Three reasons to fear the coming crash in bitcoins

Opinion: Three reasons to fear the coming crash in bitcoins

Published: May 24, two thousand seventeen 12:55 p.m. ET

The bursting of the bitcoin bubble could ripple far beyond investors


An investment of $1,000 in bitcoin in two thousand ten would be worth more than $38 million today, not $38 billion, as an earlier version of this column mistakenly stated.

$1,000 $Two,000 or $Three,000. Heck, it could be up to $Ten,000 by the end of the month, and carry on climbing from there. While most markets around the world are mildly positive for this year, the cryptocurrency bitcoin has gone through the roof. At $Two,400 it has more than doubled in value this year alone, and it is hitting fresh highs almost every day.

But hold on. Bitcoins themselves may be very fresh, yet that kind of price act is very old. In truth, it is embarking to look like a bubble, and that should be making investors everywhere feel jumpy. Why? Because it tells us that financial crazes are back. Because it will lead to overinvestment and wild speculation. And because bubbles inevitably crash — and once that happens, the losses can ripple out in unexpected ways.

If you were fortunate enough, or clever enough, to stream up on some bitcoins early, you will be feeling a lot wealthier heading into the summer.

On Monday, the value of bitcoin BTCUSD, +1.52% raced up close to $Two,200, an all-time high. By Wednesday it was soaring over $Two,400.

If you had put $1,000 in the electronic currency in 2010, it would be worth an extreme $38 million (up from $35 million on Monday and compared to $Two,500 if you had put it into the S&P five hundred SPX, +0.05% ). Not many people were ever going to be that quick off the mark, but if you had loaded up on a few when the price last crashed in two thousand fourteen you would have almost quadrupled your money. In the last month alone, the price has risen by 87%, and there is little sign of it stopping there.

There are slew of solid reasons why bitcoins are going up in price. It is growing in importance, along with other cryptocurrencies, as more and more companies accept it as a means of payment, and as regulators embark to accept it as a legitimate investment. It may well commence to break out of a puny techno world, and become a mainstream asset, like the dollar, or equities, gold or bonds.

Even so, 87% in a month is not a normal price movement. In reality, no one truly needs to spend time debating whether it’s a bubble or not. It is just demonstrable. The interesting question is what will be the consequences of that, and how much harm it might do when it bursts.

On one level, the reaction might be — not much. For all the hype and hoopla around electronic currencies, they are not yet a large financial deal. There are sixteen million bitcoins out there, and they presently have a combined value of $35 billion.

Okay, so that might be $40 billion or even $50 billion by the time you get around to reading this far, but in the context of the global capital markets that is not a hefty sum.

Apple AAPL, -0.15% has a market value of $805 billion. All the gold in the world has an estimated combined price of $8.Two trillion. The United States bond market is worth an estimated $31 trillion. Bitcoin is hardly that significant. Associated British Foods ABF, +0.46% , a relatively abate company you have very likely never heard of, is worth about the same as all the bitcoins put together — and the markets would not crash if it went pop.

On another level, however, the bubble could matter a lot. Here are three reasons why it should be making investors, whether they have any cryptocurrencies in their portfolio or not, feel anxious.

Very first, like any mania, it will lead to overinvestment, and that will lead to a misallocation of capital. Only this month, a company called RSK Labs raised $Trio.Five million for a bitcoin “smart contract.” Coinbase, a digital wallet startup, raised $75 million in funding.

Anyone who has time on their mitts this week might want to attempt rolling up to a venture capital fund with a whizzy idea for a bitcoin something-or-other. They will very likely walk out with $Ten million, and a promise of more funding when that is used up. Sure, some of those will be good ideas, and go on to make everyone a lot of money. But a lot of them will flimsy and unpractical — and will burn however a lot of cash that could have been more usefully deployed elsewhere.

Next, it tells us that manias are back.

In any long bull market, there are always one or two assets where the price goes downright crazy. It might be dot-com stocks, or space exploration companies, or apartments in central London, or hedge-fund managers, or if you go back far enough, radio shares, or South American railway companies.

But it is always something. If there is an asset bubble underway, it surely tells us that we are close to the peak of a bull market — and sooner or later, that will turn down.

Ultimately, if bitcoin crashes, it might not do that much harm. $30 billion can vanish without leaving much of a trace in the capital markets. The worrying point is this. Bitcoin is not just any old asset. It is also money, if not of the conventional sort.

As we learned in two thousand eight and two thousand nine when a part of the financial system starts to crumble, abruptly the entire edifice starts to look pretty shaky. We don’t truly know what contracts have been linked to cryptocurrencies, what derivatives have been hitched to them, or how deeply they have been embedded into the financial system. One thing is for sure, tho’. In a crash, we would find out very quickly – and the losses might ripple out in all unexpected ways.

Right now, bitcoin is on a roll. We have no way of knowing what its real value might be. The peak of a run might well be some way off. But when a crash comes, it won’t just be its holders who feel the agony.

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