Beware the bitcoin bubble

Investments in cryptocurrency have become part of a get-rich-quick scheme

In January 1637, the price of a rare tulip bulb on the futures market in Amsterdam was equal to 10 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.”

Bitcoin, the original cryptocurrency, was valued at 8 cents July 2010, $8,100 on Nov. 20, 2017, and $17,900 on Dec. 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 bitcoin and the long-term holders will loose some or all of their money. That would be regrettable. But like straightforward pump-and-dump market manipulations of a stock, some will win while others lose.

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 bitcoin and its ilk could follow dynamics similar to mortgage-backed 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.

Speculators now can leverage futures purchases of cryptocurrency at 15-1. This means a 7 percent drop in the price of bitcoin will wipe our your capital, returning us quickly to the momentous margin calls of 2007-08.

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 writes in Forbes: “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 a Fed or even a government bailout.”

The intent of those driving the explosion of cryptocurrency prices is not a desire to use cryptocurrency as a low-cost, reliable medium of exchange, but as a magic carpet to wealth. If you’d bought $100 worth of bitcoins in 2010, they would be worth $1.79 million as of Dec. 15, 2017. It is paradoxical that cryptocurrency, allegedly meant to free us from fiat currency, finds its liquidity and value in the almighty dollar.

There is much to recommend blockchain technology for its potential use as a reliable and low-cost means of trade whether is tied to cryptocurrency or not. For example, blockchain is being used in Brooklyn, N.Y., to test the sale of solar energy from local producers to local buyers, with the exchange medium in dollars not cryptocurrency.

Cryptocurrency and block chain could be an important tool for people who live unbanked and with little access to cash or liquidity of any kind. Cryptocurrency could become a reliable exchange medium and basis for a community controlled economy.

But by making cryptocurrency into an investment whose 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. 

The cryptocurrency 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 bit-coin and cryptocurrency bubble will not end well. 

Roy Morrison is the author of “Sustainability Sutra.”