A True Bubble Does Not Pop Without Leaving Something Behind
Implications for crypto
Last week we told you why Bitcoin is not a bubble and it has nothing to do with its price. Bitcoin is not a bubble because it does not generate cash flows and therefore, does not even qualify. Remember, our definition of a bubble is:
A bubble is the significant overpricing of a cash-flow-generating asset
relative to its intrinsic value.
We then presented you with a few examples of people and institutions who believe that Bitcoin is a bubble.
There is one alternative view that is worth exploring which would be along the lines of: “You guys restrict the definition of a bubble to cash-flow-generating assets only. One might as well change ‘cash-flow-generating assets’ to just ‘assets’ in your definition. Since Bitcoin’s intrinsic value is zero, it would be a bubble at any price. As such, the critics you disagree with actually have a valid point of view.”
A mathematician might tend to agree. “If a bubble can be had for a cash-flow-generating-asset with an intrinsic value of $1, why could one not have a bubble when the intrinsic value is zero? Intrinsic value of zero is simply a special case.”
That point of view is certainly not meritless. However, in this case, expanding the definition of bubbles to all assets does much more harm than good and we will tell you why.
We have been arguing for some time now that the most prominent issue is that crypto is being viewed as on par with stocks. We keep coming back to this delightful 2021 article by Fortune, Your father’s stock market is never coming back, because it explained the issue as well as any other:
With a Robinhood account, your first exposure to cryptocurrencies does not frame them as an unproven alternative to stocks. The two stand on equal footing. Coke and Pepsi. Feel like trading one or the other? Have at it, no difference. This is radically different from the experience of the Gen X and boomer investors … The generation creating the new conventions of the investing landscape views stocks and crypto coins as interchangeable.
Remember what we said back in 2023:
If every tradeable is a financial asset and every trade is an investment, then the world of finance turns into a utopia that was unfathomable just a few years ago. Everything trades and nothing matters. What people are buying or whether they know what they are buying becomes pointless. It trades! That’s all that matters. If people can buy it, it means that somebody else can buy it from them and potentially at a higher price, so potentially they can become a zillionaire overnight.
The distinction between a cash-flow-generating-asset and any asset is lost. That means the distinction between investment and speculation is lost. The financial system will not recover unless we unapologetically demand that distinction comes back.
That is why we have to demand excellence and consistency in all of our definitions. This is an area where a compromise is actually unhealthy. Could one define a bubble such that it applies to all assets? In theory, yes, but what would that accomplish exactly? It only contributes to the perception that crypto has parity with stocks. Breaking that perceived parity is of utmost importance and we owe that to future generations. Our definition of bubble is simply the only one that is consistent with that goal.
There is a mental map that is available that is consistent with our view. Let’s watch:
What does this video have to do with Bitcoin?
Do us a favor, fast-forward to 1:47 please and watch that segment again. When the bubble pops, what happens?
Did the bubble disappear? No. There are the remains of the bubble, which the bubble blower dutifully puts back into her mouth.
That, ladies and gentleman, is the intrinsic value.
Bubbles in real life, the ones the kids are very familiar with, are not created out of nothing. You need bubblegum to create a bubble. You need a liquid solution to create a soap bubble. When the bubble pops, we go back to what we started with; in the case of bubblegum, there is the chewed bubblegum piece and in the case of a soap bubble there are some water droplets. They may evaporate and turn into air almost immediately, which may give you the illusion that nothing is left, but that is not true; something is left, it just becomes invisible to the human eye very quickly.
Remember, a bubble is the significant overpricing of a cash-flow-generating asset relative to its intrinsic value. When a stock is bubbly, its price has diverged from its intrinsic value for euphoric reasons or otherwise. When it pops, it reverts to its intrinsic value, or very close to it. It may even overreact in the opposite direction, in which case you would have a potentially great investing opportunity! The same type of bubble holds true for real estate.
On the other hand, if an asset with no intrinsic value “pops,” there is nothing left. But there are no real life bubbles where the bubble pops and nothing is left. Starting with something, rather than nothing, is a requirement for a bubble. As such, when the bubble pops, we revert to that something, as opposed to nothing. We are simply translating that same principle to finance; that’s why our preferred definition of a bubble is one that requires a cash-flow-generating asset.
You might then reference the 17th century tulip mania which most have been calling it a bubble ever since. Then the public at large did the same thing with Beanie Babies. Were we wrong all along?
Our answer is yes because society adopted a subpar definition. We believe part of the problem is that these assets, namely tulips and Beanie Babies actually had some utility. In those cases, the price was not zero to begin with because those items were being purchased because they gave utility to their buyers. After the mania ended, the prices reverted to the asset’s utility value, which likely contributed to the perception that we had experienced “financial bubbles” for a period of time. However, something was still left behind in each of those cases. What was underappreciated was that what was left behind was the asset’s utility value, not its intrinsic value.
Calling these episodes bubbles has conditioned the human brain that crypto, too, can be bubbly; however that is, quite simply, an illusion. Crypto, similar to tulips and Beanie Babies, does not generate cash flows and therefore cannot be a bubble. Most crypto, unlike tulips and Beanie Babies, has no real utility, and thus, if the price reverts to the asset’s intrinsic value, there will be nothing left behind.
If we adopt the better definition of a bubble, maybe, just maybe, we can help prevent some financial catastrophes and that is a goal worth fighting for.
