The promises of enormous and fast profits have also lead to some incredible speculative bubbles. One of the most famous was the Dutch “Tulip Mania” that at its peak in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman.
The seminal book on bubbles is Manias, Panics, and Crashes, by Charles P. Kindleberger, Robert Aliber. According to their book, a bubble involves an unsustainable (parabolic) move in prices, or cash flows. See page 8, price history for Bitcoin for an example.
The book lists 10 of the most famous and biggest bubbles in economic history:
1. The Dutch Tulip Bulb Bubble
2. The South Sea Bubble, 1720
3. The Mississippi Bubble, 1720
4. The U.S. stock market bubble, 1927 – 1929
5. The surge in bank loans to Mexico and other emerging countries in the 1970s
6. The Japanese real estate and stock market bubble, 1985 – 1989. Japan hasn’t really recovered from their bubble.
7. Scandinavian’s real estate and stock market bubble, 1985 -1989
8. Thailand, Malaysia, Indonesia and other Asian countries real estate and stock market bubble 1992 – 1997
9. Surge in foreign investment in Mexico, 1990 – 1993
10. Tech, dot.com bubble 1995 – 2000.
Not included in the list, the U.S. real estate and sub-prime mortgage bubble, 2003 to 2008.
Some Ponzi schemes also wind up as bubbles, Madoff being the latest. Many Ponzi schemes burst because they can longer find fools to fund the ruse, or the law catches up with schemer.
The latest scheme/speculative bubble is the Bitcoin frenzy that has thousands of speculators, investors and tax dodgers dreaming of windfall profits. The amazing thing about Bitcoins is that unlike most Ponzi-Schemes and speculative bubbles is that so much is unknown about who actually launched it.
Accepted by few, Bitcoin is money that has no backing by any country, banking institution and can literally be created out of thin air!
Bitcoins are a virtual currency created by anonymous programmers around 2008, 2009. They are 100% digital. They are not minted in silver, copper, gold, plastic or even printed on paper. They exit entirely in the digital world. They can be used currently to buy a broad range of products -from cupcakes to computers, electronic and even illegal narcotics.
Bitcoins are popular with Liberterians who like the fact that Bitcoins are a currency outside the the control of governments.
Bitcoins were created by a person or group using the name Satoshi Nakamoto. However, this person or group has yet to be identified. There are a few patents involving the encryption for Bitcoins that are owned by a few individuals but all have denied that they are involved with Bitcoins when reached and or interviewed.
New Bitcoins are generated by programmers, engineers or anyone who can solve mathematical riddles – literally out of thin air. Owners of Bitcoins store them in computer wallets, which are identified by a long string of numbers and letters. The wallet 1933phfhK3ZgFQNLGSDXvqCn32kbuXY8a, for example that holds 111,111 Bitcoins, which amount to about $15 million – all sitting on someones hard drive.
While newly created exchanges have been created, and they are the most organized component of the Bitcoin frenzy – these exchanges are not regulated by any government agency, require no licensing by any government.
My name is James DiGeorgia and I am the editor of GoldandEnergyAdvisor.com one of the world’s leading investment advisory services.
Over the past 30 years I have become one of America’s best known experts on precious metals, oil stocks and even rare coins. I have appeared frequently on Fox Business, CNBC, CNN, BBC, CBN and been quoted in the world’s leading financial journals, newspapers and websites.
I have also during my career built a reputation for sniffing out investment scams and exposing them. In some cases my coverage of bogus investment scams has led to the arrest and conviction of some pretty slick con-artists.
Several years ago I was featured in Barron’s when I was receiving bomb and death threats from a family running a boiler room operation selling gold to thousands of investors who never received their gold or money back.
The Bitcoin scam is being fueled by a growing list of true believers
Truly devastating Ponzi-Schemes and speculative bubbles occur when they capture the imagination, greed and lust of people looking for something for nothing. The Bitcoin frenzy has taken a few years to catch on and snow ball - but today it is already a scam that could rob those caught up in it – of a billion dollars.
Keep in mind that since there is no central company, person or government standing behind Bitcoins there is no way to know how many there actually are.
If you do some solid research you’ll discover there’s a “Bitcoin system” that supposedly only generates (anonymously) a limited amount of coins for a given period of time.
The propaganda used to sell the concept of Bitcoins stresses this limited number of Bitcoins. Without any solid evidence the Bitcoin propaganda also hypes them by insisting that “the Bitcoin system” will somehow reduce the amount of Bitcoins generated about every four years. So far I have found no credible evidence that this claim is true.
Proponents of Bitcoins argue that they are accepted by a growing number of internet merchants, service providers and charities. Like most financial scams the Bitcoin frenzy has been featured in the mainstream media as a speculative investment opportunity that’s yielding big profits as a result of the media attention, Bitcoin prices have gone parabolic up and also down.
Bitcoin has and may continue to have spikes in prices (and crashes) when well-known participants are involved. The Winklevoss twins of Facebook and Social Network movie fame have been reported to be involved in Bitcoins. They are said to have bought when the Bitcoin was in single digits, so they are probably sitting on a nice profit. The twin’s net worth is about $250 million (from suing Facebook). So their allocation to the Bitcoin is probably just a few percentage points of their net worth.
What type of conviction do the twins have regarding Bitcoin? In a news article about the twins and Bitcoin, one of the twins is quoted as saying. “We could be totally wrong, but we are curious to see this play out a lot more”. Not a lot of conviction.
There are many reasons I believe this Bitcoin frenzy is the next Multi-Billion dollar Ponzi scheme and why you should be paying attention.
Bitcoins are absolutely NOT money!
I’ve been fascinated with money since I was a 6 years old. Left alone for a few hours as a youngster I discovered a 1922 Peace Silver Dollar in a draw in my father’s desk. At that very early age I learned the difference between fiat money and hard money. So when I consider Bitcoins, literally backed by nothing I can’t help wonder if those buying into them have lost their minds.
I always tell investors that they must understand the valuation of every asset and investment they own or are considering.
There are two prices that investors must consider: the true value of the investment, and the market price. The most important is the true value of an investment, as the market price will normally gravitate to the true value of an investment.
Investors call the true value of an investment its intrinsic value. A U.S. Silver dollar has slightly less than an ounce of silver. A U.S. $20 Gold minted prior to 1933 also weighs just under an ounce. These coins are worth about $20 and $1300 even if scratched because of their intrinsic precious metal value.
When considering an investment in a stock, bond, commodity or even foreign currency there are many methods, models, calculations to determine their value including ..: replacement cost, production cost, balance of payments, dividend yield, discounted cash flow analysis, book value, comparison analysis….
For example gold, we know both the market price of gold and the cost to produce an ounce of gold. Every few years we go through the analysis and determine the value, cost of gold. The input costs of gold include: royalties, environmental cleanups, materials, labor, processing. All these costs have been going up.
How are currencies valued?
There are many variables that determine the value of a currency: the assets, resources of the currency; the size of the countries’ economy, GDP; inflation; interest rates; rule of law; debt; political system; accounting systems and reporting; transparency; the diversity of its industries; the educational attainment of its citizens…
If we were to use the variables listed above to value a Bitcoin, it would have - no intrinsic value.
If tomorrow people woke up and realized the Bitcoin frenzy was nothing more than a Ponzi scheme, they could literally have no value in a matter of minutes!
This is what participants in the Bitcoin market should understand. The downside risk of Bitcoin is 100% - you are risking a complete and total loss of any money invested or used speculating in this “virtual digital currency”!
Bitcoins Poorly Conceived
The individuals that created Bitcoin are obviously computer programming geniuses that are masters of the accelerating technology of computer programming, the internet and math.
But, they do not know a lot about international finance and markets, asset valuation, international economics, governance but most importantly, how to build a financial system that economies, companies, merchants, and consumers will use with confidence and trust. Perhaps this was not their intent. There’s a lot we don’t know about Bitcoins and the people behind it.
Confidence is very important in an investment. To build confidence requires: trust in the people that stand behind it; executives, administrators that are in charge of maintaining trust and integrity, building value, and even promoting the use of the product and service; that the value is knowable and understandable; laws, rules, regulations and qualified regulators; transparency.
Below are more questions participants in Bitcoins should ask.
With no official issuer and no central bank responsible you’re not going to get some of the most important questions asked.
Who started Bitcoin? Where do they live? Where were they educated? What degrees do they have?
Who is in charge now? How much are the paid? Are they trustworthy? Do they have criminal backgrounds?
Are Bitcoins Legal?
There are no countries that have deemed Bitcoins legal. In the U.S, Bitcoins are not legal tender. Also, at this point government regulators have left the currency alone – for now. Like most Ponzi schemes the government gets interested after people get robbed!
Some analysts believe that criminals are using Bitcoin to hide and launder their illegal activities. A recent story posted on Huffington Post lead with the headline: Bitcoin Celebrated As Way To Avoid Taxes and featured a treasurer of a limited liability company bragging…
She is celebrating Bitcoins as “a novel way to avoid any audit trail -- and thereby any liabilities to Uncle Sam. Goodbye American dollar, hello Bitcoin.”
“We don’t intend to file tax paperwork anymore,” the treasurer told The Huffington Post Monday, as many others scrambled to fill out tax forms or stood in long lines at the post office. “We’re not going to do business with the government from now on.”
Let me assure you that anyone thinking Bitcoins can be used to dodge taxes is – looking at the same Federal prison cell that so many people occupied for buying into the belief that income taxes are voluntary.
I know one Harvard educated gentleman that spent 5 years in prision who even after convicted and serving his sentence STILL insists that income taxes are unconstitutional and paying them is a voluntary option.
Absence of Regulation
As alluded to above, consumers, investors and speculators are not protected against theft, fraud, and losses in Bitcoin transactions.
Regulators have mandated that Bitcoin report large and suspicious activities to the Treasury.
Because of the lack of a governing body to monitor, regulate, establish rules, protect participants issue more currency, and adjust to economic conditions makes investing or speculating in Bitcoins the equivalent of betting on the Houston Astros to win the World Series in 2013 look like a smart move.
The Success of the Bitcoin Frenzy Will Bring Competition
There is lots of competition, choices if an investor wants to have exposure to currencies.
Virtual currencies have a few choices, but that will surely change because of the relatively low barriers to entry to establish a virtual currency.
The potential for more virtual currencies will certainly reduce the demand for Bitcoins.
Every investor must understand the universe of participants in a market.
It’s hard to determine who the dominant participants in the Bitcoin frenzy are, but they probably include: technology workers who established Bitcoin and who it was meant for, currency traders, hedgers, criminals, speculators, novices.
I doubt traditional stock, bond or commodity investors are involved because of their focus on valuations.
Shaky Ground and Huge Swings Up and Down -- have already occurred!
The Bitcoin frenzy has already experienced several setbacks that have hurt its credibility…
One of the possible creators of Bitcoin (one of the individuals who own the patents to Bitcoin) communicated that he “had moved on to other things”.
There are sure to be more mishaps.
Volatility and Manipulation
Investors must always avoid emotional decisions based on fear and greed. Fear is the most harmful decision and emotion.
Mt. Gox is the main website where participants can trade the Bitcoin. The site does keep track of the trading history of Bitcoin.
Here is a chart for the Bitcoin for one year, 2011.
The Bitcoin hardly moved the first 4 months of this graph.
In June 2011, Wikileaks began accepting Bitcoins as donations, giving bit coins some legitimacy. In late 2011, the news wore off and prices crashed.
Here is the trading history for the past 12 months:
As can be seen, prices have recently spiked. Parabolic moves like this are a sign of speculation and illiquid markets.
The current value of the Bitcoin market is about $1 billion. This is very small compared to the currency markets that trade $ trillions every day.
It would not take a lot of money to move prices up and down.
Expect the Bitcoin market to be very volatile.
Traders and investors must understand the nature of volatility of fear and greed. Let’s look at an example:
The above current, short-term chart is for Bitcoin.
Notice that it took several weeks to go from 50 to $250, greed.
Also notice that it only took a few days to crash from $250 to $50, fear, and to lose its value so quickly. This is very normal in small, illiquid markets.
Again, the chart above is normal where speculation, illiquidity and fear reign.
The left side of the graph shows volume for the Bitcoin. The blue trend line is volume with the size of volume on the left side of the chart. There were many days were there was little to no volume, but during the collapse volume spiked to 30k. There are several points here: Bitcoin has little volume and would be considered illiquid; you normally see more volume on selling versus buying; fear is a powerful emotion.
The important lesson here: FEAR is more powerful than greed. Money can be lost very quickly.
US Officials Freeze An Account Linked to Bitcoin Exchange
On May 15, 2013 U.S. officials dealt a serious blow to the Bitcoin market by freezing an account tied to the largest Bitcoin exchange just months after regulators warned such entities should follow traditional anti-money laundering rules.
The Department of Homeland Security obtained a warrant last two weeks ago to Mt. Gox, a Tokyo-based exchange that says it handles 80% of all Bitcoin trading. The warrant alleges the company and a subsidiary were conducting transactions "as part of an unlicensed money service business."
Bitcoin startups are beginning to raise sizable investment capital even as industry leaders warn as I reported earlier in this article that hackers are abusing the Internet virtual currency for profit.
Meanwhile Bitcoin has been on a wild ride since March, ranging between $125 and $98 over the past 10 days and rising as high as $230 in April. It was trading at about $112 the second Wednesday on the Mt. Gox exchange. So speculators are still buying into this multi-billion dollar scam!
Why Buying Gold and Silver Bullion as Your Hedge Against Future Financial Crisis Much More Sense
The best alternative to holding U.S. Dollars or for that matter paper currency and assets is gold, silver and platinum bullion. The best way to buy these precious metals is buying bars or the several different bullion coins minted by the United States Mint or private mints like Englhard and Johnson Matthey.
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