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Could Bitcoin be telling us something?

Could Bitcoin be telling us something? Although not widely held, its meteoritic rise and subsequent fall might have a message about the wider market. Bitcoin’s sell-off could reveal other stresses in the financial system. And, we might be surprised at what correlates with cryptocurrencies. A virtual asset certainly, but with implications for some real-world banks and market participants.

Bitcoin’s recent ascent has coincided with excess global liquidity that triggered a boom in technology stocks and more generally in some exciting highly-rated growth stocks. Indeed, the linkage between Bitcoin and Tesla is deeply embedded – not just with the enthusiasm of Elon Musk, but by common holdings in a number of funds. The rise of virtual currencies has created new funds and overnight experts. The cryptocurrency is also connected to leverage; an opaque pyramid propels its price in a way that seems disproportionate to underlying transactions. Some of this euphoria spills into short term equity trading. It may prove more correlated with conventional assets than we think.

Increasingly, wealth planning involves alternative asset classes, such as property, private equity and infrastructure. But understanding the intrinsic value or earning power of cryptocurrencies puts them off limits for most investors. Bitcoin polarises opinion but even those who avoid it should not ignore its influence.

For disciples of Bitcoin it is typically an act of faith. It captures all the shiny new characteristics of the future, and seems to have unlimited potential. This goes beyond the usual behavioural finance lens of emotional and cognitive biases. Even agreement on the facts tends not to shift the thinking of the converted. It reminds us that behavioural theory often offers no useful answers; no tools to puncture beliefs other than big permanent losses. In the short term sharp price falls merely leave stranded holders determined to hold on for recovery.

Yet there is a sense in which crypto currencies are important and may indeed be the future of money. This is unlikely to be a volatile private currency with limited acceptability for transactions, hard to capture within the tax system. Instead, it is likely to give way to government controlled digital currencies that promise much tighter control of tax and transactions.

Apart from pulling the rug under some opaque leverage, Bitcoin’s demise might tell us something about the future of money. With China in the lead, it points to the plans that central banks themselves have for their own digital currencies. That might bring a big shake-up to the financial system. National digital currencies could go a long way to outlaw black-markets and tax evasion. And from there, it is but a short step to tighter regulation of what sort of financial activities are acceptable. That could not only extend government control of the economy, but reach into society itself. The concept of linking currency to social credit – a recognition of whether an individual’s behaviour aligns with society – might take the world very far from a traditional concept of the separation of money and morality.

Initially, Bitcoin’s fall from grace may represent a rapid reduction of wealth, which has hitherto both boosted consumption and equity markets. It may even give gold a chance to shine again as the alternative currency of choice, in a world where money printing debases currencies. Bubbles are rarely as narrowly defined as we think – there are often links between excesses.

A version of this article was published on Citywire on 25/05/2021.