The price has now increased by a factor of 20 during this
year and the movements now really do mirror the price of Dutch tulip bulbs over
the period 1636-37 (see chart). Like tulips, Bitcoin represents something
totally new, hence the difficulty in setting an appropriate market price.
Unlike tulips, Bitcoin has more than merely intrinsic value: Investors bought
tulip bulbs (never the flowers) because they knew there was a demand for them
amongst those wealthy people keen to adorn their gardens with rare flowers. In
theory, Bitcoin is a medium of exchange so a rise in its price allows investors
to buy an increased quantity of goods and services with it, although it now
appears to be desired for its own sake as investors buy it in the expectation
that its price will rise further. We should be in no doubt that this is a
bubble: I have experienced a few in my time – though never one quite like this
– and I have no doubt that this one will pop.
One question which was posed to me today was whether the establishment of a futures contract on a recognised exchange marks the point at which Bitcoin is about to go legit, which will allow it to attract institutional investors. I suspect the answer is almost certainly not. For one thing, regulators are concerned about the risks posed by money laundering. A basic definition of laundering is the process of allowing “dirty” money earned from proscribed activities to enter the legitimate economy via three main steps: placement, layering and integration. The placement stage represents the movement of cash from its source but the blockchain system underpinning Bitcoin does not allow us to identify the source, merely the fact that a transaction took place. Similarly, the layering process which is designed to make it difficult to detect illegal activity, is facilitated by the blockchain process. Accordingly, the integration stage, which is the conversion of cash earned through illicit means into a legitimate form, becomes so much easier.
Another aspect of the law which is increasingly taken seriously by financial institutions and regulators are the KYC (know your customer) regulations. The anonymity offered by Bitcoin transactions runs a coach and horses through the rules. Accordingly, no reputable institution worth their salt will want to incur the wrath of regulators by offering Bitcoin related products. Back in September Jamie Dimon, CEO of JP Morgan Chase, called Bitcoin a “fraud” and threatened to sack any of his staff who deal in it (its highest value at that point was $4880 which looked pretty elevated at the time). He subsequently said “the only value of Bitcoin is what the other guy'll pay for it.”
This strikes me as an astute assessment of market trends in recent months. This is how pyramid schemes work and in his column in the Daily Telegraph a couple of weeks ago, Jeremy Warner suggested that Bitcoin is “very probably already the biggest such racket in history.” He might want to have words with his sub-editor, though, who titled his column “Investing in Bitcoin is not idiocy but perfectly rational – it's called 'the greater fool' theory.” There is nothing rational about the greater fool theory.
That said, I have pointed out previously that I believe digital currencies have a future, for reasons I will come back to another time. But a Bitcoin collapse could set back the cause of digital currencies a long way. After the price of tulip bulbs hit their peak in February 1637, prices collapsed by anywhere from 80% to 95% over the next five years depending on the tulip variant we pick (there are significant variations in types of tulip, hence lots of price variation). A lot will thus depend on the extent of any market correction. What will help digital currencies in the long run is that they are underpinned by the blockchain which could yet turn out to be one of the most significant developments in the digital world.
But consider this: The total value of physical cash in circulation around the world is $31 trillion and the total number of Bitcoins it is possible to create is 21 million. If Bitcoin were to totally supplant cash, this would put the equilibrium price of Bitcoin somewhere close to $1.5 million per unit at current prices. The total value of all cryptocurrencies in circulation is currently around $450 bn – around 1.4% of the total value of cash. Suppose for the sake of argument that in the long run Bitcoin were to account for 5% of all cash transactions: This would still put the equilibrium unit price above $73,000. Presumably investors continue to believe this is where Bitcoin is headed – and good luck. Obviously, nobody has a feel for the equilibrium price of Bitcoin. But wherever it is, I still maintain the market price will go down long before it gets to that level and it may not survive a big crash as other digital currencies take its place.
One question which was posed to me today was whether the establishment of a futures contract on a recognised exchange marks the point at which Bitcoin is about to go legit, which will allow it to attract institutional investors. I suspect the answer is almost certainly not. For one thing, regulators are concerned about the risks posed by money laundering. A basic definition of laundering is the process of allowing “dirty” money earned from proscribed activities to enter the legitimate economy via three main steps: placement, layering and integration. The placement stage represents the movement of cash from its source but the blockchain system underpinning Bitcoin does not allow us to identify the source, merely the fact that a transaction took place. Similarly, the layering process which is designed to make it difficult to detect illegal activity, is facilitated by the blockchain process. Accordingly, the integration stage, which is the conversion of cash earned through illicit means into a legitimate form, becomes so much easier.
Another aspect of the law which is increasingly taken seriously by financial institutions and regulators are the KYC (know your customer) regulations. The anonymity offered by Bitcoin transactions runs a coach and horses through the rules. Accordingly, no reputable institution worth their salt will want to incur the wrath of regulators by offering Bitcoin related products. Back in September Jamie Dimon, CEO of JP Morgan Chase, called Bitcoin a “fraud” and threatened to sack any of his staff who deal in it (its highest value at that point was $4880 which looked pretty elevated at the time). He subsequently said “the only value of Bitcoin is what the other guy'll pay for it.”
This strikes me as an astute assessment of market trends in recent months. This is how pyramid schemes work and in his column in the Daily Telegraph a couple of weeks ago, Jeremy Warner suggested that Bitcoin is “very probably already the biggest such racket in history.” He might want to have words with his sub-editor, though, who titled his column “Investing in Bitcoin is not idiocy but perfectly rational – it's called 'the greater fool' theory.” There is nothing rational about the greater fool theory.
That said, I have pointed out previously that I believe digital currencies have a future, for reasons I will come back to another time. But a Bitcoin collapse could set back the cause of digital currencies a long way. After the price of tulip bulbs hit their peak in February 1637, prices collapsed by anywhere from 80% to 95% over the next five years depending on the tulip variant we pick (there are significant variations in types of tulip, hence lots of price variation). A lot will thus depend on the extent of any market correction. What will help digital currencies in the long run is that they are underpinned by the blockchain which could yet turn out to be one of the most significant developments in the digital world.
But consider this: The total value of physical cash in circulation around the world is $31 trillion and the total number of Bitcoins it is possible to create is 21 million. If Bitcoin were to totally supplant cash, this would put the equilibrium price of Bitcoin somewhere close to $1.5 million per unit at current prices. The total value of all cryptocurrencies in circulation is currently around $450 bn – around 1.4% of the total value of cash. Suppose for the sake of argument that in the long run Bitcoin were to account for 5% of all cash transactions: This would still put the equilibrium unit price above $73,000. Presumably investors continue to believe this is where Bitcoin is headed – and good luck. Obviously, nobody has a feel for the equilibrium price of Bitcoin. But wherever it is, I still maintain the market price will go down long before it gets to that level and it may not survive a big crash as other digital currencies take its place.
No comments:
Post a Comment