Strategic Insights | Bitcoin and blockchain: a bubble about to burst?
Like Brexit and bottled beer, Bitcoin is another one of those things beginning with the letter “B” that gets people hot under the collar and sparks frenzied debate. And that debate will continue for years to come.
Volatility and cryptocurrencies go hand-in-hand. But there must be something particularly capricious and whimsical about Bitcoin if its value can surge by 20% simply because one man lends his support to it on Twitter (although admittedly that one man just happened to be the world’s richest). January saw Bitcoin’s price climb far above any previous record it had achieved. Then it hit a new record high (US$48,000) after Tesla said it had bought about US$1.5 billion of the cryptocurrency.
After 12 years, many people believe that Bitcoin is shaking off its “techno-geek” status and moving into the mainstream. BlackRock, for example, has recently opened up two of its funds to invest in Bitcoin. Its Chief Executive Larry Fink believes that we have over a hundred years until the final Bitcoin is “mined” (only a finite number can be mined in total), and its increasing scarcity will drive the price up. Meanwhile, customers using Starbucks’ app can now pay for an assortment of items on its menu through iPayYou’s Bitcoin wallet.
And yet… and yet… Governor of the Bank of England Andrew Bailey warns that Bitcoin’s days are numbered. Lloyd Blankfein (Goldman Sachs’ former Chief Executive) shares his concern: “if I were a regulator, I would be hyperventilating over Bitcoin”. And economist Paul Krugman has described Bitcoin as “a bubble wrapped in techno-mysticism inside a cocoon of libertarian ideology”.
So what is it? Is it the future? Or is it the mother of all bubbles? Is it the final settling point for the design and governance of a lasting digital currency? Or will it be remembered as the Betamax of digital innovation in payment, consigned to the dustbin of history alongside LaserDiscs and Microsoft’s Zune?
Interest from two camps is driving Bitcoin’s price higher. The first wants to make money quickly by capitalising on the interest and selling at a profit. The second sees the digital asset as a scarce resource which will increase in value because there is a fixed supply and “normal” currencies will be devalued by inflation.
There is every chance that its popularity will be relatively short-lived, but the question is… just how short-lived? It is equally likely that increasing numbers of “serious” investors will start buying cryptocurrencies as part of their investment portfolios to hedge against rising inflation. Then once a number of major players are onboard, a flood of new money could flow into Bitcoin, driving up its price.
Collective delusion? Or the solution to years of low interest rates?
Over the years, Bitcoin has established itself as the Kleenex or Hoover of cryptocurrencies. Some think of it as the future of money, others claim it is a giant Ponzi or pyramid scheme, duping the trusting and the gullible.
To really understand Bitcoin, prospective investors have to read up on the dark web, the online drugs markets and enigmatic underground computer programmers (in particular one Satoshi Nakamoto). But they also need to consider what lies ahead: ultra-low interest rates for decades and yet more quantitative easing, all against a backdrop of good old-fashioned supply and demand.
While George Soros and Warren Buffett describe it as a “bubble” and a “mirage”, Bitcoin is being taken extremely seriously by large and respected investors, tech chief executives and governments, as well as – most importantly – the younger generation. Many commentators believe that it is here to stay.
Bitcoin is based on blockchain, a technology that handles data transactions that are then stored on a public ledger. Bitcoin is sent via the blockchain between wallets with unique keys. The coins themselves cannot be faked because the blockchain that underpins it is public, as are all the transactions carried out on it. The result is a system that is completely tamperproof.
The coins are “mined” and released into the blockchain by computers cracking complex coding problems. However, approximately every four years, these codes become twice as complex, meaning the same computing power can only “mine” half the number of Bitcoin.
This means the supply of Bitcoin is slowing down. There are currently 18.5 million Bitcoin in circulation and protocols dictate that there will only ever be 21 million. Just as oil, copper and gold are all commodities the value of which are correlated with their increasing scarcity, Bitcoin is a digital currency with a limited and slowing supply of coins: it could take another hundred years until the final Bitcoins are released. The result is that many investors who currently own Bitcoin expect the price to continue rising for decades to come.
Gold is often described as a “safe-haven” asset. Governments can always print more money if circumstances require it, but since there is a finite supply of gold in the ground, it is a hedge against inflation. As governments unveil stimulus packages (funded by borrowing), gold becomes more valuable. And this upward price effect is amplified when interest rates plummet. The opportunity cost of owning gold decreases as yields fall on rival “safe” investments (bonds and cash saving accounts). In many ways, Bitcoin is not dissimilar to gold. Governments have no control over it, it pays no income and there is a limited supply of it. Indeed, it is often said that what is good for the price of gold will also be good for the price of Bitcoin.
But what really causes Bitcoin to surge… is simply human interest in it (witness the recent surge on the back of Elon Musk simply changing his Twitter bio to “#bitcoin”). But the Bitcoin price has a tendency to swing violently as the public fall in and out of love with the idea that it is the future of money. And for many investors, this is the ultimate hallmark of a bubble: the price moves when interest changes, not when the investment case does.
In many ways, it’s too soon to dismiss it as a bubble and a bad investment. Sure, it’s difficult to feel confident about something that you cannot touch, feel and pile up in vaults (one UK investor accidentally discarded a hard drive containing a cryptographic key to about US$300 million in Bitcoin – one couldn’t “misplace” that amount in gold bars). But a number of experienced investors believe that the potential gains from owning Bitcoin outweigh the risk of its value plummeting. In other words, they’re prepared to take the bet.
At Investment Quorum, we have adopted a “wait-and-see” policy and are monitoring Bitcoin and other cryptocurrencies very closely, trying to determine whether there is any merit in holding them. It is highly unlikely that Bitcoin will ever replace gold as a safe-haven asset, but there are arguments for holding both in a well-managed portfolio. Covid-related uncertainty, the long-term prospect of lower interest rates and the volatility of the equity markets all constitute a strong case for owning assets whose value is not tied to economic whimsies or government policies. Watch this space…
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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