Bitcoin madness without an end?
The fourth industrial revolution has brought with it major change and innovation in many fields and has given rise to the world’s first digital currency or first digital commodity in the form of bitcoin.
The sharp rise of bitcoin and other cryptocurrencies recently has created a lot of interest in this market but there have been questions and arguments including that it is not a real currency, that there is no place for it in an investment portfolio and that it is simply fraud.
To further unpack this issue, Antje Hargarter, Dean of School of Investment and Banking chatted to Manfred Huebner, managing director of Sentix in Germany. Huebner is an expert in the fields of sentiment analysis and behavioural finance, and a Certified European financial analyst. With the Sentix Global Investor Survey, he has developed the leading sentiment barometer in Europe. He conducts research and has the role of chief strategist, based on 25 years of experience in the capital markets.
Antje: Manfred, thanks so much for sharing your thoughts on the bitcoin topic with us. What do people expect when they invest in bitcoin? Is it a search for the ultimate, manipulation-safe, inflation-free alternative form of money? Or is it pure greed?
Manfred: Thanks for inviting me to speak about this fascinating subject. Can you believe it: since May of this year, the price of bitcoin has doubled yet again! At the same time, this bubble – like many other bubbles – can get much bigger before it bursts! To my mind, investors make a number of wrong assumptions about bitcoin.
Antje: What are some of those assumptions, in your opinion?
Manfred: Investors who purchase bitcoins believe that they are indeed investing in an alternative currency. However, they actually acquire ‘digital assets’ from another person. Any one euro that a buyer spends will not ‘flow’ into bitcoin but will increase its intrinsic value. Any euro spent will go directly to the seller. Due to the scarcity of the supply and the speculative increase in demand, prices are rising. And let’s be clear: it is the price that increases, not necessarily the value!
Antje: That sounds very similar to stock market speculation?
Manfred: Indeed. What drives stock prices are speculative feedback loops - the price drives the demand, which in turn drives prices even higher because of scarcity. The underlying company did not necessarily experience any increase in value from a fundamental point of view; we are only talking about a stock price increase. Price and value of a company can decouple easily in reality.
Antje: Sounds plausible. The stock market will function slightly differently though, won’t it? In the case of a listed company, their share prices rise, leading to an increase in the valuation of the company. A takeover of competitors can be financed through the stock exchange by issuing new shares, which is not possible with bitcoins in conceptual terms.
Manfred: Correct. Besides this, there is also a significant difference between bitcoin and classical currencies: when investors move their investments from the euro to the US dollar, the inflow of capital influences real-life flows in goods. A sharp rise or fall in the exchange rate would have real economic consequences for both ‘currency areas’, which is why equilibrium prices are set and speculation is less encouraged.
Antje: I agree, this is not true with Bitcoin and other cryptocurrencies. Since only the price of a virtual asset is affected by the transaction, there is no relationship to the real world at all.
Manfred: Exactly. The purchase of a bitcoin does not change the amount of money in the issuing currency: in the background, a shift occurs between classic currencies; for example, when the buyer pays with Euro and the seller receives US dollars. If one-day bitcoin crashes, no real value is destroyed.
Antje: Right… What are other complications that investors need to keep in mind?
Manfred: A few weeks ago there was a split-up of bitcoins because the ‘community’ could not agree on how to develop the protocol so that bitcoins could be useful as a means of payment. So suddenly there were two types of bitcoins – overnight. Compared to other investments, the process of a share split in a corporation usually leads to a reduction in the price of the old shares. This did not happen in the bitcoin case! All owners were simply given a new cryptocurrency. The inflation of the underlying asset thus leads to a prosperity increase based on no actual facts.
Antje: Hmmm, sounds like speculative overheating to me…
Manfred: [Laughs]… Nothing is more beautiful for a speculator than when rising prices attract new buyers! The scarcer the good, the more the price rises. Behind this phenomenon lies simple, blind greed.
Antje: So, nothing new in terms of investors’ greed?
Manfred: As André Kostolany already pointed out decades ago: when it comes to speculation, whether in stocks [or in bitcoin], it is always about whether there are more investment opportunities than stupid investors or more stupid investors than investment opportunities. Since the number of bitcoins is fixed, but investor greed is limitless, it seems logical that prices can still go much further. But the price is what you pay for. Value is what you get.
Antje: I guess whenever asset prices have increased to the extreme in the past, this has never been indicative of a fundamentally healthy development in human history.
Manfred: Very true!
Antje: Have you looked at other technological developments related to the fourth industrial revolution other than bitcoin?
Manfred: I see blockchain technology as a very valuable development with great potential for the future. Not so with the derived cryptocurrencies… I do not expect any of the existing instruments to become a fully legal payment tool.
Antje: What about the other stakeholders participating in the hype? How are they affected?
Manfred: The service providers around the whole bitcoin story profit to a considerable extent from the speculative activity and the price increases. For example, the Bitcoin Group claims that their own bitcoin investments are currently being revaluated – to my mind though, this enormous market capitalisation is not justified. There are increasing signs that speculation is moving into other areas, and everything that somehow sounds like blockchain and bitcoin is affected by the exaggerated speculation. This development is very similar to the Internet hype of 1998 to 2001 when companies just had to be called something like dot.com to put the investors in sheer ecstasy.
Antje: Agreed, but that came to an end very abruptly. Will we see the same for bitcoin and blockchain?
Manfred: It is highly unlikely that all cryptocurrencies and all blockchain service providers will end up being a success. However, every investor believes that his cryptocurrency or his investment in blockchain has prospects for success. This, in turn, means that the whole market is far too optimistic. In science, this phenomenon is known as a ‘base rate/case rate’ anomaly.
Antje: But as with the internet bubble, there will only be a few winners…
Manfred: Indeed. The internet formula of the ‘winner takes all’ principle also applies to cryptocurrencies. Perhaps those cryptocurrencies that will be successful in the future do not even exist yet today and could be issued and managed by a government or quasi-governmental authority…
Antje: Manfred, thanks for sharing such valuable insights! Do you have one last conclusion for us?
Manfred: I believe that the more hype there is around bitcoin and blockchain, the more obvious the speculative character and the absurd misconception caused by the greed of the investors will become. In the meantime, there will be many winners who will bring about this speculation. ‘Success stories’ of so-called ‘early adopters’ are instrumental in heating up the speculation. But in the end, there will be many, many losers…
02 Oct 2017