Are Cryptocurrencies Overvalued? An Analysis of the Market Bubble
With the total cryptocurrency market capitalization recently breaking $2 trillion, many are left wondering whether this market is entirely a bubble or if this valuation is deserved. Though there are lots of strong projects in the cryptocurrency space that are nearly guaranteed to disrupt industries and be a mainstay in our society, they may not deserve their current market cap, and many others do not deserve theirs at all.
Every single time cryptocurrencies are mentioned in the news, investors always have one question on their mind: is this market a bubble? It seems crazy to think that a digital currency, which has no backing from any government and cannot be held physically, has a valuation of over a trillion dollars, and still has some speculators thinking it will be valued as high as $10 trillion. Even though the answer to this question is incredibly tricky to pinpoint with complete accuracy, let’s take a look at some of the reasons behind the belief that cryptocurrencies are overvalued, then see why others think they are still undervalued.
One of the reasons that putting an accurate valuation on Bitcoin and other cryptocurrencies is so difficult is the fact that they are a completely new asset class. With stocks, which represent shares in a company, one can look at the company’s profits in order to determine how much an investor can expect to receive in profits from that company. With cryptocurrencies, holders are not entitled to profits, and at first glance there seems to be no fundamental value or benefit to holding them, besides holding a piece of digital money.
Furthermore, it appears that there is no reason for the price to increase or decrease day-to-day, and holders are speculating about the future happenings of the currency, such as whether or not it will be adopted by merchants or put in the investment portfolio of a large company. With this constant speculation and future-oriented mindset, it’s hard to see why Bitcoin deserves the market capitalization it has today. An argument made for Bitcoin’s market cap is that it will one day be accepted and used universally, but that does not explain why it is worth $1 trillion today, other than pure speculation.
This type of future speculation can be seen everywhere in the space. For example, Cardano, the smart contract platform that plans to beat Ethereum, has a market capitalization of $40 billion, more than many profitable companies, without even having smart contract functionality or a single application built using its ecosystem. The valuation at the moment is fundamentally baseless, and relies solely on the future potential of the project. When retail investors see the high price, instead of thinking the project is overvalued, they get FOMO and decide to buy more, leading to an even more outrageous valuation.
Additionally, when removing the name-brand value from Bitcoin, it is simply an expensive way to send money around the world. This can be done by any cryptocurrency, regardless how big the market capitalization. The only thing that a trillion dollars does for Bitcoin is allow it to be accepted more universally and for billion-dollar transfers to take place. Besides those two benefits, any cryptocurrency can do what Bitcoin does with a fraction of the market cap.
Another reason to be wary of a cryptocurrency bubble is the number of scam or illegitimate projects with massive market caps. One has to look no further than Dogecoin for an example of a project with no fundamental value and a sky-high market capitalization of $34 billion. If a meme project can reach $34 billion effortlessly, how can we trust that any other cryptocurrency is fairly valued?
After looking at these few reasons, it is easy to see why some see cryptocurrencies as overvalued. However, there are others who think that their current valuation is more than deserved, and that these prices will actually be seen as incredibly low in the future.
The $1 trillion dollar market cap of Bitcoin looks incredibly small when compared to its full potential. If Bitcoin truly becomes the world’s digital gold, if a market capitalization of ten, if not one hundred, trillion dollars is feasible. Furthermore, if a project like Cardano is able to kill Etheruem and become the basis for the next generation of the internet, its true worth is nearly impossible to calculate. The following graph is outdated in terms of cryptocurrency market cap, but still demonstrates how much room there is to grow for the asset class.
Even though it’s easy to say that Bitcoin does not deserve its market cap due to its slow transaction times and high fees, there is one important fact that investors are forgetting: the Bitcoin blockchain is the most secure and provably legitimate document in all of human history. Every transaction, once written on the Bitcoin blockchain, is confirmed and stored by tens of thousands of validators all over the world, and left there for as long as their storage is around. This level of trust and security available is incredibly valuable, and allows for transfer of money and trust at a level which has never been seen before in the financial world.
Even though some smaller projects are fundamentally worthless but have billions of dollars in market capitalization, this does not mean that the entire market is overvalued. And even if some projects today carry a market capitalization higher than they are worth as of today, constant developments mean that projects are continually improving, and will one day hope to live up to their current market cap. A problem only arises when, for example, investors buy ETH today in hopes of the release of Ethereum 2.0, raising the price, and then the price rises again because of the release. However, if this happened, it would not necessarily mean that investors are overvaluing Ethereum, but that they believe it carries a premium value based on its potential.
With the current state of the cryptocurrency market, it is easy to see that a bubble is forming, due to the high levels of speculation by both retail and professional investors. However, it is impossible to know the size of the bubble, and when, and if, it will pop. Accurately valuing Bitcoin or Etheruem is as difficult as valuing the internet itself. The best course of action for current investors would be to do diligent research on every cryptocurrency, and ensure that they see a fundamental value and strong future potential worthy of its current market cap.
By Lincoln Murr