Beyond the Bitcoin bubble with Matthew Lynn

Confidant article – Autumn issue 2017

Jamie Dimon, the CEO of banking giant JP Morgan Chase, certainly didn’t mince his words when it comes to Bitcoins. He recently dismissed the cryptocurrency as a “fraud”, adding to the controversy surrounding one of the biggest financial stories of 2017. However, a look back at history reveals that plenty of wild, speculative investment crazes are spawned from genuinely useful innovation. Bitcoin is just the latest example. And whilst that makes it a spectacularly risky investment, it should not be dismissed altogether.

What lies beneath

Behind the war of words it is worth remembering that an increasingly digital global economy was always likely to spawn contenders for a purely digital currency.

The technology underlying the currency has huge potential, and just about every financial institution in the world is overtly, or furtively, spending millions on working out how to use it to make paying for, and settling, trades cheaper, safer and more efficient. Meanwhile an army of venture capitalists are pouring funding into variants on the crypto-currency, and new ways of using it. Plenty of investors have piled in – in the early days because they could see genuine potential in the technology but latterly through the sheer fear of missing out. The problem is that once a credible story gets massively hyped and ordinary investors have access to it, conditions are ripe for a bubble to form.

Bubble trouble

No-one who follows the financial markets can have failed to miss the staggering rise in the digital currency in the last year. From $600 last September, it had soared to $4,950 by the end of August, an eight-fold rise in a single year. Its price doubled over just the three preceding months. Plenty of fans are predicting the price could soon hit $10,000 or even $20,000.
Mr Dimon is in little doubt that things have got out of control – he labelled anyone trading it as ‘stupid’ and said they ‘should be fired’. While it might be useful for a ‘drug dealer’ or ‘murderer’ any sane investor should get out before the inevitable collapse. In short, the bubble in the crypto-currency is ‘worse than tulips’. Strong words indeed, that cause the price to drop 11% almost immediately.
I agree with him that an eight-fold price rise within a single year is crazy. That is not how a normal asset behaves. It is what happens when speculators start jumping on a bandwagon, and when a mania takes over from sober assessment. Bitcoin has been billed as a future, alternative means of exchange, yet such a sharp rise completely undermines its credibility – few holders want to spend Bitcoins now when they might well be worth four or five times as much within a year.

Lies, damn lies and the Bitcoin price

However, it is going too far to suggest, as Dimon did, that crypto currencies are worthless or the preserve of criminals. Sober investors with a keen eye for history, will know that we have been here before and several times. When a significant new technology emerges, investors are usually quick to see its potential. But then what ex-Federal Reserve Chairman, Alan Greenspan, once labelled “irrational exuberance” takes over and prices quickly part company with any “fundamentals”. It happened with railway stocks in the nineteenth century, with radio stocks in the 1920s, and with internet stocks in the 1990s. Yet in time, railways clearly did re-shape the global economy, radio and electrical goods spawned huge new industries and internet technology is still busy changing the way we live.
The truth is that true bubbles, when investors chase up the price of something that is completely worthless, are actually pretty rare. So, the key question for potential investors is how to judge when the price for something that is genuinely transformative, gets crazily ahead of itself. Joe Kennedy once famously quipped that once the shoe shine boy is talking to you about stocks, it’s a bubble. I feel much the same way about the manic enthusiasm for cryptocurrencies being displayed by Uber drivers. So whilst I disagree with Mr Dimon – Bitcoins are better than tulips – if I was going to buy any, I’d be keeping my powder dry for now.
This article originally appeared in the Autumn version of our client magazine Confidant. Should you wish to read the full magazine please contact us at [email protected] to receive the digital version.

This article does not reflect views of Killik & Co, so please do not interpret it as a recommendation for your personal investments. If something has piqued your interest and you would like to find out more or discuss what investments might be suitable for you, please contact one of our Investment Managers on 020 7337 0777.