As an economist, I think the Bitcoin price rollercoaster has been one of the most interesting monetary experiments of this century! While last time was clearly a bubble, this time I do not think it is.

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What might be surprising is that economists have not really found a reliable way to indicate whether we are in a bubble or not. The reason because no one knows the true price of an asset and the first economists who figures that out will stop being an economist and become a trader instead.

Irrational exuberance

That being said, for a behavioural economist like me, one the clearest signs of a bubble is the presence of what Nobel Prize Winner Robert Shiller calls irrational exuberance. Meaning most people are really enthusiastic about the price of an asset and that the general sentiment is that it will only go up.

In 2017, there was clearly irrational exuberance.

Another tell-tale sign was that most of my friends that were never into finance, economics or investing, all of the sudden, could talk about nothing else but Bitcoin investing. They all seemed to make fortunes. It was interesting to experience that! Even though I knew it was a bubble, it was really difficult (emotionally) not to jump in. This must have been the case for many people. Indeed, many of them acknowledged that I made solid arguments when saying that it was a bubble. Still, they kept investing anyway. The dopamine shot of numbers going up seemed bigger than their rational sense that it was a bubble. I suspect Fear Of Missing Out (FOMO) was also a big influence. Then, when the bubble popped most of my friends sold way too late. Turning massive profits into losses.

Embarrassingly, it was only at this point that it started to feel good that I never bought into the bubble and that I stuck to my economic intuition. In my mind, this validates the importance of behavioural finance. Behavioural finance, in contrast to the previously popular efficient market hypothesis, basically assumes that while markets are often efficient, they are sometimes captured by an exuberant period. This exuberance is irrational because the price of a financial asset will be pushed far above what it should really be worth.

That’s when there is a bubble.

So, the last time Bitcoin was clearly a bubble because of the presence of irrational exuberance. Similar to how it was in the 2006 housing market bubble. Check out the Florida scene in The Big Short to see what I mean.

Importantly, in behavioural finance, if prices have risen really quickly, that doesn’t mean we are in a bubble. After all, there could be fundamental reasons for why these prices have risen so much. For example, it could be the case that the central bank has purchased many assets, driving the fundamental price up by making financial assets scarcer.

What does that mean for Bitcoin?

Now, even though Bitcoin price is at an all-time high, there is quite a bit of optimism, but also quite a bit of pessimism. Nothing we can call exuberance. At least not with inexperienced investors.

It seems more like the most famous crypto currency has matured to a ‘proper’ financial asset. All major asset prices are at all-time highs, especially considering the economic Coronacrisis.

So, does that mean that the Bitcoin price will not crash again, or will only go up?

To be honest, I really do not know. If I truly could predict asset prices, I wouldn’t be making YouTube videos now would I? Remember that when you next see someone on YouTube claiming to know exactly where the market it heading.

I do know that I am not buying in because I don’t fully understand where the value of Bitcoin comes from. Is it mostly used as a financial hedge, like gold? Is it increasingly used in illicit transactions or to avoid capital controls?

What do you think?