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Will the cryptocurrency bubble burst?

Will the cryptocurrency bubble burst?

It’s been an eventful few weeks for cryptocurrencies, and in particular Bitcoin. Last month, China – the world’s biggest Bitcoin market – announced a ban of cryptocurrency exchanges and initial coin offerings (ICOs), in which cryptocurrencies are used as a way of raising funds from the public. This announcement caused the value of Bitcoin to fall by 35%. While some countries, like South Korea, appear to be following China’s lead in banning ICOs, others, like Japan and Taiwan, are taking a different tack, and embracing cryptocurrencies. In a bid to boost its fintech sector, Japan has recently recognised Bitcoin as legal tender, and the Financial Services Agency has issued operating licences to 11 Bitcoin exchanges in the country.

Meanwhile, despite the fall brought about by China’s announcement, the value of Bitcoin continued to climb, reaching a peak of USD $6020. At the time of writing, 1 Bitcoin was worth USD $5506.

cryptocurrencies.pngThe value of Bitcoin in USD over the past 60 days. Source: blockchain.info

Some say that Bitcoin, and other cryptocurrencies like Ethereum, are going to crash. Others say that while, yes, cryptocurrencies are highly volatile, their prices are only going to continue to rise as more people adopt them. So who’s right?

The doomsayers

One of the most outspoken critics of Bitcoin would have to be JPMorgan Chase CEO Jamie Dimon. Calling it a “fraud”, Dimon compared the Bitcoin craze to the tulip bulb mania in the 17th century, saying, “It’s worse than tulip bulbs. It won’t end well. Someone is going to get killed.”

He also added he would “fire in a second” any JPMorgan trader he found trading in Bitcoin, because, and I quote, “It’s against our rules and it’s stupid.”

Kenneth Rogoff, professor of economics and public policy at Harvard University, and former chief economist of the IMF, also suggested caution, though in more restrained terms than Dimon, predicting in an article for The Guardian that though the technology would thrive, Bitcoin would collapse. He wrote, “[I]t is folly to think that Bitcoin will ever be allowed to supplant central-bank-issued money. It is one thing for governments to allow small anonymous transactions with virtual currencies; indeed, this would be desirable. But it is an entirely different matter for governments to allow large-scale anonymous payments, which would make it extremely difficult to collect taxes or counter criminal activity.”

Angela Walch, associate professor and research fellow at the Centre for Blockchain Technologies at University College London, said, “We’re in a cycle where prices have been driven up and now crypto hedge funds are driving them up higher. It’s a game, and it looks very much like a bubble. Of course, there’s no way of knowing when a bubble is going to pop, but that’s what it looks like.” She cited a fundamental lack of understanding of cryptocurrencies, coupled with people wanting to jump into investing so they don’t “miss out”, as potentially creating a “dangerous situation”.

“I’m worried we’re throwing money at things we don’t understand, we’re building complex structures we don’t understand, and acting as if we understand it or not caring if we understand it, and those types of decisions have proven very problematic in the past,” she says.

The believers

Despite the warnings, there are still many willing to take a chance on cryptocurrencies, with celebrities even getting in on the game. This year, hotel heiress and reality TV star Paris Hilton, boxer Floyd Mayweather, rapper Ghostface Killah, and actor Jamie Foxx have all promoted various cryptocurrency ventures, endorsing ICOs and cryptocurrency exchanges.

Venture capitalist and crypto investor David Siemer drew parallels between the current cryptocurrency market to the dotcom boom in 1995–6. Yes, the dotcom crash was still ahead – but so too was a landscape that allowed internet giants like Facebook, Google and Amazon to proliferate. “In 1995, the entire internet world was worth around $80bn. The entire cryptocurrency space right now is valued at around $170bn. In 1995, there were 24 million internet users, and there’s not even 20 million in crypto. The analog is almost perfect across every level.” Though, while he professed Bitcoin was likely not going to go anywhere, he did concede regulations by the US Securities and Exchange Commission was likely to put “a big dent in things”.

Robert C Wollcott, a professor at the Kellogg School of Management, Northwestern University, made similar claims, arguing that while cryptocurrency crashes were inevitable, this was in fact a good thing, saying, “The more troubles occur early, the more likely economic actors might climb steep cryptocurrency learning curves.”

Dominic Frisby, author of Bitcoin: the Future of Money?, says claims that blockchain technology will continue to be used, while Bitcoin will crash are specious. “[Y]ou can’t just shut Bitcoin down,” he wrote in an article for The Guardian. “It’s a decentralised, distributed network. That’s the whole point of its design. There is no central point of failure.” He concludes that Bitcoin is “here to stay, though I’d say it is unlikely to replace the primacy of the US dollar. Rather, we are headed into an age in which multiple currencies coexist, some private some public.”

Clem Chambers, CEO of private investors’ website ADVFN.com, argues that the trustless aspect of blockchain makes the eventual adoption of the technology unavoidable. In an article for Forbes, he writes: “[B]lockchain technology has huge potential to revolutionize economies by building a trustless infrastructure with transparency. This will disintermediate layers of inefficient gatekeepers whose rent-seeking behavior gums up the economies of the world with their unnecessary tollgates. Any economy using that technology will wield a massive economic advantage against luddites, so the outcome is economically inevitable. Luddites can’t win. Have they ever?”

The verdict about investing in Bitcoin or other cryptopcurrencies: Tread carefully

While it can be easy to get swept up in the ever-increasing value of Bitcoin and the promises of ICOs, the lack of investor protection and the unregulated nature of the market means people should proceed with caution, particularly when it comes to ICOs, which can have a high potential for fraud. “ICOs are very high-risk, speculative investments,” said the UK’s Financial Conduct Authority (FCA). “You should be conscious of the risks involved … and prepared to lose your entire stake.”

Many investors suggest a restrained approach when it comes to cryptocurrencies. “The general sensible view is that the more volatile the investment, the smaller proportion of your wealth you should consider storing in it,” says Marc Warne, founder of Bitcoin exchange Bittylicious. “I have heard of people moving their life investments into Bitcoin and this is a bad idea.”

Venture capitalist and co-founder of Union Square Ventures Fred Wilson voiced similar caution. Though he is an advocate of cryptocurrencies, he wrote on his blog that he was “certain the big crash will happen”, and urged investors to diversify their portfolios, recommending that people invest no more than 20% of their net worth in cryptocurrencies. “I know a lot of people who are true believers in crypto and have made fortunes in it,” he wrote. “They are ‘all in’ on crypto and have much of their net worth (all in some cases) invested in this sector. I worry about them and this post is aimed at them and others like them. It is fine to be a true believer and being all in on crypto has made them a lot of money. But preservation of capital is about diversification and I think and hope that they will take some money off the table, pay the taxes, and invest it elsewhere.”

If you’re keen to learn more about Bitcoin, cryptocurrencies and Blockchain make sure you register for CeBIT 2018. The program will soon be ready and will include world-class speakers on these topics. See you there.

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