The bitcoin bubble explained: Understanding the mathematics of the inevitable bitcoin crash

Tuesday, April 09, 2013 by Mike Adams, the Health Ranger Editor of NaturalNews.com (See all articles...) Tags: bitcoins, speculative bubble, market crash

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(NaturalNews) John, Mary and Kate are three "investors" who are buying bitcoins. Each time one of them buys a bitcoin, the value of bitcoins rises due to increased demand.

John got in early and bought 10 bitcoins for $1 each. So John's investment is a total of $10.

Mary got in a month ago and bought 10 bitcoins for $20 each. So Mary's total investment is $200.

Kate just bought her bitcoins, purchasing 10 of them for $200 each. So Mary's total investment is $2,000.

The total amount of their combined purchases as $10 + $200 + $2000, or a grand total of $2210.

But the three of them, in total, THINK they have a grand total of $6,000 worth of bitcoins because ALL the bitcoins they purchased are now "valued" at the most recent purchase price of $200.

In other words:

John currently owns 10 bitcoins valued at $200 each, so John thinks he's got "$2,000 worth of bitcoins" in his account.

Mary's 10 bitcoins are also valued at $200 each, so Mary thinks she's got "$2,000 worth of bitcoins."

Kate's bitcoins are also worth $200 each, so Kate has $2,000 worth of bitcoins.

In total, these three people believe they have $6,000 worth of bitcoins.

Yet, they only "invested" $2210.

Somehow, $3,790 in "value" was created out of nothing.

Where did this extra $3,790 come from?

Answer: It doesn't exist. It is an illusion.

Bitcoins, like stocks, create the illusion of free wealth during a rise in valuation

In truth, John, Mary and Kate are all suffering under a shared delusion by thinking they each possess $2,000 worth of bitcoins. All currencies are shared delusions, including the U.S. dollar. They only hold their value as long as very few people sell the currency. Once a selloff begins, the mathematical process that created the excess "virtual valuation" reverses itself, destroying valuations across all the investors.

All currencies depend on "faith" in the currency. That's why the U.S. dollar is claimed to be backed by the "full FAITH and credit of the U.S. government." Without the faith, the currency collapses.

Bitcoin valuations also require faith... faith that a large selloff will not occur. Because if it does, prices will naturally fall as the supply of bitcoins increases due to people selling them into the market. Here's how that will happen (in reverse of the earlier example):

Kate sells first, commanding $200 for each bitcoin she sells, so she recovers her full $2,000 in US dollars.

By the time Mary tries to sell, bitcoin prices have collapsed to $20 per bitcoin. So she gets $200 for selling her bitcoins.

Finally, John is the latest to sell, and by that time prices have collapsed to $1 per bitcoin, so John gets $10 for selling his.

What's the total cash they all got out? $2,210. Importantly, this is NOT equal to $6,000 -- the dollar amount they all believed they had in bitcoins.

The brings up a truism about any such investment vehicle, including currencies, stocks and bonds:

Perceived valuations do not reflect the actual cash value to be received during a mass selloff. What they reflect is the maximum optimism, multiplied across all account holders, based on the last selling price.

Here's another way to understand this

Suppose one million people currently own one bitcoin each, and the latest selling price for bitcoins is $200.

This means the total valuation of the currency is $200 million (i.e. $200 x 1 million).

Now, suppose some guy gets excited and offers to buy just ONE bitcoin at $220, signifying a $20 price increase. A seller figures, "Well, I'll make twenty bucks" and sells him the bitcoin at $220.

Now, suddenly, $220 is the latest selling price for bitcoins, making it the new valuation for ALL bitcoins. So those one million people who all own bitcoins now think each of their bitcoins has gone up by $20. This has the effect of creating $20 million in extra valuation out of thin air.

Yep, suddenly the total valuation of bitcoins is $220 million instead of $200 million, and this was all due to ONE transaction placed by ONE person, using nothing more than $220 in U.S. currency to make the transaction.

Now you see how easily the central banks could be manipulating bitcoins into a sky-high bubble followed by a crash.

How the central banks can easily crash bitcoin valuations back to historical values

If you're a central banker, you hate bitcoin. You want to see it destroyed, of course, but more importantly you want to see it discredited. You want to portray it as a "pyramid scheme" that ultimately hurts a lot of people. And you want to promote the "safety" of government-backed banks (i.e. central banks).

How to accomplish this? It's stupidly simple: Just start creating money out of nothing (i.e. crank of the U.S. dollar printing presses) and use that fake fiat currency to purchase billions of bitcoins at ANY price, driving bitcoin valuations sky-high.

Keep pumping money into bitcoins until the speculators ("fools") jump on board, thinking they're all going to get instantly rich by joining the latest new "free money fad."

Stand back as the bitcoin valuations reach the stratosphere, suckering even more people into parting with their hard-earned cash by buying into the system.

And then, when the timing is right, start SELLING billions of bitcoins into the marketplace at any price. FLOOD the marketplace with your entire inventory. The price support for bitcoins will shudder and collapse, and once the collapse begins, fear will kick in and sellers will pile on. As the prices collapse even further, fear will turn to panic, and people will attempt to "sell everything at any price!"

That's the point where bitcoin crashes hard, thereby accomplishing the exact goals of the central banks. History shows that markets crash FASTER than they rose, so you can expect the eventual bitcoin crash to be wildly accelerated in terms of velocity. Billions of dollars in valuation will be wiped out overnight, and more importantly, the reputation of bitcoin will be destroyed.

Mission accomplished for the criminal central banks who excel in market manipulations and psych warfare.

How high will bitcoin go before the crash?

Mark my words: Bitcoin is headed for a disastrous crash. All the signs are there. It's undeniable. When speculative investors, driven by greed, flood a particular investment vehicle creating a fast-expanding bubble, a crash is inevitable.

But nobody knows just how high bitcoin might go before greed turns to fear. It could reach $500, $5,000 or even $50,000 per bitcoin before this happens. If more craziness unfolds in the EU, that could also accelerate a rush of capital into bitcoins, causing their value to skyrocket even more.

But make no mistake: Bitcoin has now become a casino. If you are buying bitcoin right now, you are gambling with your money. There's a sucker born every minute... try not to be one of them.

The only smart play right now is to buy bitcoins at market while having an automated sell system in place to sell bitcoins if they drop to a specified trigger price (a non-expiring sell order). To my knowledge, this can only be accomplished through custom software development, not through any existing bitcoin wallet service or exchange service.

The few smart people who manage to build such systems and deploy them will likely become millionaires. Everybody else who depends on human reaction times in an attempt to try to "time the market" will ultimately be the losers. If you are buying bitcoins right now and thinking to yourself, "I'm gonna buy today, hold them, and sell at the top!" then look in the mirror and mouth the word "SUCKER" to yourself ten times until it sinks in.

Like everyone else, you will fail to sell at the top. You will ride the losses down to nothing, and you will lose almost everything you put into the system. Why? Because you're only human, and when it comes to the fear and greed of markets, human psychology is pathetically predictable.

All this has happened before, over and over again. Bitcoin is new, but the current craze behind it is just history repeating itself.

Personally, I'm saddened to see bitcoin become a speculative investment fad. It's going to harm the credibility of this currency that the world truly needs as a long-term decentralized crypto-currency. I want bitcoin to succeed in the long run which is why I lament the manipulated bitcoin crash that I know is coming.

Rest assured, however, that I will be buying up bitcoins in huge numbers once the crash fully unwinds. There's never a better time to buy than when all the world's sellers are in a panic, trying to unload their bitcoins at any price.