Cryptocurrencies

Is there something different about the crypto bubble? 

There certainly are people out there who have made plenty of money investing in cryptocurrencies. Over the last few years the price of Bitcoin and many other cryptocurrencies have increased by a staggering amount. And no one knows how high these prices could go. On the other hand, there are significant risks and some alarming similarities between the current surge in prices and other investment ‘bubbles’ that have occurred in the past. Below I discuss a few of these:

• Where is the intrinsic value? – Enormous price increases in cryptocurrencies have been largely fueled by speculation. As cryptos aren’t a commodity and there is no income that can be derived from them, their value as an investment lies in people’s perception that their price will increase. The hype is speculative. On top of this, there are now a large number of people who either don’t use the technology, or even have an understanding of how the technology works, that are pouring money into it in the hope of generating a return. There are parallels that can be drawn between the mania surrounding cryptos today and the ‘tech bubble’ of the 90’s. Back in the late 90’s, many people invested in dot-com companies without understanding internet technology, in the hope of seeing price increases. Some of these dot-com companies didn’t actually do anything or make any revenue and ended up going bust. Even the tech companies that survived took many years to recover. It’s a classic sign of an investment bubble when people who don’t understand what they are investing in, pour money into something because they believe it will increase in value. Nothing drives investment like the fear of missing out.

• Can Cryptocurrencies actually be used as currencies? – Most people don’t want to buy something with a currency that is so volatile. Would you want to buy a $40,000 car with Bitcoins when they might be worth $80,000 a month later? Likewise, would a car dealership want to accept $40,000 in Bitcoins when they might be worth $20,000 in a month? Many of the companies that accepted Bitcoins as payment in the past no longer do. The risk of volatility is too high.

• Regulatory risk – Cryptos remain largely unregulated, particularly in Australia. However, it is unchartered territory for governments around the world and how they respond to it may have significant consequences on its value. China is already shutting down Bitcoin exchanges and India has announced their intention to do the same. Many of the world’s largest banks (J.P. Morgan, Bank of America, Citibank) have also banned the use of credit cards to purchase cryptocurrencies.

• Hackers – Crypto exchanges are a target for hackers and there have already been plenty of cases of coins being stolen and exchanges being used to scam potential investors. Without government regulation and oversight, these risks are heightened. In Australia, Cryptocurrencies are undefined in law, which is why ASIC is unable to provide the usual investor protection or investigate losses as they would with other types of investment.

• Liquidity Risk – Due to the immense popularity of Cryptocurrencies, many of the exchanges that trade them have had issues dealing with the volume of trades, some of them being shut down for days or weeks at a time. This can be an issue if you’re trying to cash out and get your money.

• Concentration Risk – around 4% of the Bitcoin market own over 95% of all Bitcoins in circulation. Many of these people have owned Bitcoin from the very beginning meaning that they have experienced enormous gains in the value of their holding. If these people were to withdraw from the market (i.e. cash in on their millions) then it would have a huge impact on the prices of cryptos worldwide.

With any investment, it’s important to understand the risks involved. In the case of cryptocurrencies, the risks are high. The returns for some people have been significant but dependent largely upon speculation by the ever growing numbers of new investors; not on any true underlying value. The price of these currencies may continue to rise but it will be a highly volatile ride and it is important to ask the question – where is the real value? History tells us that bubbles like this nearly always end in pain and tears. One for the real gamblers with money they can afford to lose.

Sean Condell

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