A Bit(coin) of a Bubble?

“A bubble is a bull market in which you don’t have a position.” – Eddy Elfenbein, (via Twitter).

“The trouble with quotes on the internet is that it’s difficult to determine whether or not they are genuine” -Abraham Lincoln

In a world of the Central Bank liquidity tsunami, the “pundit sphere” is awash with talk of bubbles; Google “Bitcoin bubble” and you get 12.6 million results , which may hint at a bubble in bubble talk. Interestingly, no-one mentions the $450 million paid for a painting recently nor the endless, day after day “pricing in” of US Tax cuts as a bubble, so it may have a much more to do with perspective than financial analytics. The powers that be declare Bitcoin to be “highly speculative“, but seem to be unsure how to react to its rise. Given their track record in spotting previous bubbles however, their warnings appear to be falling on increasingly deaf ears. The rise in prices for Bitcoin (and others) has been meteoric; despite the naysayers, the expectation of a massacre once futures trading begins and the near vertical ascent, it appears that the world’s population want to buy non-Government backed (and thus non-fiat) assets.

Below shows how long it has taken the virtual currency to pass round numbers in the last year.

Who’s buying it? Explanations vary, but a couple of “suspects” have emerged :

1) Traditionally, Gold has been seen as a “safe haven”, particularly in regions where political instability and high inflation have been prevalent. This article suggests that the uber-rich in Latin America are now using Bitcoin to store their wealth. Given the relatively small amounts needed to buy it, it compares favourably with Real Estate (which cannot move) and Gold (which is difficult to move). The on-going economic carnage in Venezuela has also prompted those locals still possessing assets to buy it, again as a protective measure as the Bolivar collapses.

2) The second group of investors may have different motivations. After the Chinese Government effectively shut down Bitcoin trading in their country, the baton (according to Deutsche Bank), has been passed (and enthusiastically taken up) by Japanese men in their 30s and 40s, a group that previously engaged in Forex trading [2]. The Nikkei newspaper (their equivalent of the FT, though slightly less obsessed with trying to prevent Brexit), stated that 40% of all Bitcoin trading in October and November were Yen denominated. According to Forex Magnate, as of Q1 2017, 54% of Global Leveraged Forex trading was done by Japanese accounts and GMO Click Securities- the biggest broker in this market- say that 79% of the FX accounts are held by men, of which 63% are between 30 and 49-as of end-September 2017). A survey by the Futures Association of Japan revealed the motivations behind trading FX, and ALL are applicable to Bitcoin at present. The difficulty of beating Institutional FX traders (and Algorithms), may have further encouraged this migration. The steady rise in Bitcoin prices has meant gains are also rising, which in turn encourages more new players expanding the pool of new money further still, in a (for now) virtuous circle. The Japanese Tax Agency has made it clear that profits from selling Bitcoin is taxable, which reduces the incentive to sell, as many do not wish to pay tax (up to 45%) on these gains.

In typical fashion, Hedge funds, having spent most of the year warning about Bitcoin’s dangers are now piling in, (rather undermining Deutsche Bank’s view of participants as being unsophisticated retail investors). The opening of Bitcoin futures has given a new boost to trading, but it has been a wild ride; this week alone the price has fallen from $19700 (17/12) to $16340 (20/12) a drop of 17% in just 2 trading days!

The behavior of the upper classes in Latin America highlighted above suggests a more interesting possibility: that there is not a bubble in Bitcoin at all, but an anti-bubble in government-backed currencies; the corollary of the rise of Bitcoin is a decline in the relative value of global currencies- are global investors anticipating the ultimate success of Global Central Banker’s heretofore seemingly futile attempts to generate inflation? If Bitcoin is a medium of exchange, [1] rather than a tangible good in itself, it makes perfect sense for it to rise as the US Dollar (and all other fiat-backed currencies) depreciate-in the same way, for example, that Gold prices rise as the Dollar falls. Ben Bernanke posited that generating inflation would be relatively easy; he has been proven wrong thus far, but that doesn’t mean he wont be correct in the future. If so, what seems like a bubble now, may well in hindsight be the market working efficiently to process available information and coming to a view on where the future is heading.

I am not sure I will be putting my life savings into it anytime soon, however, looking at recent events, not to mention the sheer scale of recent gains. But shorting it may be a one-way ticket to the poor house; as Nassim Taleb has pointed out, Bitcoin cannot be “properly” shorted (i.e. with controllable risk) as there are no options contracts available and so losses are potentially unlimited. Thus “price discovery” is an impossibility and with it goes any way of gauging expected returns, let alone downside risk.

What of the future? Will Bitcoin go mainstream or will it fade away into history? Markets (and assets) need skeptics to progress (as without them there would be nobody left to buy), but there are major obstacles in its path, not the least of which are Governments, who are not likely to tolerate the usurpation of their ability to print money with impunity. Another potential obstacle comes with the number of potential competitors to it, which can be created almost at will. Which one will gain traction is anyone’s guess and it may not be what anyone expects (think Betamax versus VHS -if you are old enough to remember this episode).

However, the demand for it (potentially as a means of payment for goods and services) is sure to grow as more and more companies start to accept its use. One day, perhaps, EBI will launch a Bitcoin Vantage portfolio!

[1] Of course, this depends on other individuals’ willingness to hold it, or accept it as payment on an on-going basis. Thus far, we have no evidence either way as to its sustainability. That will depend on its’ relative scarcity, scalability and usefulness.

[2] The bank also informs us sneeringly that the level of “financial literacy” of Japanese investors is low and greatly below that of UK and US investors (unlike the PHD -owning Worlds Central Bankers who have done such a sterling job of solving everything since 2009).