We’ll all get burned by bitcoin

Over the last 12 months, bitcoin, the digital currency, has been on an extraordinary surge. Last week, it broke through the $4,500 barrier for the first time. Since the start of this year, it has more than quadrupled in price, rising from $1,000 a coin to more than four times that. Over a 12-month period, it has risen almost eight-fold. There appears to be no stopping it right now. It would be no great surprise to anyone if it hit $8,000 by the end of the year, and $10,000 soon afterwards.

Bitcoin is fast establishing itself as mainstream. You can buy and sell just about anything you want with bitcoin. So it makes sense they should be rising in price. But hold on. An 800% rise in the space of a year? Quadrupling in value in a little over six months?

An 87% gain in single month? That is not a normal rise in the price of an asset. It is a wild, speculative bubble, and we have a couple of hundred years of financial history to tell us how those usually end. This matters, and not just to the relatively few people who actually own some bitcoins. Here are three reasons why.

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First, like any speculative mania, it will lead to manic over-investment. If you have some spare time on your hands, and know your way around a PowerPoint presentation, then you should be putting together a pitch for a crypto-currency start-up. A half-plausible idea, and you should be able to trouser a seven- or eight-figure round of venture-capital money by the end of the week.

Capital is pouring into new currencies at an accelerating rate. We saw something similar in the dotcom bubble, and in every other investment boom before that. A huge amount of capital that could have been better deployed elsewhere will be wasted in the process and we will all be worse off for that.

Second, the boom tells us that manias are back. We already knew that we were well into an exceptionally long bull market. In any long upwards run in prices, there is always one asset that goes crazy, and ends up becoming a signal that the whole market had become wildly over-exuberant. It was sub-prime mortgages last time around.

Before that, it was internet stocks, and if you go back even further it was radio or railway stocks. Everyone piles in and the price explodes. But when you look back a few years later, it is clear that it was the price of that asset that was telling us that the whole market had become unhinged from reality, and was about to collapse.

Finally, a crypto-currency is exactly what it says it is. A form of money. True, it is not huge in terms of value yet. All the bitcoins in the world still only add up to about $50bn (or possibly $60bn by the time you are reading this). That is a lot less than GlaxoSmithKline is worth, to take just one example. In terms of the size of the global capital markets, it hardly even registers.

Apple has a market value of more than $800bn. All the gold in the world has a combined value of an estimated $8.2trn. The US bond market is worth $31trn. The digital currency does not get anywhere close to any of those.

Even so, it is still a form of money, and, day by day, it is being integrated into the financial universe. As we learned in 2008 and 2009, once one part of the monetary system starts to wobble, then the whole edifice can suddenly look very shaky.

We don't really know what contracts have been linked to cryptocurrencies, what derivatives have been hitched to them, or how deeply they have been embedded into the financial system. One thing is for sure, though. In a crash, we would find out very quickly and the losses might ripple out in unexpected ways.