The exciting growth story behind a bubble requires respect

Bitcoin price is following the classic pattern of an investment mania

John Authers

If not truly anarchist, the demand for bitcoin reflects a radical and global breakdown of trust in existing institutions © Getty

Investment bubbles must be respected. They do not come from thin air, but rather from a reality that has been misperceived.

This is a truth that springs from the most famous bubbles of the past. Internet stocks, canals, railroads and motor cars all had a great future ahead of them when they were at the centre of bubbles. A brief bubble in ethanol in 2006 grew out of an increasing global preoccupation with climate change and the search for alternatives to fossil fuels. Bubbles in Japan in 1989 and China in 2007 grew out of two of the most extraordinary stories of economic growth in history.

In all cases, there was an exciting growth story to be told, but the growth was in the future and impossible to value with any confidence in the present. Greed swamped fear as people saw prices rise. But the reality was positive, just misperceived.

So what exactly is the misperception that is driving the mania for bitcoin? And is that misperception diverting money from other assets, and creating what the hedge fund manager Diego Parrilla calls an “anti-bubble” in a new book?

Some basic facts for those lucky enough to avoid the excitement: bitcoin is a revolutionary form of digital money that allows transactions on decentralised computer networks. Money resides in your own computer “wallet”, not in a bank’s ledger. It is protected with state of the art cryptography.

Since its introduction almost a decade ago, bitcoin has spurred the most impressive burst of entrepreneurial activity since the first wave of investment in the worldwide web. There are now many other cryptocurrencies, while different entrepreneurs are working to expand the concept to contracts and even to journalism.

Only the resolutely unimaginative could fail to be excited by the technology. As with the internet two decades ago, its potential to be transformative is evident. But this does not necessarily extend to the price of bitcoin itself. As the dotcom bubble proved, even the most exciting long-term technology can also inflict grievous long-term losses on you if it gets sufficiently overvalued.

Bitcoin has already enjoyed two extreme bubbles. During 2013, when it gained almost 5,500 per cent. Now it is doing it again, and causing intense excitement.

Wonderful though the technology could well be, there is no possible valuation scheme that would justify raising its price fivefold through the first 11 months of this year, and then another 70 per cent in the last week. Price is following the classic pattern of an investment mania.

Why? A big part is that the technology is so exciting. But there is more to this than paying far too much for stock in Cisco Systems, as people did in 2000.

It would make sense if this were part of a broader loss of confidence in fiat currencies. Central banks have continued easy monetary policy since the crisis in a bid to prop up asset prices and spark activity. Stocks look blatantly overvalued. Bonds look even more so. Art has never fetched such big prices. The bitcoin is only an absurd appendage to what is already a “bubble in everything”.

Thus bitcoin might be seen as a bet against rampant asset price inflation, and an attempt to protect against a forthcoming implosion as higher interest rates finally lead the financial house of cards to collapse. But that does not explain everything. Gold is up about 10 per cent for the year. That is less than the growth in stocks, and it has been falling during the latest overdrive phase in bitcoin.

Rather, bitcoin mania can be attributed to broader social conditions. Demand is greatest in the countries of the Pacific Rim, with South Korea, Taiwan, Japan and China all trying to curb extreme interest in trading the currency. Especially in China, demand reflects a distrust in governments, and not just in their currencies.

This also seems to be true of demand for bitcoin in the US, where backers seem keen to go far beyond doing without banks or central banks. They seem far more interested in cutting governments out of the equation altogether. If not truly anarchist, the demand for bitcoin reflects a radical and global breakdown of trust in existing institutions.

Decentralised technology plainly permits this possibility. But it is horrifying that people find the notion appealing. Computer networks, we now know, are easily attacked. Cryptography helps, but there are weak points when people enter and leave the blockchain system. Thursday brought news of a major theft of bitcoins. In a decade or so, quantum computing may well be able to sweep aside the best current defences.

Meanwhile, most governments around the world are democratic and derive their legitimacy from elections. But trust in democracy itself seems so low that putting trust in wholly unelected developers seems more appealing. The bitcoin craze can take its place with the various shocking election results of the last few years as a symptom of a breakdown in trust in western institutions — and also of frustration in Asia with the institutions that have guided growth there.

So, with bubbles in bitcoin to go with bubbles in stocks and bonds and cash, where are the “anti-bubbles” that Mr Parrilla was seeking? Given the desperation for a store of value, gold might be one of them. He also suggests that volatility and insurance against it are now far too cheap. One final possibility may be that there is an anti-bubble in government. Faith in the ability of governments to do anything that helps anyone seems to be reaching a crisis point — the rewards could be there for anyone who can demonstrate to people that their governments are working for them, and can deliver something.

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