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How to prepare for the bitcoin crash

Bitcoin is in a bubble like any other. And when that bubble bursts, says Matthew Lynn, the pain is sure to be felt far and wide.

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We will soon rediscover the allure of gold

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Every bull market has at least one asset that goes crazy. Last time around it was property, and before that it was dotcom stocks. This time, it is bitcoin and the host of digital currencies that have been launched in its wake. Like most investment crazes, there is a basically good idea underneath all the hype. In an increasingly digital global economy, it makes sense to have a global digital money to trade in. But that doesn't mean it's worth a fortune indeed, one of the features of a functioning currency is that its value remains fairly stable.

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Digital money has turned from a concept with potential into a bubble. Last weekend the value of a bitcoin went past $9,000, and will probably be well into five figures by the time you read this. Some of its rivals have been shooting up even faster. The total value of cryptocurrencies is now above $300bn. Any asset that has risen tenfold in a year clearly has a touch of irrational exuberance about it, and anyone who thinks otherwise needs to re-read some financial history.

Anyone who was lucky enough to own some bitcoins has hopefully sold most of them by now. The rest of us are surely avoiding the bubble by steering well clear of them all and investing in safe assets instead. Yet that is unlikely to be enough. A crash affects everyone.It didn't matter whether you had a sub-prime mortgage: the financial collapse of 2008/2009 hurt people who had nothing riskier than some cash in a building society.

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Everyone felt the consequences of the dotcom crash, regardless of whether they had invested in any flaky internet start-ups or not. Likewise, a crypto crash will ripple out everywhere. All the venture-capital money that has been pouring into cryptocurrency start-ups may well be wiped out.

Those losses are bound to show up somewhere. Every cryptocurrency is a form of money, and we know from 2008 what happens when part of the financial system starts to wobble. Losses start turning up in all kinds of unexpected places. And those losses easily trigger a wider wave of selling. When a few ridiculously overvalued dotcom start-ups started to slump in 2000 it was only the beginning of a wider bear market.

When the wider sell-off starts, it is bound to be both sudden and ugly. So what can investors do? There are a few obvious precautions. Investors should steer well clear of cryptos themselves. But that is not likely to be enough if a collapse in digital money is just the start of a wider downturn. They should also avoid sectors most likely to be hit by the crash. Such as? Financials will be in trouble. The major banks are likely to be the counterparties to any contracts struck in bitcoin and it rivals.

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They may well have loans outstanding that will be wiped out after all, if a hedge fund borrows money then who knows what it might be speculating in? On top of that, the financial giants have been investing in lots of digital-currency start-ups. That money will have to be written off fast. But it is not just the banks. A lot of the tech firms have been caught up in the feeding frenzy. They will suffer as well and since many of them are starting on sky-high valuations, the falls could be substantial. If the whole market falls, those two sectors will be hardest hit.

Against that, a few assets will do well. Old-style analogue cash will be one of the biggest winners. It won't go up in value it doesn't do that but it will hold its own. Gold will be the biggest winner. Not only does it always do well in a crisis, but there has been a lot of talk about bitcoin replacing it as a store of value. When the cryptos crash, everyone will be scurrying back to its metal alternative. Expect some safe-haven currencies to look good as well Swiss francs, for example, will be stronger than ever.

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