Yves here. This post focuses on why bitcoin has gone from being a mere speculative mania to a potential risk to the economy. Futures contracts make is possible to engaged in levered speculation. The booms and busts that have had destructive real economy effects have involved borrowed funds, because the collapse blows back to lenders, who almost without exception have intertwined relationships with other lenders and/or the payments system.
Note that the exchanges have set pretty high margin requirements for bitcoin. From the CME’s website:
As of December 12, and subject to change, the Maintenance Margin for the BTC future is 43%, where the Initial Margin for Hedger is 100% of the maintenance margin and the initial Margin for Speculator is 110% of that number.. Margin offsets with other CME products will not be offered initially. Additionally, FCMs may require a margin level beyond CME Clearing’s minimum requirement.
However, some speculators are already working with borrowed funds, albeit not with the short fuses of margin accounts. Any leverage with an “investment” this volatile is playing with fire.
In a longer-form treatment, banking expert (and diehard libertarian) Chris Whalen decries bitcoin as a financial fraud in the American Conservative:
Stripped down to its basic elements, bitcoin is a classical fraud, a form of high-tech gaming that has captured the imagination of millions of greedy and gullible people around the globe. Participants exchange a legal tender dollar or some other real asset, for example, for a share of the limited supply of bitcoins at whatever the current price may be at the time. The participants exchange something for nothing – namely bitcoin, which have no intrinsic value or yield, but which trade over the world of ethernet, outside of the regulated world of banks and financial payments…the remarkable thing is that much of the effusive praise for bitcoin that is heard from participants is self-generated flimflam…
Sad to say, there is little likelihood of bitcoin displacing any of the existing fiat currencies sponsored by governments. First and foremost, the cost of solving the ever-lengthening blocks of cryptographic transactions is prohibitive. The total electricity consumed today by the bitcoin “miners” who validate the transactions (and thereby earn a 25 bitcoin reward) already exceeds the total power consumption of small nations.
The same technology that makes bitcoin secure as a means of exchange also makes it hideously inefficient compared to other payment technologies. But the more serious objection to bitcoin is that it enables criminals and terrorist organizations to move value around the world out of sight of national governments and law enforcement. Some nations that have already banned bitcoin include China, India, Sweden and Vietnam. So far none of the Anglo nations have been willing to prohibit this overt act of criminality – at least not yet.
“At the first serious (and likely coordinated) move by governments to regulate or bank the digital currency, bitcoin’s price will crash to zero,” writes Lawrence Baxter in The Wall Street Journal. “Panicked owners will rush to exit and the bubble will burst. Bitcoin futures and options may just as well be based on pixies and fairies. Nothing will be able to save them. Speculators will depart for the next lunacy, leaving behind the greater fools to wonder where their supposed wealth went and demand that government do something about it.”
The price of a rare tulip bulb on the futures market in Amsterdam in January 1637 was equal to ten times the annual wage for a skilled crafts worker. A single bulb was reportedly exchanged for 1,000 pounds of cheese at the height of tulip mania. The market collapsed precipitously starting in February 1637, bottoming out in May 1637.
According to Economist Brian Dowd, “By the height of the tulip and bulb craze in 1637, everyone.. rich and poor, aristocrats and plebes, even children had joined the party. Much of the trading was being done in bar rooms where alcohol was obviously involved…bulbs could change hands upwards of 10 times in one day. Prices skyrocketed… in 1637, increasing 1,100% in a month.”
Bit coin, the original crypto-currency, was valued at $.08 in July 2010; $8100 on November 20, 2017, and $17,900 on December 15, 2017. The sky is apparently the limit.
The danger of course,is not just that at some point, the bigger fools, the last purchasers of bit coin and the long term holders (“hodlers” in crypto-speak) will loose some or all of their money. That would be regrettable. But like straight forward pump and dump market manipulations of a stock some will win while others loose.
But, as in 2007 and 2008, the creative greed behind global financialization is creating not just a bubble in bitcoin and many other crypto-currencies as investors , as in Holland in 1637, pile into markets as buyers. There is a real and, I believe, rapidly emerging threat that bit coin and its ilk could follow dynamics similar to mortgage back securities as the basis for highly leveraged and complex financial instruments, like credit default swaps that were traded in unlimited volumes with no limits based on the actual number of mortgages.
Cyrpto-currency has now entered the leveraged futures market, creating the potential for to the momentous margin calls of the 1987 crash and the cross-market selling of 2007-2008. And there is no limit to the number of futures contracts. Derivative instruments of more complexity and undefined risks are almost certain to swiftly appear as they did in 2007 when,for example, insurance giant AIG took enormous bets to earn premium on credit default swaps on mortgage backed securities. After all were, these were AAA rated… The sudden collapse of mortgage backed securities led to a liquidity crisis. The securities could not be sold for almost any price and the giant financial institutions on wrong side of the bets were suddenly bankrupt.
As Frances Coppola in Forbes points out, “As more and more financial institutions with connections to the real economy pile into the cryptocurrency mania, the chances of a similar disastrous collapse rise ever higher, and along with it, the likelihood of Fed or even a government bailout.”
The intent of those driving the explosion of crypto-currency prices is not a desire use crypto-currency as a low cost, reliable medium of exchange verified by a transparent block-chain, but as a magic carpet to wealth. If you’d bought $100 worth of bit coins in 2010, they would be worth $1.79 million as of Dec. 15. 2017. It is paradoxical that crypto-currency, allegedly meant to free us from fiat currency, finds its liquidity and value in the all mighty dollar.
There is much to recommend block-chain for its potential use as a reliable and low-cost means of trade whether is is tied to crypto-currency or not. For example, bock chain is being used in Brooklyn, NY to test sale of solar energy from local producers to local buyers, with the exchange medium in dollars not crypto-currency.
The Media Lab at MIT is working on designing crypto-currency projects that could facilitate, for example, trades and transaction by the global poor purchasing and selling locally produced community renewable energy. Crypto-currency and block chain could be an important tool for people not just beyond power lines, but who live unbanked and with little access to cash or liquidity of any kind. Crypto-currency could become a reliable exchange medium and basis for a community controlled economy.
Bitcoin is also seeing the transaction costs for bitcoin transaction soar rising to $20 charged by block-chain “miners” whose computers verify transaction and at the same time create more blocks and produce more bit coins as part of the solution of the algorithm that verifies transactions. Far from being a means for vey quick cheap, anonymous financial transactions, bit coin is becoming slow and expensive to use. A newer generation of crypto-currencies like IOTA offers an improved block-chain with zero transaction costs and faster transaction all the better to attract investors.
Crypto-currencies could represent a tool for self-management and community economies, a way to use the internet to help challenge the growing netocracy of the Googles, Facebooks, Twitters, Amazons, Ali Babas and their ilk. But by making crypto-currency into an investment who use is part of a get rich quick scheme as opposed to a free instrument of exchange and trade it has become just another arrow in the quiver of making the rich richer and worsening the already grotesque distribution of income. Crypto-currency speculation will make some people rich, as does day trading and house flipping, where many more will loose then win.
I suppose the original sin of crypto-currency was to allow its purchase in dollars, and not, for example, in services provided by one to another based on labor time and materials. But the crypto-currency model is based on a limited quantity that makes it resistant to inflation, but enshrines scarcity and therefore value and the siren calls of greed and desire as it does for scarce commodities like cocaine or diamonds or gold.
The bitcoin and crypto-currency bubble will not end well.