How do we know when a price signals a bubble, when the market is demanding far too much? Simple: compare what the thing being bought can actually deliver in the future.
Take Dutch tulip mania. A tulip bulb offers some aesthetic pleasure, but many flowers do the same. Trading a house for one bulb was absurd overpayment. Or imagine someone asking a thousand dollars for a casino chip that redeems for only a hundred dollars. An obvious rip-off. If your neighbor wants your house in exchange for the same amount of fiat money a bank created by lending him money for a Toyota Camry, with the car as collateral, you would spot the nonsense instantly. If he defaults, he loses only the car, while the house satisfies far greater needs: shelter, security, life itself. A company share trading at five hundred dollars but worth only one dollar in tomorrow's liquidation is a bubble. A text-editing software product trading for hundreds when free alternatives exist is a bubble.
But what if the thing can do literally nothing in the future, yet it is traded for extreme amounts of money? That would be an infinite bubble, because price divided by zero future output approaches infinity. We had never seen such a bubble before, but about fifteen years ago, one appeared. It is called Bitcoin.
Bitcoin is a system in which computers compete to guess so-called hashes until one meets the target set by the Bitcoin protocol. The “winner” gets to append a block to a peer-to-peer database. But what does that database track? It tracks numbers assigned to cryptographic keys, units called bitcoins that these “winners” receive for correct guesses. The creator or creators labeled these “incentives,” but that is misleading because they are simply arbitrary assignments by the creators. They do not represent obligations that must be met in the future, like casino chips or fiat money. They do not represent a share in a company that can be liquidated tomorrow. They do not represent units of something tangible or digital that can be used in the future, like tulips or software. They only record that computers successfully guessed hashes. It is like being told to find a hidden object in a room, and if you find it, someone writes an arbitrary number on a piece of paper. It is a token of past effort, not a token of future benefit.
Prior to Bitcoin, numbers in trade represented units of tangible items, digital products, or liability instruments that delivered some future benefit. That benefit could be aesthetic pleasure, edited text, funds from a liquidated company, or a mortgage released by a bank after loan repayment. By estimating that future benefit, we could estimate whether the market was giving too much for these units.
But with Bitcoin, units represent only past computational effort, and there is no future benefit to estimate. That is why exchanging anything for bitcoins constitutes overpayment by definition, an infinite overpayment. Even swapping a Monopoly bill for all the bitcoins would be too much, as this bill could at least be burned for heat. The well-known 2010 transaction of ten thousand bitcoins for two pizzas was not a charming anecdote, but the first recorded exchange of something valuable for something totally worthless. Every trade since has followed the same pattern: something with actual future delivery given up for an item that delivers nothing tomorrow.
Bitcoin is not merely one more bubble among many. It is the most logically extreme example ever, an infinite bubble.