It looked like a bubble and it turns out to have been a bubble. After soaring from around $1,000 at the start of 2017 to over $19,000 in mid-December the price of a bitcoin plummeted to a low of just under $6,000 earlier this week—inflicting losses of two-thirds on those who bought the digital currency at its peak. How and why has this reverse happened and what does it mean for bitcoin’s future?
The collapse in the bitcoin price has put paid to the bullish arguments about why the cryptocurrency, so called because cryptography is used to secure and verify transactions while shielding the identity of users, could carry on appreciating.
Bitcoin was founded on the innovative blockchain technology, in which shared digital ledgers are created that allow peer-to-peer transactions without any intermediary. For its enthusiasts, the new decentralised digital currency was the way of the future, sweeping away the need for banks and central banks. It was destined to become a form of digital gold since only 21m bitcoins could ever be created. Of these nearly 17m had already been “mined” by computers that crunch data to solve increasingly laborious mathematical puzzles rather than machines that crush ores.
This story has turned out to be as spurious as other narratives spun to rationalise a speculative frenzy. In particular, the frantic swings of the bitcoin price have vitiated the notion that it could supplant conventional money that provides a stable means of exchange and store of value.
Instead the behaviour of bitcoin has conformed to the familiar pattern of financial bubbles. These typically involve investors piling into assets not because of their intrinsic merit but because they see others doing the same and profiting from it. It is an extreme version of John Maynard Keynes’s now rather un-PC depiction in his General Theory of professional investment resembling a beauty parade in which the prize is to guess who the other punters will typically judge the prettiest. Eventually the frenzy halts when those who bought early take their profits. As the price starts to fall, the pretty turns ugly and there is a rush for the exit.
“The auspices for bitcoin now look unfavourable as regulators sound the alarm”As well as this inherent tendency for bubbles eventually to burst, bitcoin is now facing attack on several fronts. Up until now it has dominated the digital wild west. But its outlandish performance has caused the sheriffs to ride into town even if at present they lack all the ammunition they need to tackle the upstart cryptocurrency.
In America federal regulators are talking tough about bitcoin and other cryptocurrencies and arguing that they may need new powers to oversee bitcoin exchanges. In testimony to Congress on Tuesday, Christopher Giancarlo, head of the Commodity Futures Trading Commission, and Jay Clayton, head of the Securities and Exchange Commission, made clear that bitcoin was in their sights. In France, Bruno Le Maire, the finance minister, reiterated on Wednesday his call to regulate bitcoin.
Banks are also getting tougher with bitcoin investors. In America three big banks including JPMorgan Chase are no longer permitting the use of credit cards for the purchase of cryptocurrencies. Lloyds Bank has taken a similar step in Britain. The restrictions are understandable given the exposure of any such borrowers to massive losses.
Moreover, there is a greater awareness of another risk in dabbling in cryptocurrencies, that of outright theft as despite the vaunted cryptographic features hackers exploit security weaknesses. The most recent episode was a raid on Coincheck, a cryptocurrency exchange in Japan. Hackers managed to get hold of over 500 million units of XEM, a cryptocurrency, worth around $500m.
The auspices for bitcoin now look unfavourable as regulators sound the alarm and plot countermoves. A speech on Tuesday by Agustin Carstens, general manager of the Bank for International Settlements, the central banks’ bank, was nothing less than a call for arms. Decrying bitcoin as not just a bubble but also “an environmental disaster”—referring to the extraordinary amount of energy used in the digital mining—Carstens said there was a “strong case for policy intervention” to contain the risks arising from cryptocurrencies. Regulatory measures will be discussed when G20 finance ministers meet in Buenos Aires in March.
Bitcoin had snapped back to around $8,000 in early trading on Thursday. Yet once a bubble has burst it rarely reflates. Although bitcoin’s recent collapse has been remarkable, it remains far higher than five years ago, when it was worth only around $25, according to Coindesk. Yet as the regulatory environment becomes more hostile, bitcoin investors will be hard-pressed to retain their faith in the cryptocurrency.
