For a system of currency to be worth anything, people need to believe in it – and at present there is no shortage of belief in so-called ‘cryptocurrencies’.
Bitcoin may be the one most people will have heard of but there are now around 100 cryptocurrencies in existence and, earlier this month, their combined worth surpassed $100bn (£78bn) for the first time.
On 1 April, by way of context, they were worth a quarter of that.
If, on reading that, the word ‘bubble’ has just popped into your head, you would be in good company. Recent articles on the subject have included “Cryptocurrency is a bubble” (Forbes), “What the hell is happening to cryptocurrency valuations?” (TechCrunch) and “What if the Bitcoin bubble bursts?” (The Economist). And not forgetting, of course, CityAM's own coverage.
Yet for all the bubble warnings, you would also find plenty of people ready to argue why this ‘digital asset class’ is only just getting started.
What is a cryptocurrency?
Cryptocurrencies are digital currencies built on the sophisticated and decentralised ‘blockchain’ technology.
Thanks, among other things, to their perceived security and independence from nation states and central banks, the values of trailblazer Bitcoin and more recent offerings such as Ethereum and Ripple – which make up about four-fifths of the market – have been rocketing upwards.
Some of the numbers surrounding Bitcoin are extraordinary – if, for example, you had bought $1,000 of the currency in 2010, it would now be worth around $35m.
The early peak came in late 2013 when one Bitcoin was worth $1,100 but the currency then crashed to less than a fifth of that not much more than a year later.
Since then, it has zigzagged its way up to within touching distance of the $3,000 mark.
Has the bubble burst already?
As it happens, between our planning to write this piece and actually sitting down to do so, it looked as if the cryptocurrency bubble had indeed burst.
Sticking with Bitcoin as our proxy for the market, after peaking at $2,941 on 11 June, the currency fell some 20% to below $2,200 on 15 June … from which point it gained more than 15% to head past $2,600 on 18 June.
Forgive us if that number is wildly different by the time you read this – things move pretty fast in the world of the cryptocurrency – but you can certainly see why The Economist, Forbes and others have been talking in terms of ‘bubbles’.
However it turns out, though, the language being used about cryptocurrencies – and the associated market reaction – is certainly reminiscent of the dotcom boom and bust at the turn of the century.
Whether it was the internet back then or cryptocurrencies now, the arguments involve technologies that are not widely understood but nevertheless whip up great excitement among investors because of their huge potential and ramifications for how we interact with the world. Over the last two decades or so, a few internet-related stocks have lived up to and even surpassed that excitement but a far greater number have not.
One major problem investors faced with dotcom stocks related to valuation. Arguably they face to an even grater degree the same issue with cryptocurrencies.
If cryptocurrencies were stocks, investors might at least have a chance of getting to grips with their balance sheets and working out what they were really worth but, as it stands, there is simply no metaphorical bonnet to open up and check underneath.
In fact, the only real point of comparison for Bitcoin, Ethereum, Ripple and the rest are traditional currencies, which brings us back to our initial point – that every money system is a man-made construct that is dependant for its very existence on an act of faith.
The same goes for gold, two ounces of which can now be bought for a single Bitcoin…
So – eye-watering numbers or mouth-watering prospects? The price movements of the last week or two mean the jury is still out on whether cryptocurrencies are a potential bubble. What seems more certain, however, is the sort of behaviour we are currently witnessing in much of the market is herd-like and short-termist in nature and thus more akin to speculation than investment.
- Andrew Williams is an author on The Value Perspective, a blog about value investing. It involves a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction. Click here and enter your email to receive a weekly round-up of investment ideas.
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