By Richard Bernstein, Richard Bernstein Advisors

It’s always hard to remain objective during the hype of a bubble, and the current cryptocurrency bubble is no exception. However, our take on cryptocurrencies is that cryptocurrencies are merely the winning bounty of on-line games. The difference between cryptocurrencies and on-line games’ “coins” is that cryptocurrencies are tradeable.

Playing Candy Crush and using the resulting coins to buy goods or to trade on an exchange sounds silly. However, change the words “playing Candy Crush” to “solving a sophisticated mathematical formula,” and suddenly global currencies have been revolutionized.

What defines a bubble?

Since the bursting of the Technology and Housing bubbles, market observers tend to use the term “bubble” too frequently. There have been many periods of financial speculation, but bubbles are quite rare. It is true that bubbles contain speculation, but all periods of speculation aren’t bubbles.

Financial bubbles differ from financial speculation and overvaluation because bubbles pervade society as a whole whereas financial speculation tends to be confined to the financial markets.

We’ve always argued there are five characteristics of a financial bubble. We’ve derived these from Edward Chancellor’s Devil Take the Hind Most. As we’ve previously written, all five of these characteristics exist within the cryptocurrency market.

  1. Increased liquidity – there remains considerable liquidity in the financial
  2. Increased use of leverage – the use of futures contracts and borrowing to
  3. Democratization of the market – everyone gets to take part in the
  4. Increased turnover – trading volumes have
  5. Increased new issues – there are over 1300 cryptocurrencies (for comparison, there are only 180 country currencies).

The presence of a bubble does not mean that the economics and businesses related to cryptocurrencies are not viable businesses. Rather, a bubble suggests that the return-on-investment could be considerably lower than investors currently expect.

Many forecasts made during the Technology bubble regarding the internet’s impact on the global economy have turned out to be true. However, those who invested in the Technology sector during the bubble have largely been disappointed with their returns because so many internet-related companies were severely overcapitalized.

“Mining” cryptocurrencies is simply playing an on-line game

As any player of on-line games can attest, the goal of most games is to win coins, tokens, jewels, or the like that are helpful in reaching new levels in the game. One receives a certain number of coins  when one wins a level, and is allowed to proceed to the next level of the game. Depending on the game, coins can be used to enter  new levels of the game or to purchase accessories that help win.

Additional coins can typically be purchased for real money via a credit card.

Related: Income + Tariffs + Inflation = Underperformance

Winning game coins or tokens is remarkably similar to “mining” of cryptocurrency coins. Coindesk.com actually uses the heading “solving the puzzle” for the description below (emphasis is mine), which can be found on their website under the heading “How Bitcoin Mining Works”.

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