Crypto-currency to asset class: bitcoin keeps soaring
The price of bitcoin went through the roof on Wednesday to $11 000 (R150 000), then dropped by the end of the day to $10 000 a coin. Large fluctuations in prices are a textbook case for an asset entirely dependent on demand pressure from investors and speculators. In this respect, it is evident that the price dynamics are heavily dependent on investors’ behaviour. As of now, there are more than 16.5 million bitcoins in circulation and more than 800 000 bitcoin users (unique addresses). Early this year, there were 300 000 fewer users, while the number of coins mined and circulating barely changed (16.1 million). Demand pressure is intensifying while available supply is flattening, as is indeed designed by the protocol.
The number of bitcoin transactions has been constant, around 300 000 a day, growing from around 200 000 a day at the beginning of last year. From a purely fundamental perspective, there are no signs of decelerating market activity despite the increasing difficulty of mining new coins. All this points in a simple direction. Bitcoin has been trading more like an asset class than a pure method of payment. The number of active bitcoin wallets and exchanges has grown exponentially over the past year, partly driven by increasing margins and profitability due to increasing prices.
In a clear sign of the increasing professionalisation of bitcoin as an asset class, the Chicago Mercantile Exchange group, the world’s leading derivatives marketplace, announced it would launch futures contracts on bitcoin by the end of this year, pending regulatory approval.
The exchange already publishes both a bitcoin reference rate and a real-time index as a benchmark for investors. The obvious analogy is the dotcom bubble. Interestingly, the dotcom bubble makes a case for the crypto-currencies market in general. Although the bubble burst in early 2001, the underlying technology that permitted the bubble, the internet, remained well and alive. Given that the supply is controlled, the inflation rate cannot really keep up with exponentially increasing demand unless prices increase accordingly.
Even if the bitcoin bubble bursts, the underlying technology — the blockchain — is here to stay for a long time. Yet, bitcoin is not the only market that has been bullish over the past few years. Both the US and the European equity markets have been extremely bullish despite political risk and the looming threat of the increasing rate of public and private debt. The VIX index, normally defined as a “fear gauge”, remained at historical low levels, despite Brexit, Donald Trump and the political turmoil in Europe. Given the small size of bitcoin relative to global financial markets, a correction in cryptocurrency markets will certainly have way less devastating consequences for financial markets. Stabilising bitcoin prices after a collapse might be a sign that crypto-currency markets are maturing.
The real question is not “if” there will be a correction in bitcoin prices, a natural consequence for such a fast-growing market — it is more like when and after what price.
Nothing can prevent bitcoin reaching pre-crash record values. The substantial volatility of valuations shows that it is a rather risky investment and that, at least at the moment, the comparison with gold is improper, especially from a hedging perspective.
Everyone engaging in bitcoin should discount the fact that, it being a completely unregulated market, the losses could be quite relevant, especially for late entrants.
Bianchi is an assistant professor of finance at Warwick Business School