Bitcoin: digital or fool’s gold?

Developed anonymously, decentralised, limited in supply and elegantly marketed as digital gold, bitcoin has taken the world by storm, rising to over US$10,000 per coin in November 2017, giving the world’s most famous cryptocurrency a market capitalisation of nearly US$200 billion.

Investors in bitcoin and other cryptocurrencies have generated incredible, potentially life-changing profits over this time, and to date, appear happy to ignore the warnings of those who fear this a modern-day re-run of tulip mania.

Is it too late to invest?

The key question investors new to this sector are asking is whether or not it’s too late to invest in bitcoin.

Whilst it’s not for me personally, especially after a price move of the magnitude we’ve seen at time of writing on 5 December 2017, we can understand the attraction of speculating in bitcoin, or in cryptocurrencies more generally with a very small portion of one’s net worth.

After all, blockchain is indeed exciting technology, and there are a handful of other tailwinds that will support bitcoin in the years ahead, including the continued monetary largesse we see in the developed and developing world, which is leading investors to seek out alternative assets.

The bitcoin bull market could also continue for some time, so there remains the potential to make money in this space, even if there is an ever-present risk of a significant price correction.

These factors, combined with generally elevated financial assets, support the notion of speculating in bitcoin, although we can’t stress enough that we would limit it only to money one could afford to lose without it meaningfully impacting their lifestyle.

Is it the future of money?

On the surface, bitcoin has many money-like qualities, which help fuel the hype that we see in the marketplace today. The supply is in theory strictly limited to 21 million coins, it allows for near immediate transfers of wealth across borders, and, insofar as there is a publically viewable ledger, offers more transparency to all users.

Attractive as these qualities sound, it is still far too early to claim that bitcoin will be the future of money. Unlike fiat currency, it does not carry the imprimatur of any sovereign state, and, despite the uptick in merchants accepting payment in bitcoin; it is not widely used as a medium of exchange, let alone as a unit of account anywhere on earth.

There are also potentially significant governance and regulatory issues, if not necessarily with bitcoin itself, then with the exchanges that people use to trade it and other cryptocurrencies. If a major exchange goes bust, or a significant number of clients lose their bitcoin, then this could impact confidence in bitcoin as a whole.

Importantly, bitcoin has also only existed for eight years, meaning it has not even survived through one full business cycle.

Finally, whilst for now bitcoin is limited to 21 million coins, there is no guarantee that this won’t change in the future. In this sense, would-be investors should be aware that whilst the attributes of gold, to which bitcoin is often falsely compared, are governed by the laws of nature, the attributes of bitcoin are set by the consensus of people.

The former is a lot harder to change than the latter, a point that should be highly relevant for those who think the history of money can teach us anything about its future.

So it’s a bubble then?

Type “bitcoin is a bubble” into Google, and you’ll get close to 40 million results, which is a fairly clear indicator about the number of warnings that have been made about its imminent demise.

These warnings are largely falling on deaf ears for now, with major bitcoin trading exchanges like Coinbase seeing record levels of account opening and trading — in some cases more than 100,000 accounts a day.

It is understandable that people are ignoring the warnings, for two reasons.

The first of those reasons is that, so far, they’ve all proved premature, with bitcoin prices blasting higher after every pullback, rewarding speculators who’ve held their nerve through every period of volatility.

The second reason is arguably more interesting, and it lies in the increasing lack of trust that everyday citizens have in society’s political, academic and financial leaders.

Indeed, to many of these people, part of the attraction of bitcoin is that, to all intents and purposes, it exists entirely outside of the financial system. They are also reluctant to heed the bubble warnings coming from the mainstream finance community as the majority of the people ringing the alarm bell on bitcoin conveniently ignore the almost certain bubbles that exist in more traditional financial markets.

After all, consider that towards the end of 2017:

• US equities were trading at close to 32 times cyclically adjusted earnings, their second most expensive level in history
• Over US$11 trillion in sovereign debt trades at negative yields
• The Swiss National Bank has a balance sheet with a value that exceeds 100 per cent of Swiss GDP
• Argentina, the home of six series sovereign defaults in the past century alone, just raised $2.75 billion through a 100-year bond that was three times oversubscribed
• Salvator Mundi, a Da Vinci masterpiece, just sold for $450 million

Finally, Veolia, a French BBB rated corporate, issued a 500-million-euro three-year bond at a negative yield. It was four times oversubscribed, meaning 75 per cent of would-be investors that, on a yield to maturity basis, wanted to guarantee they’d lose money went home empty handed.

The point I’m making of course is that if bitcoin is indeed a bubble, then it’s likely in very good company. More importantly, bubble or not, bitcoin is not the most important risk SMSF trustees and their advisers will need to monitor as 2018 unfolds.

Jordan Eliseo, chief economist, ABC Bullion