Bitcoin continued its staccato march skywards on Wednesday, with prices achieving fresh all-time highs above $12,600. At the moment the momentum traders are further fuelling the bubble with speculative longs but this could be about to change.
What’s driving Bitcoin prices higher?
Casting around for causes for these fresh gains, you have to look at the imminent launch of Bitcoin futures as the most important catalyst. CBOE goes live on Dec 10th, while CME follows on Dec 18th. The thinking is that these will attract further investor interest and inflows of capital, giving this bubble new oxygen and an early Christmas present for speculators.
In addition, we have seen several institutions warming to cryptocurrencies which has helped prices rise. JPMorgan’s volte face, saying it could be the new gold, is a factor in what seems to be a growing trend to legitimise cryptos.
But futures are not entirely positive for the bulls – in fact they may spark a significant repricing as they will make it significantly easier for bears to go short. When the only way to short is to sell your bitcoin and effectively exit the market, there is a clear bullish bias as owners (enthusiasts and speculators – both of whom want prices to go up regardless) cling on as long as prices keep rising. The ability to go short creates a new dynamic in the market and should create a better functioning market.
But once you bring Bitcoin into the mainstream, investors (both bulls and bears) and regulators will demand it to behave like other asset classes or at least be able to co-exist in the same ecosystem as other assets. By introducing futures contracts – and potentially ETFs as a result – you try to make Bitcoin more like any other asset and price discovery becomes a lot less opaque, i.e. people will see just how badly priced it is. At the moment it’s dominated by enthusiasts and speculators who want the price to go up. Once you get enough shorts and enough people taking the other side of the bet, there will have to be a significant repricing that pops the bubble. Because of greater scrutiny and because Bitcoin cannot live up to the expectations that the current pricing (speculative driven) imply, it will not be able to sustain the price gains and there could be a shock for the bulls.
Suggestions that it could be the new gold seem fanciful given the supply of new cryptos is limitless. Meanwhile there will be at some point a regulatory crunch for Bitcoin and the development of regulated derivatives only accelerates by bringing it into the mainstream. Once you start hammering Bitcoin exchanges with AML, KYC and all the other regulation, the appeal of cryptos as an off-grid currency significantly diminishes.
More broadly, the US government in particular exerts huge control over not just global financial markets but wields power in wider diplomatic, economic and military terms by controlling the supply of US dollars and the financial networks. It is not about to relinquish this to a handful of unidentified crypto enthusiasts, unless it’s got a sizeable stake in Bitcoin itself.
For now Bitcoin remains in a bubble and there could be a further squeeze higher as we approach the launch of the futures contracts by CBOE and CME. It’s hard to say precisely where we are in the curve, but the shape of the chart is parabolic and heading vertical – these things don’t last and the advent of regulated derivatives may be the thing that pricks the bubble.
The rapid rise in prices is indicative of a speculative bubble because of the reasons people are buying. The chief reason people are buying Bitcoin is because they expect it to rise in value. It’s almost entirely speculative.
We’re in a cycle where the more prices rise the more people think prices will rise in the future – this is a dangerous situation that signifies an unsustainable bubble. But to be clear, prices could go up a lot more before it all unravels.
All speculative bubbles take the same pattern – first the displacement resulting from a disruptive force in the market (in this case the blockchain technology, which is revolutionary). In the last great bubble the displacement was the rapid fall in US interest rates that fuelled the housing boom that led to the subprime crisis and global recession. Then we have the boom when the smart money moves, which is followed by the euphoria phase as everyone rushes to get in on the action for fear of missing out. This is when the ‘greater fool theory’, which states that an asset has as much value as what the next person is prepared to pay for it, is most evident and prices soar. After this we get profit taking as the smart money moves out and then, finally, the panic. For investors who are interested in Bitcoin, the judgment they need to really make is whether we have yet reached the euphoric stage or are still in the boom phase. The other question is when to get out before panic sets in.
If Bitcoin is just a method of exchange – a currency – then it’s impossible to justify this rise in prices given that the supply of new cryptocurrencies (there are already more than 1,000) is infinite. New technology can displace existing cryptocurrencies and it must be stressed how energy inefficient the mining process is.
If you want to see it as an investment, there are just too many hurdles and it cannot be sustained. There is no yield or dividend, so holding Bitcoin becomes a cost (opportunity cost) to the person who owns it – they could be earnings interest on a government bond, or dividends from stocks, for example.