Bitcoin bubble embodies our bipolar year of optimism and doubt

Andrew Sheng says cryptocurrency has some clear vulnerabilities that make its current highs temporary, but before the coming market correction, optimistic traders will carry on as they did before the 2008 global financial crisis

PUBLISHED : Friday, 22 December, 2017, 2:00pm
UPDATED : Friday, 22 December, 2017, 7:33pm

As 2017 draws to a close, the breaking out of the champagne to celebrate the US tax cuts and the record stock market prices suggest that bubbles will continue into 2018. In hindsight, 2017 was a most exciting year for its “bipolar” nature. Anyone who has lived with a bipolar personality would recognise that a high makes one feel they are walking on clouds, but the lows feel very, very low.

There was hardly a dull moment with President Donald Trump’s tweets changing long-standing policies by the minute. From withdrawing from the Trans-Pacific Partnership and Paris climate accord to calling the North Korean leader “rocket man”, nothing could be more divisive than making Jerusalem the location for the US embassy for Israel.

Brexit ended the year looking like the departing wife has to pay a huge sum for the divorce, keeping a back door (common Irish border) open for sneaking into the family house. And there is no doubt that when the far right won 13 per cent of the votes in the German elections, polarisation in Europe on how to handle immigration will be its primary threat.

Through all the geopolitical stresses and strains, the global financial markets sailed through 2017 by creating record highs, ignoring any fear that the central banks would reverse their unconventional monetary policies. Indeed, the biggest surprise winner in terms of returns is bitcoin, which started the year at US$1,000 or so, and last traded at US$18,000. According to Investopedia, if you bought US$100 worth of bitcoin on January 1, 2011, you would be worth more than US$3.7 million at the end of this November.

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This is a bubble far worse than the South Sea Bubble of 1720. I am amazed at how sanguine central bankers and financial regulators are on how easily innocent investors in cybercurrencies can be taken to the cleaners in this bubble. Most retail investors do not realise that cybercurrency has no intrinsic value, and it is not anyone’s liability, with no custodian or central register. So when someone tells you your cybercurrency has “disappeared” due to hacking or fraud, the cybercurrency investor has no legal protection at all. According to Bloomberg, roughly 1,000 key players own up to 40 per cent of bitcoin, so no one can check whether the prices and liquidity are subject to manipulation. If you cannot crack blockchain and trace who is doing what, how can any regulator find who is responsible for what?

Since the market value of all cybercurrencies already exceeds US$200 billion, and regulators allow both futures and initial coin offerings to open and trade, if and when institutional investors also get into the game, any collapse of the bubble will be widespread and catastrophic.

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The authorities’ complacency smacks of the “monumental collective intellectual failure” that did not foresee the 2008 global financial crisis. If the reversal of the cybercurrency bubble causes systemic failure like in 2007-08, then be assured the regulators will ask for more laws, powers and blame it all on “shadow players”, where no one needs go to jail, no regulator is negligent and we can solve all this through more investor and consumer education.

A reversal of this bubble seems unavoidable, taking down smaller players. Of course, since algorithms or computerised trading accounts for up to half the total trading in some markets, it would not be surprising that every drop will be an opportunity to buy the market higher. Hence it is quite possible the market will continue to trade higher for a while, but it cannot defy gravity forever.

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Basically, the financial markets are riding on expectations that economic growth is recovering everywhere. But any unknown trigger could send it crashing. We live in a simultaneous knife edge of massive greed and bottomless fear – including the fear that we will miss the upside.

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On the bright side, the Fed has finally made its interest rate adjustment, followed quickly by the People’s Bank of China. This means that interest rate normalisation is on its way.

The real question is whether a flat US Treasury yield curve, which historically signalled a slowing economy, will come true or not. Optimists think the US tax cuts will keep boosting the market, while Trump opponents argue the reverse.

Unbounded optimism happens when there is what Charles Kindleberger calls displacement – a phenomenal event that disorients rational thinking. The 18th century South Sea Bubble happened because great fortunes were made in colonies from growing cotton using slave trade.

Even Isaac Newton lost a fortune playing stocks. As he famously said, he could calculate the motion of heavenly bodies, but not the madness of people.

We now live in an age of wondrous technology, at a time of great change that brings hope as well as despair of the unknown. This explains our euphoria and worries. 2018 will be a year of great hope for optimists and despair for pessimists. Enjoy the bubble while it lasts. Happy New Year to all.

Andrew Sheng writes on global issues from an Asian perspective