He could have decided to enter a fixed amount of Bitcoin for each block that got mined, but doing so wouldn’t have created the exponential growth effect that characterizes Bitcoin, or at least not as marked as it is today.
Consequently, he decided to halve the amount of newly issued Bitcoin every four years, to create a very marked and interesting stock-to-flow effect that would push the price higher and higher.