As a currency and asset class, the Bitcoin has weaknesses that can prove fatal, which is why the bursting of the Bitcoin bubble is only a matter of time, same could happen for Altcoins (whiteoutpress.com). At least that is the opinion of Stefan Hofrichter, Head of Global Economics & Strategy Allianz Global Investors. The blockchain technology behind Bitcoin and other crypto currencies could, however, offer considerable advantages for investors.But there are of course many others who don`t believe in that, see http://www.educationviews.org/.
In the weeks before Christmas 2017, Bitcoin speculation had reached its peak and the bitcoin exchanges couldn`t handle so many customers. In spanish speaking countries there was a big hype too. For the first time, Bitcoin futures were traded on two of the world’s largest options exchanges, the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME). On December 18, Bitcoin broke through the USD 20,000 barrier on the cash and futures markets. After that, however, it went steeply downhill; the all-time high marked in December has not been reached since then. At the end of February, the Bitcoin rate had halved to around USD 10,000 in just two months.
Is this the beginning of the end of the Bitcoin hype as the global currency model of the future? Probably not, Bitcoin and other crypto currencies do not yet seem to have served their time as speculative objects. From our point of view, however, Bitcoin has serious shortcomings: its steep flight corresponds to that of a classic financial market bubble. Moreover, due to the lack of central monetary functions, it does not fulfil the criteria of a currency.
Bubble formation at Bitcoin
Bitcoin’s hyperbolic share price performance since 2009 (the year of its market launch) bears distinct features of bubble formation. If one compares Bitcoin’s five-year (inflation-adjusted) share price performance with that of earlier asset price bubbles, then Bitcoin not only puts the bubbles of recent financial history clearly in the shade (the dotcom bubble of the 1990s and the Japan bubble of the 1980s), but even the two bubbles with the historically largest price explosion followed by a crash: the tulip mania of 1637 and the Mississippi bubble of 1720 are warning examples.
In addition, Bitcoin meets all the criteria we consider to be essential for the emergence of a wealth bubble:
- New era thinking. Bitcoin is regarded as a completely new currency model and a monetary innovation of the Internet age.
- Increasing speculation/euphoria. According to BIS data, the trading volume has increased almost fivefold over the past five years.
- Liquidity glut on the markets. Despite several interest rate hikes by the US Federal Reserve, the global monetary policy environment remains expansionary.
- Lack of regulation. Supervisors around the world are reluctant to take on Bitcoin’s “Wild West” conditions.
- Launch of corresponding financial instruments. New products for this emerging asset class are lowering the barriers to market entry – from CBOE and CME futures to “digital IPOs” (initial coin offerings, ICOs).
- Increasing indebtedness. Not only has the private sector’s debt risen to new record levels worldwide, but credit-financed speculation in Bitcoin is also on the rise.
- Illegal and fraudulent activities. Bitcoin has become a popular tool among criminals because it allows anonymous payments outside traditional banking channels.
- High overvaluation. While many other asset classes are currently highly valued, Bitcoin outshines them all.
What is the fair value of a Bitcoin?
This leads us to the question that is all that matters: What is the fair value of a Bitcoin? In our opinion, the intrinsic value of a Bitcoin is zero: there is no claim against a third party – unlike government bonds, shares or paper money. In addition, Bitcoin does not yield any returns; admittedly, the same could be said about gold, with the difference that gold has proven to be a widely accepted commodity for more than two and a half millennia, while Bitcoin has not existed for ten years.
It could also be argued that overheating is currently occurring not only in Bitcoin but also in other asset classes: The cycle-adjusted price-earnings ratio (“Shiller-KGV”) of the S&P 500 Index is about twice as high as the long-term average. The spreads of numerous high-yield and investment grade bonds are extremely low worldwide. Many housing markets are clearly overvalued, particularly those in Canada, Sweden, Australia and Hong Kong, which have largely escaped the effects of the global financial crisis.
Although the crypto currency Bitcoin is not the only overvalued asset class, it fulfils all the criteria of a classic bubble that we consider essential – the bursting of which is probably only a matter of time. What impact would the bursting of the Bitcoin bubble have on investors in traditional asset classes such as equities or bonds? We estimate that the spillover effects in the “real world” would be small due to the still relatively small Bitcoin market. We therefore consider the risks to financial stability posed by Bitcoin to be negligible – at least for the time being.
Bitcoin – neither currency nor ESG-compatible
If Bitcoin is not a “real” asset class due to the described shortcomings, does it at least meet the criteria of a currency? In our eyes no, for several reasons:
- In view of the high costs involved in processing Bitcoin transactions, it would only make economic sense to use it as a means of payment for high-priced goods.
- Due to the extreme price fluctuations, Bitcoin is not suitable as a unit of account with which goods and assets can be expressed and compared in a generally accepted reference value (numeraire).
- In view of all the arguments presented so far, it seems almost impossible to use Bitcoin as a store of value.
Even if environmental, social and governance (ESG) criteria are taken into account, Bitcoin is not an appropriate instrument for us. The energy needed to produce (“mine”) Bitcoins in a year is equivalent to the average annual consumption of Ireland. As the number of Bitcoin transactions increases, so does the complexity of the computational process due to the design, and with it – due to the need for ever higher hardware performance – power consumption.
Advantages of blockchain technology
While skeptical about Bitcoin, the underlying blockchain technology (a form of Distributed Ledger Technology (DLT) where the transaction history consists of a chain of transaction blocks) undoubtedly has potential, especially as it can significantly reduce the cost of transaction validation and digital networking. This is attracting the attention of various financial institutions, including central banks, to take a closer look at this technology and to explore practical applications, including the processing of financial transactions.
