Fintech on Friday: is bitcoin in a bubble?

When the man in the street starts talking about an investment craze, is it a sign to stay away?

The rise in the value of bitcoin, the crypto-currency based on blockchain technology, has been staggering. On Wednesday November 30 it reached an all time high of $11,434, that is a more than 12-fold rise for the year, over 1,100 per cent.   

Despite the fact that it appears volatility is likely to be a feature going forward – on the same day as reaching its peak, bitcoin also sank by as much as 21 per cent to $9,009 before rebounding – it is small wonder that people are starting to ask if this is an investment they just have to get in on.

The value of bitcoin is proportional to the size of the network, explains Charlie Morris, chief investment officer at Newscape Capital Group. “In that sense, it behaves just like a social media stock. The more people that use it, the more valuable it becomes.”

If an investor bought $100bn of gold, people would be jealous of their obscene wealth, he says, yet if that investor bought $100bn of bitcoin, they would be laughed at. “That's because the value isn't in bitcoin itself, but in the network that brings people together to exchange value. No network means no value, and a vast network means the opportunities are vast."

A number of clients have expressed real interest in investing in bitcoin and other crypto-currencies, reports David Storm, head of multi-asset portfolio strategy at RBC Wealth Management. “We have spent some time thinking about how to get it into portfolios. Is it an inflation hedge, is it an uncertainty hedge? Is it equity or simply a piece of software?”

Multi-family offices have been particularly interested, he says, as, in general, they tend to be early adopters of disruptive technologies. “They get presented with a lot of opportunities and their founders often tend to be entrepreneurs looking for interesting opportunities. It is part of their mindset.”

Investors tend to sit up and make enquiries when something they haven’t got exposure to starts to make a lot of money, says Guy Stephens, technical investment director at Rowan Dartington. “The temptation to get involved based solely on past performance is very strong despite understanding very little about it. This has been a common feature with all historic bubbles, all of which ended in disaster, although some investors made a fortune along the way.”

On the one hand it is easy to dismiss crypto-currencies as a passing fad, he says, but look at all of those people who wrote off the internet before Amazon was born. But it is also very easy to get “consumed by greed” and try to climb aboard the bandwagon in the hope of making a quick buck.

Bitcoin is a virtual currency, a little like gold, where intermediaries play a very limited role and central banks and governments none at all, says Mr Stephens. The fact that banks and governments are bypassed is probably the single biggest reason why it is unlikely to succeed, he explains.

“At the moment, any transactions involving a crypto-currency cannot be monitored and completely bypass any regulations or security and exclude banks.”

With the authorities increasing occupied with preventing money laundering and tackling cybercrime, vast swathes of regulation are being enacted in the coming months. Crypto-currencies such as bitcoin cut straight through all this regulation and control, which is why they have proved popular with illicit trades such as drug trafficking. “It is possible it could become outlawed by the authorities,” he says.

“The golden rule of investment is to understand what you are buying,” cautions Mr Stephens. “We cannot currently sufficiently analyse crypto-currencies and the underlying technology to an acceptable level and will only seriously consider it when we can or when it falls within a regulated environment.”

The rapid rise in bitcoin’s value seems to show all the classic signs of a bubble, says Kevin Gardiner, global investment strategist at Rothschild Wealth Management, and the firm does not recommend any crypto-currency as an investment.

“Of course, prices could rise a lot further, in which case we’ll look too cautious, but

they might collapse,” he warns. “They carry no interest – not that bank deposits do at the moment, but they will again at some stage – and unlike gold, they are not attractively shiny or immune to social collapse and/or nuclear holocaust. The only attraction that we can see is that prices have been going up – a classic bubble-like reason for getting involved.”

But whatever happens to the value of bitcoin, the technology behind it may well transform financial markets, says Mr Gardiner. But although the investment case here may be stronger, it is more difficult to act upon.

“No one knows who the winning suppliers will be. As with other waves of innovation – from printing, through transportation, to the internet – the safest way to invest may be to back the business users whose costs will be cut, not the would-be producers.”

Speculating on crypto-currencies is not something that appeals, says Peter Wilson, managing director of HarbourVest Partners and director of HarbourVest Global Private Equity, although the firm does have exposure to blockchain, the technology which underpins them.

The notion that there will be a medium of exchange other than cash that can be more efficiently mediated between buyer and seller is attractive, he says. “The idea that rather than wiring money and having it sit in a bank overnight incurring friction costs, that theme is one I hope we will benefit from.”