In case you've been living under a rock, cryptocurrencies, headed by bitcoin and ethereum, are absolutely on fire in 2017. After beginning the year with a $17.7 billion aggregate market cap, the more than 900 cryptocurrencies that can be purchased by consumers witnessed their market cap recently soar beyond $160 billion as a whole -- that's a better than 800% increase in about eight months.
Though bitcoin is up "just" a tad over 300% year to date, it's largely responsible for the market cap gains since it represents almost half of the aggregate digital currency market cap. Ethereum's more than 3,000% year-to-date gain hasn't hurt, either.
Cryptocurrencies have been unstoppable this year
The fire under bitcoin, and in a broader sense cryptocurrencies in general, is mostly due to a combination of excitement surrounding blockchain technology, weakness in the U.S. dollar, and potentially investor emotions.
Blockchain, which is the digital decentralized ledger that records transactions without the need for a financial intermediary, is the technology that underlies bitcoin and ethereum. Some pundits suggest that blockchain could spur the next generation of safer peer-to-peer and business-to-business transactions. The potential blockchain holds in the financial industry has some investors in cryptocurrencies especially excited.
The falling U.S. dollar has also been a catalyst for bitcoin and other cryptocurrencies. After hitting its lowest level in two-and-a-half years against the euro, investors who fear losing purchasing power have sought the safety of bitcoin as a store of value. Traditionally, when the dollar falls, gold is the go-to safe-haven investment because of the fact that it's a finite resource. Of late, though, bitcoin, which has protocols built in that limit the number of coins that can be mined to 21 million, also has the feel of a finite resource, and has thusly been attracting investors.
We've also probably witnessed investor emotions taking hold. After all, it's not every year we see investments that climb by 300% or 3,000% in a matter of months, and these gains are likely attracting money from folks who frankly don't understand cryptocurrencies and are hoping for a quick buck. Emotions can increase volatility to both the upside and downside.
Bitcoin is a fraud?
But what if this (i.e., bitcoin) were all a sham? According to Jamie Dimon, the CEO of JPMorgan Chase (JPM -0.80%), the largest bank in the United States by market cap and deposits, bitcoin "is a fraud."
In an interview at CNBC's annual Delivering Alpha conference, Dimon said, "It's [bitcoin] just not a real thing. Eventually it will be closed." Dimon clarified his comments by suggesting that he's "not saying go short on bitcoin and sell $100,000 of bitcoin before it goes down. This is not advice of what to do. My daughter bought bitcoin, it went up and now she thinks she's a genius." But he also opined very plainly that if any of its traders at JPMorgan bought or sold bitcoin, they'd be fired "in a second" since it's "against our rules and they are stupid."
In a separate conference earlier that day, Dimon also suggested, "It's [bitcoin] worse than tulip bulbs. It won't end well. Someone is going to get killed. Currencies have legal support. It will blow up."
While not everyone is sure to share Dimon's opinion, his views could have some partial validity. In terms of the actual coins themselves, Dimon could be correct. A portion of the bitcoin community is counting on growing acceptance of bitcoin as a legal form of payment, with a number of brand-name companies jumping on board back in 2014. However, if bitcoin's volatility were to pick up or its price were to drastically fall, it's not out of the question that these brand-name businesses will stop accepting bitcoin altogether. That may not be a death blow to bitcoin, but it certainly wouldn't be good news.
Dimon also speaks to a pretty convincing long-term trend that says rapid short-term gains are often fleeting. Within the stock market, the next hot thing usually ends with huge gains being dashed in relatively short order. Examples include the genomics bubble bursting in the early 2000s, the dot-com bubble popping around the same time, and the 3D-printing bubble bursting just a few years ago. These bubbles are confirmation that investor emotions can easily get carried away, leading to unsustainable valuations.
A more reasonable (but still bearish) view of bitcoin
One area where this writer would clearly disagree with Dimon is that the blockchain underlying bitcoin is very much real, and it does have potential. The transparency and decentralization that blockchain provides would make it considerably tougher for cybercriminals to alter transaction data.
However, this isn't to say that anyone has any clue at the moment how valuable blockchain can be. The Enterprise Ethereum Alliance currently has more than 150 organizations testing out a version of ethereum's blockchain in either pilot or small-scale programs, possibly placing it ahead of bitcoin in terms of allure for businesses. But these small-scale projects don't give us any idea of what the technology is really worth as of yet. Bitcoin recently upgraded its blockchain (the SegWit2X update), which should lower its transaction fees, speed up transaction times, and improve capacity within its network, but it remains to be seen if this will be enough to attract businesses to utilize its blockchain.
Increased regulation could also be something of a double-edged sword for bitcoin. If U.S. regulators were to crack down on bitcoin, it would in a way validate the digital currency. Then again, if regulators were to step in, it would crush the dreams of libertarians who view bitcoin as a means to get around a central bank.
There's also pretty clear evidence within the stock market that a bubble may exist. The Bitcoin Investment ETF (GBTC -2.68%) operated by Grayscale owned 172,721 bitcoin as of Aug. 31, 2017, which works out to a net asset value $668 million with bitcoin at $3,870 per coin as of Sept. 13. However, the market cap of the Bitcoin Investment Trust as of Sept. 13 was $1.12 billion. This shows that investors are paying a 68% premium for shares of this bitcoin-based ETF for virtually no reason, other than perhaps improved liquidity over purchasing bitcoin directly from an exchange.
Is bitcoin a fraud? Probably not, but that doesn't mean it's worth anywhere near its current value.