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Bitcoin: Bubble or boom

By: Zain Wilson, an investment analyst at Old Mutual’s MacroSolutions boutique

What lies ahead for the golden child of cryptocurrency in 2018?

Since hitting an all-time high of almost USD20 000 per bitcoin in December 2017, the cryptocurrency has almost halved in value over the past month. To put bitcoin’s performance in context of equity market crashes, the correction we have seen over the last month is larger than both the Black Monday and Tuesday stock market crashes (the largest global equity market corrections on record).
Given that bitcoin is closer to being a currency than an equity or a bond, the stability of its price will ultimately be determined by its likely use as a currency and as long as this remains unclear the bitcoin price is likely to be volatile and the risk of it being in a bubble relatively high.
This is according to Zain Wilson, an investment analyst at Old Mutual’s MacroSolutions boutique, who cautions that while shares can sustain periods of large drawdowns (as long as the underlying businesses do not go bust), excessive volatility and a collapse in the price of a currency can perpetuate vicious cycles, driving away those that use it as a means of exchange.
“There are plenty of signs that bitcoin and the broader cryptocurrency market are in the midst of a bubble. While the technology is potentially disruptive, the balance of speculators in comparison to real users of the currency appears unstable. Adding to this, the extent and pace of the increase in price, and with it the market capitalisation, has been astronomical.”
Wilson points out that the US dollar price of bitcoin is up from US$747/BTC at the start of 2014 to US$11 394 (26 January 2018) – a growth rate of 95% per year. “With it, the market capitalisation has gone from just over US$9 billion to US$189 billion. To put this in context, it is almost 60% of South Africa’s annual GDP! The total market capitalisation of all cryptocurrencies is estimated to be around US$557 billion – nearly two times our annual GDP.”
Despite this, as a form of digital payment, Wilson says that bitcoin is underpinned by a viable value proposition. “Although not enabling completely free transactions, it presents an alternative form of digital payment, which will find niche markets for transactions that are uneconomical for current payment systems. This opportunity is large, and meaningful.
“However, this is not a commoditised market – the software on bitcoin is open source and it is free for anyone to copy and attempt to improve upon. Thus, the only true advantage bitcoin has over its peers is the larger network of users it has already established,” he adds.
Bitcoin as a digital currency, however, is slightly more complex, says Wilson. “The success of any currency depends on some failure or discontent in the currency that precedes it, and a build-up in trust and usage via a strong network in the new currency.
“The argument that bitcoin – the digital money – has no intrinsic value is misguiding in that it is no different from other forms of fiat money. Whether or not there is trust and a large enough network of users, is a more appropriate question for a currency to be legitimate. The two greatest obstacles to expanding this network is the uncertainty around regulation from governments, and the high volatility in the price of bitcoin, which can dissuade an everyday mom and pop user.”
While there are a few cryptocurrency exchange traded funds (ETFs), futures and even dedicated mutual funds (investing ONLY in cryptocurrencies) in the US, Wilson says that regulation remains an obstacle globally. “For instance, it is not clear whether cryptocurrencies are considered currencies or commodities, and what the respective tax implications would be on any profits. While countries such as China and India have banned bitcoin, lack of regulatory direction in South Africa leaves cryptocurrencies as un-investible for all of our funds and, as such, MacroSolutions does not have any exposure.”
In addition to the regulatory uncertainty, Wilson believes that the highly competitive market in which cryptocurrencies operate, and the absence of intellectual property protection, weakens the competitive edge of any one cryptocurrency over the next, while valuation remains distorted by the amount of speculators active in each currency.
“For now, this would exclude bitcoin and other cryptocurrencies from being considered as an appropriate investment opportunity. Exciting and interesting, but speculative is a more appropriate space,” he concludes.

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