As author of the Short and Sharp column, it’s only right that I discuss an asset with one of the shortest histories and sharpest inclines: bitcoin. As I write this, bitcoin stands at around US$17,000. By the time you read this, it may be at $20,000. Or $10,000. In a year when investors have been complaining about shockingly low volatility across asset classes, bitcoin volatility has surged.
The fundamental appeal of bitcoin is threefold:
- Limited supply. There are currently around 16.8 million bitcoins in circulation and the maximum that will ever exist is capped at 21 million.
- Transactions of bitcoin are recorded in a decentralized online ledger – a blockchain. The identity of those behind the transactions are hidden and they avoid the fees usually imposed by financial intermediaries, making bitcoin especially appealing to the criminal world.
- Distrust of the “establishment.” Fears of inflation and currency debasement as a result of quantitative easing mean that cryptocurrencies; digital assets that are not associated with any sovereign, central bank, or bank payment system, are a sign of the times.
The general price direction suggests that one or more of these points has become more pertinent, increasing the appeal of bitcoin (for more background on bitcoin see the latest Economic Insights). But, if anything, the opposite is true. Bitcoin is facing increasing competition from rival cryptocurrencies, so the limited supply of bitcoin will not necessarily push up the price. There is nothing to suggest that demand from the criminal world has soared, and, there is little sign of inflation globally and the Federal Reserve is on the verge of quantitative tightening.
Perhaps it has something to do with bitcoin becoming more mainstream. The Chicago Board Options Exchange has become the first to allow trading of bitcoin futures. This should make trading bitcoin more trustworthy to skeptic institutional investors and it should add some legitimacy to bitcoin. This is an important step for an asset whose value increases as it becomes more widely accepted as a store of wealth and a means of payment.
Ultimately though, for an asset with no underlying commodity, the recent price surge is audacious. Bitcoin has simply become a vehicle of speculation. Is it a risky trade? Absolutely. Do I want to get involved? Perhaps… I don’t want to miss out on the trade of a lifetime after all. This, dear readers, is the definition of FOMO – fear of missing out. Pure and simple.
In a world of tight valuations, capital gains in 2018 across traditional asset classes are likely to be much lower than in 2017. Bitcoin offers the possibility of high returns… but with extremely high risk. To me, investors’ willingness to jump on the bandwagon reeks of investor exuberance, historically a harbinger of bad times ahead. In addition, as bitcoin becomes more mainstream, a sharp drop in price could have a meaningful impact on the real economy, with negative implications for other asset classes. Anecdotal reports of families re-mortgaging their homes to purchase bitcoin could be the clearest sign yet of the potential repercussions. Stay cautious.
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