Is the Bitcoin bubble about to burst?

How to lose all your money

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“If consumers invest in these types of product, they should be prepared to lose all their money.” So said Britain’s Financial Conduct Authority (FCA) on Monday this week.[1] And the types of products it had in mind? Cryptoassets, or investments and lending linked to them, as the leading cryptoasset, Bitcoin, lost around 15% of its value. Back in June 2011 Bitcoin was worth a trifle, just $8. In 2010 10,000 Bitcoins were exchange for two pizzas.[2] In the first week of January a single Bitcoin’s value soared to more than $40,000.

The debate over cyptocurrencies’ rise to compete with gold has been stimulated by last year’s 300% increase in value of Bitcoin — the most well-known cryptocurrency — and has even broken into the pages of the leading mainstream media’s business gazette, the Financial Times.

Gavyn Davies, a former Goldman Sachs partner, ex-chairman of the British Broadcasting Corporation (BBC) and now chairman of Fulcrum Asset Management, said in the FT[3] “there seems little reason on monetary policy or financial stability grounds why regulators should be worried about cryptocurrencies competing with gold as a store of value.” Another FT columnist, Merryn Somerset Webb, who is editor-on-chief of MoneyWeek, comments: “If inflation is coming (and it probably is) you want to hold a real asset that can hedge against it — one that can’t be inflated away by relentless money creation and currency debasement. That’s particularly the case in an era of very low interest rates. If governments work to keep interest rates lower than inflation in order to reduce the real value of their horrible debt burdens, everyone knows they need a safe haven, but everyone also knows the traditional ones (government bonds) no longer offer that safe haven. That turns us to gold, the one asset that has a 3,000-year record of protecting purchasing power. No wonder the gold price is up around 40% since 2018. I hold a lot of gold for all these reasons. But here’s the thing. Might bitcoin be better at being gold than gold?”[4]

Institutional investors

The comparison between gold and cryptocurrencies is imperfect. They have similarities but also important differences.

Bitcoin (and all cryptocurrencies) has no central point of support or guarantor, which is a large part of its attraction — national currencies are a creation of the state and cryptocurrencies hitherto have eluded state interference, except where their trading is banned outright, which is at least 10 countries. Many others have yet to decide what their attitude is towards cryptocurrencies. Gold too is free from government control.

In today’s world many people question the legitimacy of their governments and hence the money they issue. Previously accepted norms are in flux. Cryptocurrencies feed on this flux. So too does gold and other assets seen as ‘safe havens’ — the degree of safety being the perceived level of imperviousness to government manipulation of money’s value, or other interference.

Institutional investors — firms and individuals that have large sums to play with — are key to Bitcoin’s recent and future strength. In June 2020 Fidelity published the results of a survey of almost 800 institutional investors in the US and Europe, concluding that 60% of them believed “digital assets have a place in their investment portfolio”. Over the next five years, 91% of those who responded and are “open to exposure to digital assets” expect to have at least 0.5% of their portfolio allocated to digital assets.[5]

Bitcoin futures can now be traded on the CME Group, which comprises four US futures’ exchanges.[6]The CME is regulated by the CFTC, the Commodity Futures Trading Commission. Cryptocurrencies have become mainstream.

Bubble territory?

Bitcoin may be “the mother of all bubbles” as one commentary put it this week[7] — or it may indeed rise further into stratospheric levels. Underlying the rush into cryptocurrencies however is one fundamental factor familiar to anyone interested in commodities (and it’s worth noting that CME is supervised by the commodity trading regulator).

That factor is called supply-and-demand. As of now only 21 million Bitcoins can be produced; around 18.5 million have been “mined”. About 20% of those 18.5 million may be “stranded assets” according to Chainalysis, a cryptocurrency data analysis firm.[8] In other words people have lost or forgotten the ‘key’ they need to access their digital currency. Users have 10 attempts to access their account before it locks them out — and the structure of Bitcoin then encrypts their tokens forever. The last Bitcoin of this 21 million batch is unlikely to be “mined” until 2140. Between now and then all manner of things can and will change. It is possible, for example, that Bitcoin’s protocol will be changed to permit a larger supply. But while Bitcoin may have its ultimately limited supply, there are more than 7,800 cryptocurrencies in existence and new ones pop up all the time, with a big graveyard (more than 1,900) of ‘dead’ coins.[9]

While your cryptocurrency might (if you are lucky) make you a millionaire, it is no simple matter to use your digital token as money in your everyday life. Some retailers accept cryptocurrency in payments but others do not. Amazon, for example, does not permit payments in cryptocurrencies — perhaps because it is planning to develop its own digital token. And some banks — HSBC included — do not process cryptocurrency payments.[10] Banks are still trying to recover reputations that have been blitzed since the 2008 financial crash and various money-laundering frauds.

Gold is not new

It might be obvious but it’s worth repeating — gold is considered by many as superior to cryptocurrencies (although both are doing the same job of resisting the tsunami of “funny money” that has been conjured out of apparently no-where by governments who, just a short while ago, were preaching austerity and ‘tight-beltism’) for the simple reason that it has been doing this job for centuries. It has proved it can last through thick and thin.

As Somerset Webb said in the FT: “My go-to inflation hedge will remain gold for the simple reason that it isn’t new. I’m nervous about the next few years and I want a portfolio protector that has a multi millennium record in the safe haven top spot. I’m also going to take the main lesson from bitcoin (when fixed supply meets rising demand, prices soar) and bump up my general commodity holdings. As economies recover this year they might not rise eight times, but they should see the same (short term at least) dynamic that has made bitcoin do so.”

Moreover, armed with a Glint card, you will find that your gold can be used as money just about everywhere you want to shop. Including by making Jeff Bezos a little richer if you choose.