Will bitcoin surge end like the 17th century Dutch tulip bubble?

JP Morgan boss Jamie Dimon, the longest-serving chief executive on Wall Street, may have toned down his views of bitcoin since he declared in 2017 that it was a "fraud" and that he would fire any of his employees caught trading the digital currency.

He made it clear at a conference in New York in late November that it is still “not my cup of tea”, even if he conceded that “very smart people” are buying into the cryptocurrency.

That hasn’t stopped investment strategists in his own bank putting out a note to clients this week, suggesting that the cryptocurrency – which surged past the $40,000 (€32,652) mark this week for the first time after doubling in value in less than a month – may ultimately reach $146,000 over the long term, looking beyond the “speculative mania” currently driving the “asset”.

This would put the value of all bitcoins in existence on a par with the $2.7 trillion of “private gold” in the world, excluding the level of the precious metal held by central banks.

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Origins

Set up in 2009 by an as-yet unidentified person using the alias of Satoshi Nakamoto, bitcoin gained traction in a post-crash world where faith in cash had plummeted.

The whole concept, after all, was about cutting out central banks, which can control exchange rates to a large extent by creating a finite 21 million units of the currency. Currently about 18 million bitcoins are in existence.

A bitcoin can be divided out to eight decimal places, so 0.00000001 is the smallest amount that can be handled in a transaction. Unlike regular currencies, which are centralised and guaranteed by central banks that control their supply and where valuations are influenced by economic and monetary policy dynamics, bitcoin is run by a decentralised network of computers around the world that keep track of all bitcoin transactions.

The record of all bitcoin transactions is constantly being updated on an open public file – or ledger – known as blockchain, making it much faster than traditional bank clearing systems.

It’s a bit like Wikipedia, the online encyclopedia, which is maintained by a decentralised network of writers and editors around the world.

While the extent to which companies accept bitcoins as payment for goods or services remains limited, that hasn’t stopped it and other cryptocurrencies from becoming a new new tradeable asset class.

While small-time investors tend buy to digital currency on US-based exchanges like Coinbase, Kracken or Bittrex, or even through fintech companies like Revolut, big investment houses prefer to invest through funds such Greyscale Bitcoin Trust, which holds about 3 per cent of the total supply of bitcoins.

‘Alternative’ currency

The recent jump in the price of bitcoin is the third big surge in its history, having seen similarly impressive percentage gains in 2013 and 2017 – fuelling speculation that it could ultimately replace gold as a store of value and inflation hedge.

A survey carried out last month by international financial advisory group, DeVere, showed that over two-thirds of the company’s millennial clients globally felt bitcoin was preferable to gold as a safe-haven asset.

“There is little doubt that this competition with gold as an ‘alternative’ currency will continue over the coming years, given that millennials will become over time a more important component of the investor universe and given their preference for ‘digital gold’ over traditional gold,” said the JP Morgan strategists.

Have they forgotten the 70 per cent slump in its value in 2018 after the 2017 advance? There’s no getting around the fact that bitcoin has been an exceptionally volatile “asset” throughout its 12-year life so far.

And while gold, like bitcoin, doesn’t produce an income for investors along the lines of interest, dividends or rent, it has had fundamental uses for millenniums. (The first gold coins were minted in 643 BC in Lydia, present-day Turkey.)

Although initial proponents of bitcoin saw it a as way of setting up a currency outside of the control of central banks, its 400 per cent price surge in the past 12 months has, ironically, been fuelled by the amount of money central banks have pumped into the financial system to help it deal with the Covid-19 crisis.

Will it end in tears for investors? Who knows for sure. But bitcoin’s recent violent surge is certainly worrying many.

Bank of America analysts warned on Friday that the world's popular cryptocurrency "blows the doors off prior bubbles", such as the dotcom boom and gold in the 1970s. Others are pointing further back, to the Dutch tulip mania in the 17th century that ended in tears.

Still, there’s little doubt that the actual blockchain technology used for bitcoin is here to stay, and will be used increasingly to move money around the world more quickly and cheaply. Dimon’s own bank launched a digital currency based on blockchain last year, though unlike cryptocurrencies, it maintains a value equal to the US dollar.

Meanwhile, central banks, who have spent most of the past decade looking at digital with suspicion, are wary of being left behind, especially as Covid-19 has boosted electronic payments.

The European Central Bank (ECB) launched a consultation paper last October on creating a "digital euro" that would be an electronic version of the single currency.

Such a currency would allow individuals to place deposits directly with the ECB and accounted for in “digital wallets” outside the banking system. This, of course, raises all kinds of questions of how banks would fund themselves in future – particularly during times of financial crisis.