By Professor Samuel Ouzan, NEOMA Business School
What is Bitcoin’s primary function? What is the current use being made of it? Is it a new form of fiat currency? Does it behave like a commodity?A stock? Or is it a new type of speculative asset of a fundamentally new variety? These questions are obviously essential when one is tempted to speculate on the future of Bitcoin and by extension on its realvalue. So why have I decided to entitle this article Bitcoin Crash rather than giving it a less entrenched and more neutral heading?Just because, although the value of Bitcoin has gone from 7 hundredths of a cent (1 $ was worth 1,009.03 BTC at the time of the first public sale of Bitcoin on 5 October 2009) to $7,524.21 at the time of writing of this article, there remains great confusion and uncertainty among investors, regulators, economists and academics around the true nature of Bitcoin.
In a recent article co-written with my colleague, Arash Aloosh of NEOMA Business School, entitled the psychology of cryptocurrencyprices, we question the psychological dimension of cryptocurrencies and have observed that certain cognitive biases relating to the nominal value appear to be more frequent in the cryptocurrency market than in the equity market.
According to so-called neoclassical finance, the market price of each share should represent its intrinsic value. For this to be so, markets must be efficient, but in reality nothing is less sure as far as cryptocurrencies are concerned, because the notion of efficiency assumes that investors have rational expectation concerning the development of Bitcoin and its global adoption. How is it possible to defend the hypothesis of the rationality of individuals dealing with Bitcoin, when specialists in the sector have great difficulty in agreeing even on its basic nature? Not to mention the extreme complexity of its economic, political, legal and technological aspects. Astonishingly, although it is undeniable that cutting-edge expertise is essential to evaluate Bitcoin’s prospects, all over the world celebrities such as the actress Gwyneth Paltrow, the rapper Snoop Dogg and the footballer Lionel Messi have promoted it. It is easy to see that the enthusiasm of the layperson for Bitcoin is without precedent. I think that this enthusiasm coupled with its extreme volatility and the confusion that still surrounds the exact nature of Bitcoin is a quite unique phenomenon, and a worrying one that should alert investors and regulators to the fragility of this market.
The major question that this article is attempting to address is how can we know if the spectacular rise of Bitcoin could be principally psychological in nature? If that is the case, a future crash is very likely! And if we accept this likelihood, how is this speculative bubble different from others, such as the Internet bubble?
I believe the bubble is even more spectacular precisely because the subject of Bitcoin is of an unprecedented complexity in the history of economic assets and the enthusiasm it arouses does not reflect an essential service it would be capable of delivering for all, so much as an ideological promise it contains. This promise is to be rid of intermediaries, financial institutions, state intervention, or any kind of system! In that sense, Bitcoin has an essentially political dimension.Some will say that the promise has been delivered. Bitcoin exists. Even if it is not widely adopted, it works. This is a valid argument. Even if Bitcoin fulfilled its role as a decentralised, anonymous currency without encountering any problems, would it ever actually be widely adopted? Would we be prepared to abandon our euros, dollars, yen, pounds sterling, or pesos, by choice? What would it really offer us above and beyond our usual currencies? Bitcoin could be of interest to countries whose currency is very unstable. It would have a certain benefit in the world of illegal trade.It would become a rogue currency. Despite Bitcoin not being widely adopted and the many structural deficiencies facing it, is this not what it is already on the point of becoming?
The reality is that Bitcoin is coming up against many systemic problems. The argument defending the validity of the Bitcoin system is analogous to one defending the validity of a technology that could construct a model when it should be capable of constructing a real building. So the true challenge in the promise of a decentralised currency lies specifically in the problem of scaling or being able to generate a system that could operate on a large scale. The fundamental problem with Bitcoin is that it cannot support a number of transactions related to global adoption. The network can carry out up to 7 transactions per second whereas, by way of comparison, the Visa network performs approximately 24,000 per second. In this respect, Bitcoin seems more like a toy than anything else. This analogy may appear extreme but it seems to me quite close to the reality. Following the enthusiasm aroused by Bitcoin, the emergence of countless cryptocurrencies that have not, however, managed to displace Bitcoin, seems to me a sign of the crash to come rather than the promise of its adoption. Their proliferation should serve to discredit Bitcoin as the alternative to fiat currency.
In practical terms, to ensure the trusted third party required by a monetary system is replicated, Bitcoin protocol uses computational competition or in other terms it is betting on competition in energy use! In a world where environmental awareness continues to grow among the public, it seems surreal to imagine any potential global adoption of Bitcoin. Yet this is what its market value suggests from a rational point of view. There is a continuing debate on whether mining for Bitcoin could in the long term generate energy use equivalent to that of the whole world or that of Ireland or Portugal. One study has shown that Bitcoin mining could alone be responsible for exceeding 2 degrees of climate warming. But the energy aspect of Bitcoin is far from being the only problem. The possibility of the Bitcoin network being corrupted in the near future because of the nature of the competition to validate transactions represents another considerable problem. This is because huge specialised computer infrastructures is necessary to validate transactions and perform the mining. This phenomenon subverts the democratic and decentralised character of Bitcoin and threaten its security. Particularly, if a monopoly on the power of mining started to become apparent. Not to mention the problems of fungibility of cryptocurrency when all Bitcoins are not considered of equal value because many have been used by criminals and put on a blacklist by exchange platforms.
Although several improvements have been made to the Bitcoin protocol, it has certain fundamental limitations which seem to me to stem from its ideological and slightly utopian character. Replacing a known and trusted third party by a competitive, almost anarchical and unstable organism, requiring inefficient energy costs, seems to me to be at least questionable. I believe that in order to analyse the chances of success of Bitcoin dispassionately we must not forget that as humans we often behave in an irrational way.We tend to considerably overestimate the impact of innovations, and to extrapolate from past performance such as the spectacular rise in the value of Bitcoin over recent years. This often makes our future expectations somewhat biased. It would therefore be premature to judge whether, as with the emergence of the Internet, the advent of Bitcoin represents a real and lasting revolution in the history of technologies.
Cryptocurrencies: the new gold?
By Gerald Moser, Chief Market Strategist, Barclays Private Bank
Time to add to a portfolio?
There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.
While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.
And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.
Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.
The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.
Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.
In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.
An inflation hedge?
Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.
Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.
Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.
From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.
Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.
Cryptocurrencies are here to stay
Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.
And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
Wall Street bounce, upbeat earnings lift European stocks
By Amal S and Sruthi Shankar
(Reuters) – European stocks rose on Wednesday after Dutch chip equipment maker ASML and Swiss luxury group Richemont gave encouraging earnings updates, while investors hoped for a large U.S. stimulus plan as Joe Biden was sworn in as president.
The pan-European STOXX 600 index closed 0.7% higher, getting an extra boost as Wall Street marked record highs.
All eyes were on Biden’s inauguration as the 46th U.S. President, with traders betting on a bigger pandemic relief plan and higher infrastructure spending under the new administration to boost the pandemic-stricken economy.
Tech stocks rallied to a two-decade peak in Europe after ASML Holding NV rose 3.0% to all-time highs on better-than-expected quarterly sales and a strong order intake for 2021.
Meanwhile, Richemont rose 2.8%, after posting a 5% increase in quarterly sales as Chinese splashed out on Cartier, its flagship jewellery brand.
Britain’s Burberry jumped 3.9% after it stuck to its full-year goals, saying higher full-price sales would boost annual margins, while Asian demand remained strong.
The pair boosted European luxury goods makers that are heavily reliant on China, with LVMH and Kering gaining between 1% and 3%.
“Any sign that retail spending is picking up in China is going to be a boost to the Western markets and those heavily exposed to it,” said Connor Campbell, financial analyst at SpreadEx.
The European Central Bank is set to meet on Thursday. While no policy changes are expected, the bank could face more questions about an increasingly challenging outlook only a month after it unleashed fresh stimulus to bolster the euro zone economy.
“With the new round of easing measures fully in place and no new forecasts to be presented tomorrow, it should be a fairly uneventful day for the euro,” ING analysts said in a note.
Italy’s FTSE MIB gained 0.9% and lenders rose 1.6% after Prime Minister Giuseppe Conte won a confidence vote in the upper house Senate and averted a government collapse.
Conte narrowly secured the vote on Tuesday, allowing him to remain in office after a junior partner quit his coalition last week in the midst of the COVID-19 pandemic.
Daimler AG jumped 4.2% after its Mercedes-Benz brand unveiled a new electric compact SUV, the EQA, as part of plans to take on rival Tesla Inc.
Germany’s Hugo Boss added 4.4% after Mike Ashley-led Frasers said it boosted its stake in the company.
(Reporting by Sruthi Shankar and Amal S in Bengaluru; Editing by Shailesh Kuber and Arun Koyyur and Kirsten Donovan)
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