Are cryptocurrencies the next step in a long history of speculative bubbles?


As the price of bitcoin fell below its 200-day moving average – known as the ‘death cross’ pattern – pessimists remembered the mania for tulips, railroads and technology. Dot-com years gone by and watched as crypto entered the annals of burst bubbles.

According to a recent survey by the UK’s Financial Conduct Authority (FCA), the ownership and value of median crypto holdings by UK consumers both increased by around 50% between March 2019 and March 2021.

What is more concerning, however, is that as more and more people get involved in investing in crypto, those who invest in 2021 are less likely to understand how the products work and nearly half of the Users weren’t clear about the benefits of stablecoins, FCA research revealed.

In addition, the high volatility of the asset class means that 29% of crypto investors check their balances every day, up from 13% in 2020, while the proportion who saw crypto investing as ‘a bet’ has fallen to 38. %, compared to 47% a year earlier. .

Responding to the findings, Rick Eling, chief investment officer at Quilter Financial Planning, said: “The fact that participation in cryptocurrencies is up but understanding is down paints a troubling picture. Rather than people seeing crypto as a bet, research suggests they see it as an investment.

“As responsible investors, we fear for the safety of the majority, for the inexperienced and for those whose investment expertise does not extend beyond an Instagram post that makes you feel like easy money. exist.”

Eling’s reaction mirrors that of many long-term, value-conscious investors, who not only favor assets that offer consistent returns over decades, but are also wary of fads that have cost speculators dearly over the centuries.

The taste of shiny things

Unfortunately, several behavioral parallels can be drawn between the most recent crypto boom and many good times for learning about history, which are the result of a hunger for speculation outweighing reason.

First, the Power of Fear of Missing Out (FOMO) exemplified during the South Sea Company (SSC) bubble of 1720. Formed in 1711 to convert £ 10million of British public debt into its own stock, the SSC agreed to take over the entire British national debt in 1720.

Speculators then bet on the success of the conversion plan and the company issued several overvalued stock placements, which then encouraged other stock companies to form with the aim of selling enrichment programs to investors. modest.

Despite securing the passage of the Bubble Act by the British government to prevent the formation of these other companies in June 1720, the SSC suffered as foreign lenders led a race for investors in August, British domestic credit became overstretched and its program collapsed, causing SSC shares to fall 75% in four weeks as £ 2million was confiscated from company directors.

Suffering because of this, renowned mathematician and scientist Sir Isaac Newton, who made a 100% profit on his initial £ 7,000 investment in SSC, only to return later in 1720 and lose £ 20,000 – or 3 million pounds sterling in today’s money – according to commentary by Jason Zweig in the fourth edition of “The Intelligent Investor” by Benjamin Graham.

Speaking about collective speculation on SSC stocks, Newton said in 1720: “[I] could calculate the movements of celestial bodies, but not the madness of people.

This collective FOMO can certainly be seen in the growth of bitcoin’s market capitalization. Even after the valuation cap hit in April, the crypto market cap hit a record $ 2.5 billion on May 12, down from $ 235 billion a year earlier.

Another lesson to be learned is the greed that drives investors to gamble more than they can afford to lose.

This was seen during the Holland ‘tulip mania’ speculation of the 1630s, where the popularity of the flower became so widespread that families of all classes began to speculate on tulip bulbs in the hope of getting their hands on one of the most coveted variegations by collectors.

This peaked between 1636, when people began to mortgage their homes, trade in large sums of livestock and crops, and sell heirlooms in order to finance bulb purchases during the flowering of the following year. .

Then, in early 1637, as the bulbs approached flowering, the tulip market collapsed. Those who had committed property they could not afford to lose were mostly given worthless bulbs and even after government intervention in 1638, tulip contracts could be canceled for as little as 3.5%. of the agreed price.

While in the microcosm, a similar dynamic has occurred in some bitcoin investment, with market cap growth data showing about half of the investment since its price surpassed $ 35,000, while 14% of investors borrowed money to finance their purchase, according to Laith Khalaf, financial analyst at AJ Bell.

Finally, hopes for future glory have seen industry valuations swell into unsustainable bubbles with no support offered by short-term earnings.

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Comparing the recent surge by crypto investors to the pre-Golden Age ‘railroad mania’ of the United States, Eling said, “Speculators have been drawn to risky assets based on the fact that “railways will change the world”.

“They did, but not before a cycle of self-promotion based purely on speculation (and often fraud) left many families bankrupt. The fact that a new technology has great potential does not by itself protect people from the risks of an associated asset price bubble. “

The combination of feverish optimism, cheap borrowing and lack of fundamentals support has seen these kinds of scenarios unfold over time, from the Japanese Zaitech bubble of the 1980s to the dot-tech bubble. -com “of the 1990s and 2000s and now – although bearing less macroeconomic importance – cryptocurrency.

Another good time to learn

Having seen their sixth most prolific month since their inception, much of the wind is leaving the sails of cryptos.

Bitcoin shorts hit their highest level since July 2019 last week and after hitting a record high of $ 64,830 two months ago, the asset’s valuation has since fallen to less than half that amount. – as low as $ 31,740 at any given time. Monday.

That’s not to say cryptocurrencies are doomed to fail. Initially launched with a vision to create decentralized digital transactions with universally accepted bidding and secure ledger, greater acceptance of cryptos and the practical applications that will hopefully lead to less price volatility from it. as the winners consolidate their position. As happened during the creation of the railroads and the dot-com technology winners, it will – hopefully – happen in digital assets as well.

This, in turn, could cause some skeptics to abandon the dreaded “gambling” and “speculation” diatribes used to undermine the legitimacy of the asset class.

For now, however, Eling is warning viewers about confusing investing and gambling.

“There has to be a much greater understanding of what constitutes investing, trading and gambling, and how the language of one category is co-opted into others,” Eling warned. “We often hear investors talk about ‘taking a punt’ or ‘hedging their bets’, but they downplay the complexity of their work.

“Instead, people should be looking to get rich slowly and develop an investment strategy that takes into account how much you can reasonably set aside each month to invest, your ability to lose and your appetite for risk given your investment goals.

“Diversified, multi-asset portfolios will protect you against violent asset price swings and ensure that your long-term goals are achievable. Something crypto assets are currently ill-equipped to deliver, ”Eling concluded.

Given the rapid roll-out of other products – such as thematic ETFs – offering exposure to dynamic games and future growth industries, investors should note that a bad temper can see the hunt for dreams end in tears.

Investment wisdom suggests that, at most, speculative investments without a foundation in fundamentals should remain a peripheral part of any investment strategy.

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