You can’t escape the noise around Bitcoin at the moment. It’s no wonder – it’s price has rocketed up over 1,900% in the past year. Depending on who you read or listen to, it’s either a promising alternative to conventional currencies, or it’s a bubble that will soon pop. In my view, there are elements of truth to both views.
As a currency, Bitcoin has been around since 2004, for much of its life so far, it’s largely been used for clandestine transactions, although it is increasingly gaining more legitimate acceptance. There is also a group of enthusiasts who see cryptocurrencies, like Bitcoin, as private alternatives to government-controlled currencies, which they see as susceptible to debasement from the authorities. For these people, cryptocurrencies are like digital versions of gold, which is the traditional currency substitute for the conspiratorial.
The technology of Bitcoin
The blockchain technology behind cryptocurrencies is highly promising. Many governments and central banks are investigating how they might use the technology to deliver conventional currencies more efficiently than they do now. It is possible, sometime in the future, that credible, widely-adopted public and private currencies will emerge based on blockchain, as ways are developed to make them reliable means of payment and places to park savings.
A tulip mania for the 21st Century?
In recent times, of course, many people have chosen to take a punt on Bitcoin and other cryptocurrencies in the hope of making large financial gains. This can be compared with a Ponzi scheme, where people are riding the wave, hoping they can exit their investment before the inevitable crash. Parallels are being drawn with historical investment manias, such as the tulip mania in Holland in the 1600s. The difference is that tulips create pretty gardens, while devalued Bitcoins create memories of numbers on computer screens!
Bitcoin is not something that Kiwi Wealth would consider investing in in the foreseeable future. However, there are two contrasting signals about investment markets being sent by the Bitcoin craze that we are taking note of.
What Bitcoin mania means for markets
First, Bitcoin mania is one of a gradually growing list of indicators of frothy sentiment toward some of the riskier parts of markets. Other signs of a degree of complacency include steep run-ups in property prices in some parts of the world, and the keenness for some of the riskier parts of credit markets. We don’t consider this over-exuberance to be pervasive across the breadth of financial markets yet, but it is something to keep a close eye on.
In contrast, the enthusiasm for Bitcoin may also suggest that investors are feeling flush from recent strong returns from conventional investments like shares, and from improvements in their job and income prospects. Bitcoin could be an outlet for investors to dabble in more speculative areas, using capital that is not essential to meeting their longer-term savings goals. In other words, the money going into Bitcoin may be funds that most investors in it can afford to lose. From this perspective, Bitcoin’s meteoric rise could be interpreted as sign of robust sentiment in a supportive market.
Both these forces are likely to be currently at play. At this stage, the Bitcoin rage may have relatively benign implications for wider markets. However, the longer the Bitcoin surge continues, and the more people borrow or draw down their savings to invest in it, the more likely it is that it will crash with severe consequences. In this situation, wider investor confidence could also be dented to a significant extent.
Photo by David McBee from Pexels
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.