Many of the characteristics of financial bubbles can be seen in the bitcoin phenomenon. Photo: AP
The View
by Richard Harris
The View
by Richard Harris

Bitcoin’s fabulous rise ... will eventually end in tears

‘Despite the warnings, I have no doubt that cryptocurrencies will continue to grow as did Tulipmania, and the South Sea Bubble’

It is a feature of all bubbles driven by the herd to find that many wise, high profile and analytical financial observers are their most ardent supporters. The rest of the crowd are blinded by greed or gripped by the fear of missing out. So it is with bitcoin.

The proponents of bitcoin, and the other 800 or so other cryptocurrencies, look on this brave phenomenon of the digital world as something new and original. Indeed it has many attributes as a cash alternative. It provides a quick and anonymous payment mechanism using a weblike method of transferring payments known as blockchain. The ledger, or book of ownership, can be updated in real time and held on different computers around the world – visible to all. This already puts us on the first rung of delusion because, doing the same thing in a much smarter way than we could before, imparts an aura of credibility to the process.

Bitcoin does boast many of the characteristics of money. It is a medium of exchange, portable, divisible and uniform (what bankers call fungible). It may be said to be a store of value, like shells, beads, cows and tulips. The Semper Augustus tulip bulb, once had intrinsic value, selling for five hectares of land – but no more; only gold has maintained a value throughout financial history.

The fatal aspect lacking from cryptocurrencies is the backing of a central bank, which has all of the economic, military and intellectual resources of a nation to support it. At this observation, many bitcoin enthusiasts will be holding their sides with mirth pointing to the hyperinflation of Weimar Germany or Zimbabwe. They observe that accepted currencies like groats or denarii have disappeared and, out of the 140 physical currencies in circulation a century ago, few remain to pay their holders. In inflation adjusted terms, the Swiss franc has lost 75 per cent of its value, the US dollar 95 per cent, and the pound 98 per cent.

Photo: EPA

Nevertheless, modern currencies backed by a nation are the best bet for providing a respectable currency base for the next century. The bitcoin community is already squabbling about whether to change the rules of mining and trading. New coins are invented daily and used as “currency” to raise money for all sorts of projects; some not fraudulent. A currency that is as volatile as bitcoin cannot be used from day to day – bitcoin has fallen 25 per cent from its high of nearly US$5,000 per coin at the beginning of this month.

Admittedly that fall came as the Chinese authorities banned initial currency offerings and shut down the online exchanges. Capitalism with Chinese characteristics enables them to act when they see a problem faster than laissez-faire capitalism. Bitcoin mania was at its wildest in the nation with as much as 70 per cent of the cryptocurrency being mined there, and 90 per cent of the trading is on Chinese-based exchanges. Such a currency can’t be seen to threaten the yuan, there is no visibility over its development, and its very anonymity opens it up to the criminal classes.

Despite the warnings, I have no doubt that cryptocurrencies will continue to grow as did Tulipmania, and the South Sea Bubble - and encouraged by market commentators, who should be thoroughly ashamed of themselves. It will not be long before coin fever takes over and will take its worst form when real assets are pledged to loans on the back of the pseudo-value created by cryptocurrencies. In the 1720 South Sea Bubble, shares rose 10 times and speculation in lunatic and fraudulent companies ran wild. One company was launched to manufacture a gun to fire square cannon balls. The mission statement of another was to “carry on an undertaking of great advantage but no one is to know what it is!!” £2,000 was invested in this project. Sounds familiar? Those who fail to learn from history are doomed to repeat it.

As more furrowed-brow experts pontificate on cryptocurrencies of ever-differing types, denomination, and segmented uses, more and more ordinary people will get sucked in. Some event will then encourage holders to exchange cryptocurrencies for real cash at the same time - and that will hurt all assets and the economy as a whole.

Cryptocurrencies are going up because they are going up; they are the Kardashians of the financial world; famous for being famous. But fame does not last forever, nor do market manias. Then the very same very wise, high profile and analytical financial observers will then try to convince us that they were the first to warn us!

Richard Harris is a veteran investment manager, banker, writer and broadcaster – and financial expert witness.

This article appeared in the South China Morning Post print edition as: Coin of the digital realm