Is Bitcoin the future of currency or is it a Ponzi scheme?
And describing the scene before the crash, the great American financier and philanthropist Bernard Baruch told of how: “Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish.”
So, when your personal trainer at the gym has started mining and marketing bitcoin, is that a sign that the market has got way ahead of itself?
That was the question one Johannesburg socialite was asking last week as the price of one bitcoin topped $11 000 for the first time in rollercoaster trading.
bitcoin is a “cryptocurrency” or virtual currency – a currency which is generated by its users, and is not backed by any central bank. It is one of several cryptocurrencies which have sprung up since 2008, when bitcoin was launched. They include Ethereum, which is bitcoin’s largest competitor and has also seen sharp price increases up and down.
Underlying them all is a technology called Blockchain, which is a giant, global, decentralised transparent database or ledger, which enables the digital transfer of money between two parties without an intermediary such as a bank.
And even if you could ignore bitcoin, says Sasfin’s David Shapiro, you have to take the underlying blockchain technology seriously. “Blockchain technology could change our lives,” he says. “A lot of products will be dominated and dictated by the technology, which could upset so many industries including the financial industry.”
The industry and its regulators are certainly starting to be upset by bitcoin’s wild ride. The currency’s value has increased almost 12-fold from about $1 000 at the beginning of this year to as high as $11 800 on Monday, though the price has fluctuated wildly. It’s been so volatile that some large global online trading platforms have imposed controls or higher fees on trading.
The surge has been driven in part by bitcoin becoming much more mainstream: it’s being traded on some of the world’s largest trading platforms and some traditional market players have launched futures contracts that enable investors to bet on bitcoin, even when they don’t own any. Understandably, many investors don’t want to miss out on the ride – and that’s fuelling demand for bitcoin even further.
It is, however, raising concern among regulators who fear the volatility could pose risks to financial stability – not to mention to investors who could lose their capital.
It’s being eyed warily too by authorities who are concerned about crimes such as money laundering or trafficking or hard pornography – the anonymity of cryptocurrencies make them the perfect payment system for the darker side of the web.
At the same time, however, it provides a safe haven for people around the world who don’t trust their governments, Bloomberg reported recently as the price of bitcoin in Zimbabwe spiked to double the international rate.
“It’s becoming the preferred way for residents of failing economies to transfer money without dealing with banks, protecting their savings from political turmoil and avoiding the local currency when its value declines due to inflation,” wrote Bloomberg reporter Rob Urban.
It has also provided a new way in which innovative tech companies can raise finance: the initial coin offering (ICO), as opposed to the initial public offering, which enables companies to raise capital from investors online using cryptocurrencies, and that has further fuelled the boom. For example, Israeli startup Bancor’s $153m ICO earlier this year, was one of the top 10 ICO’s globally.
In countries such as South Africa with strong well-regulated banks, robust capital markets and sound financial systems, however, are investors in bitcoin taking the risk that this is just another Ponzi scheme?
Says Shapiro: “It’s being talked up with no fundamental anchor. I have got nothing to value it against – other than that it’s going up.”
In his years of being a stockbroker, he has constantly been amazed at how gullible people are. And Shapiro is hardly alone in warning that this might be another bubble that could easily burst. Some of the world’s leading bankers have done so, with JP Morgan Chase CEO Jamie Dimon threatening in September to fire any trader foolish enough to bet on bitcoin and UBS Group CEO Axel Weber saying bitcoin had no intrinsic value because nothing backed it.
But ultimately nothing backs gold either, except the value investors place on it. “The value of any currency is largely a matter of faith,” Allan Gray equity analyst Jacques Plaut wrote in the fund manager’s recent quarterly commentary.
Plaut raises questions, however, about the speculation in bitcoin, which he describes as “electronic monopoly money”, is the making of a bubble, pointing out that the usual ways to value currencies – such as their price history or the quality and track record of the issuing central bank – can’t easily be applied to bitcoin. Bitcoin is currently the topic on which Allan Gray receives the most queries from clients.
Regulations do not allow most of its funds to hold bitcoin, Plaut writes. “But regulations aside, we are always looking for good ways to preserve capital and earn returns for clients. We do not think bitcoin is an instrument which will enable us to do this. Indeed, we see material risk of capital loss.”
None of that should necessarily prevent adventurous investors from taking a punt on bitcoin – but the health warning should be, as always, don’t bet the grocery money.