Bitcoin: a mania that can only end in disaster

Bitcoin is a classic bubble and it’s about to pop, says financial historian Edward Chancellor.


Bitcoin is a classic bubble and it's about to pop,says financial historian Edward Chancellor.

Bubbles aren't just about the madness of crowds, or excess liquidity and leverage. Every major bubble involves a premonition of the future. The trouble is that they turn out to be deeply flawed premonitions. The acting head of New Zealand's central bank, Grant Spencer, is right to say that bitcoin resembles a "classic" bubble.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

First, there's the exponential price explosion the South Sea Company stock soared ten-fold in 1720; bitcoin soared 20-fold this year. Great bubbles draw speculators from far and wide. At the high point of France's Mississippi Bubble, also of 1720, up to half a million foreigners are said to have flocked to Paris. Coinbase, which provides bitcoin wallets, now boasts 12 million accounts a threefold increase in a year.

All great bubbles form during periods of easy money, with interest rates low or falling and liquidity super-abundant. The Dutch tulip mania of the 1630s came amid vast capital inflows, falling interest rates and money printing by Amsterdam's Wisselbank, Europe's first central bank. At the start of 2017, the world's largest central banks were expanding their balance sheets as never before. Some $11trn-worth of bonds globally currently offer negative yields. The US stockmarket is more expensive than at any time save for the dotcom peak in early 2000. This leaves savers with an uncomfortable dilemma: speculate or starve.

Advertisement - Article continues below

A perfect vehicle for speculation

The supreme object of speculation is one which generates no yield and is thus impossible to value think tulip bulbs, gold in the late 1970s, or contemporary art in recent years. Bitcoin produces no income; new supply is restricted; and ownership is relatively concentrated (some 95% of outstanding coins are held in just 4% of accounts), providing a very small free float. It may be the ideal speculative asset. Throw in leverage, open a futures market, and there's no limit to bitcoin's potential upside.

The word "speculator" derives from the Latin for a "look out". The financial variety looks out into the future, and backs this vision with money. Great bubbles are often uncannily accurate premonitions of the future. Tulip mania anticipated the evolution of Holland's flower industry. Britain's railway mania of the 1840s reflected the potential of the new transportation technology. The dotcom bubble foresaw how the internet would change our lives.John Law's Mississippi Bubble looks most relevant to what is going on today in cryptocurrencies.

Law (pictured above) believed that money needn't be backed by any commodity. He established a bank, the Banque Gnrale, which issued paper currency and demonetised gold. Law used these bank notes to support the share price of his Mississippi Company and to cut the rate of interest the world's first quantitative-easing experiment.

His vision was prescient. We now live in his world of paper credit and central-bank money. But it was also deeply flawed. Law tried to achieve, in just a few years, what would in fact take two and a half centuries to accomplish only in 1971 was the link between currencies and gold finally severed, with the collapse of the Bretton Woods currency accord.

By contrast, confidence in what Law called his "system" soon collapsed and Mississippi's share price fell by 90%. Law, who once boasted of being the world's richest man, died in penury in Venice. Speculators in all the other great manias have also learned that, in investment, to be early is to be wrong.

Bitcoin is not the future

Cryptocurrencies aim to cure today's monetary problems a lack of confidence in central-bank money with a new technology, the "distributed ledger" or blockchain. Bitcoin believers say this will "change the world". Perhaps they will be correct in the very long run. But if that time comes, bitcoin won't be a contender. Transactions are too expensive, energy intensive and can take days to settle. Reports suggest that the verification process has become centralised in the hands of an unregulated cartel of Chinese miners. Amazon won't take payment in bitcoin. The US government won't accept it as payment of taxes. Bitcoin, for practical purposes, is going nowhere, except in the markets where it's been heading vertically upwards.

Advertisement - Article continues below

Super-parabolic price movements often contain their own premonition that the end is nigh for the mania. When the tulip boom ended, the price of Gouda bulbs fell from 60 guilders to 10 cents, a drop of 99.9%. Bitcoin has soared higher and has less intrinsic value. A similar decline is possible.

A version of this article was first published on Breakingviews. Edward Chancellor is a financial historian, journalist and investment strategist.




The currencies to bet on this year

The US dollar could be set to weaken this year, while the euro, Canadian dollar and the Swiss franc could be good bets for optimistic traders.
17 Jan 2020

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019

Bitcoin has just crashed hard – where will it go next?

The bitcoin price has taken a beating, down by 15% in one day. Dominic Frisby looks at what’s behind the crash, and where the cryptocurrency might go …
25 Sep 2019
Spread betting

Another bubble in bitcoin for traders to short

This surge in the bitcoin price seems no more likely to endure than the last one, says Matthew Partridge.
16 Jul 2019

Most Popular

Stocks and shares

Do you own shares in Sirius Minerals? Here’s what you need to do now

Mining giant Anglo American has proposed a cash takeover of Yorkshire-based minnow Sirius Minerals. Unhappy shareholders must decide whether to accept…
20 Feb 2020

Gold is at its highest level in years – here’s how to invest

Gold's rise at a time when the dollar is unnervingly strong isn't unheard of – but it is curious. John Stepek explains what's going on, and what it me…
21 Feb 2020
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
21 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019