Edit: If you find my claims speculative and full of muck, here is the math, and a google drive to some plots the source code in mathematica.
This isn’t a bubble
Bitcoin is experiencing some rapid growth at the moment that is once again turning heads in the media. Everyone wants to know when to sell their Bitcoin just before the bubble pops – that is clear. While the exact timing of the bubble pop is difficult to predict, it is easy to use some key metrics to show that what we are experiencing now is in fact long overdue growth as the past months represented the fallout of the last bubble.
Don’t get me wrong. There will be another Bitcoin bubble someday. And likely another after that. It is the natural cycle that bitcoin lives on, which is illuminated plainly by taking the logarithm of the price history.
The Bitcoin Price-Epochs
You can detect Bitcoin bubbles by realizing a few facts:
1) on average, Bitcoin price increases about 1000% / yr
2) short term deviations from this behavior represent recessions and bubbles
3) Bitcoin’s natural mode (for the moment, because it is young and had not reached equilibrium with other currencies) is to exhibit incredibly fast growth – it’s worth repeating: Bitcoin has gained a staggering 1000% year average growth since its inception. That rate of increase is so massive, that a recession superimposed over it has the appearance of price stability or even small, slow growth.
Shown above is the entire price history of Bitcoin. There was a “little” $11 bubble followed by a BIG bubble in April…and now we’re gearing up for an even BIGGER BUBBLE! Right?
Wrong. Here’s the log plot, which effectively filters out Bitcoins automatic repeated doubling every few months.
This is a very illuminating chart. It really makes me happy as a clam, because almost everything about it falls in line with the basic tenets linear impulse response. Bitcoin is quite well behaved in fact. Notice:
• The truly daunting growth rate of bitcoin is to attain about 10 times its price the previous year (I know, I’ve mentioned this now three times. I just can’t get over it).
• The bubble in 2011 was actually a much greater deviation from this standard behavior than the bubble in April 2013. This is entirely expected. Mark my words – the next bubble will appear quite large on the linear axis, but indeed be smaller than the last in the log linear sense
• Because the 2011 Bitcoin Bubble was so much bigger than the one in April 2013, the associated recession was quite long. The recession following the 2013 bubble was shorter because it was a smaller bubble.
• The recession periods are in proportion to the size of the bubble. This is to be anticipated, as just about anything in the universe has a response proportionate in amplitude to that of the impulse which disturbed it.
• The price today is actually the natural expected log linear price – Bitcoin has stayed true to this line since it began. It cannot rise in this manner forever, but there is no reason to think Bitcoin has left its rapid growth state yet – the currency is still brand new and relatively few people in the world have interacted with it. The upside will continue until of course it cannot sustain log linear growth. But it is, to put it lightly, kind for Bitcoin investors that the day has not yet come.
Economy of Scale
Bitcoin will probably continue to follow this pattern for quite some time because of the extremely low friction within the Bitcoin system. The principle is known as economy of scale. The simple fact is, there is very little stopping Bitcoin from growing. Unlike a company, which feels considerable growing pains as its stock price shoots up, and eventually levels off when growth is impossible due to diminishing returns, Bitcoin doesn’t experience any backlash for attracting more users, more excitement, more of everything. Bitcoin doesn’t feel growing pains. Nothing works like that – not usually anyway, which is why Bitcoin has fooled the silver haired finance veterans, who, despite their vast experience in markets, have gone their entire lives never having met a beast that has nothing to stop it from gaining velocity.
Conclusion: Bitcoin has a truly unique economy of scale, limited only by the flow of information and technology around the world, and the robustness of the Bitcoin protocol itself.
If I lost you on the last part, watch this TED talk by a particularly captivating scientist who researches economies of scale in both biological and economic systems:
You will be reminded of the Bitcoin price when he characterizes the economies of scale in organisms and likens this to the development and life cycle of an entire city – its people, its culture, its structural map, and its entire social being.
It is not very difficult to swallow, for me, that this really is the way the Bitcoin economy works. A city is nothing if not a set of connections – the social and economic influences, and the relationships between people in close proximity. In 2013, where “close proximity” has been redefined to mean “within arms reach of a keyboard” it is no wonder we see the topological structures inherent in the growth of economic centers emerging in the cloud.
You’ll also (hopefully) be entertained by his breakdown of economies of scale, and almost certainly will be enlightened.
Thesis: hold your coins, and watch the log plot.