UBS: Are cryptocurrencies a bubble?
Mark Haefele, Chief Investment Officer Global Wealth Management
Recently, the UK’s financial regulator, the Financial Conduct Authority, warned that cryptocurrency investors should be prepared to accept total loss. With the weekly volatility in Bitcoin exceeding that of the annual volatility in stocks, we think inves- tors looking to protect and grow their wealth over the long term should maintain discipline and exercise extreme caution on cryptocurrency speculation. Read more in our recent publication on Bitcoin.
Given the absence of cash flows or widespread use cases for cryptocurrencies, valu- ing these assets in a traditional way is challenging. Indeed, one could view crypto- currencies as an effective “forward purchase” (one of the hallmarks of a bubble) on future use cases being developed. Yet whatever these uses might be, it would seem improbable that they could have changed so dramatically as to drive a fourfold increase in price in just three months.
Publicly available data from blockchain.com, the world’s leading Bitcoin wallet pro- vider, shows 1 million new wallets were created in the past three months, as many as were created in the prior year, meaning that new users appear to have been attracted by rising prices. It also shows a significant increase in the number of addresses used (roughly equivalent to daily users), likely indicative of an increase in speculative trading activity. While still in its infancy, the open interest in the Bitcoin futures market has also increased more than threefold since October. All this, and with 95% of coins held by just 2.5% of addresses (note that one user can also have multiple addresses), the potential for price “squeezes” should also be evident.
Of course, finding signs of speculation and timing a collapse are different things. In the past, regulatory fears have contributed to declines in cryptocurrency prices. Prices have also fallen sharply without an obvious catalyst (for example, the 69%
drop following the December 2017 bubble). But the history of bubbles should teach us that they can also inflate further and for longer than seems plausible. Changes
in the way assets are perceived can also mean that bubbles may never fully deflate, and this could hold true for cryptocurrencies, too. Remember that gold has been described as the world’s oldest bubble.
That said, with prices currently likely being driven more by speculation than funda- mentals, investors looking to protect and grow their wealth should exercise extreme caution.
