Brief analysis of the most high-profile market today…
Small puzzle of the week: What is one of the most important searches on Google? One of the most criticized financial assets and yet the future CME futures contract? One of the worst potential financial bubbles known?….. The answer would be: le Bitcoin.
Bitcoin (BTC), what is it?
Initially, the BTC was a dematerialized, free and no-cost digital currency, generated by means of a computer algorithm whose equation was particularly simple to solve. That was the beginning! BTC is still a free and inexpensive currency, but the algorithm used to generate it has become drastically more complex.
You have to understand that the BTC universe is over. Technically 21 million BTCs can be “mined”, i.e. generated. At the time, a simple computer was used to generate it. Today and after having mined 16 million BTCs, the equation to solve to generate the currency has become so complex that entire data centers are needed… so you can forget to create the currency yourself it will cost you far too much.
This crypto currency is exchanged via specialized brokers whose names we will keep silent, and with the particularity of being “decimalisable” i.e. that you can buy a fraction of the currency without any worries.
The BTC has long suffered from its image related to the financing of criminal activity resulting from the lack of traceability. It also suffered from the closure of one of the main MtGox brokers in 2014, after it had obviously emptied its customers’ cash registers….
Who are the stakeholders on the BTC?
To date, nearly 70 hedge funds are currently investing in cryptocurrencies and, each day, 750 million dollars of BTCs are traded for a “global capitalisation” equivalent to or even higher than that of General Electric, i.e. $160 billion (As a reminder, GE is one of the largest companies in the world, with a turnover of nearly 123 billion USD).
How does the BTC behave?
The market is currently liquid, in other words it is quite simple to enter and exit its position. It is also volatile, meaning that its variations are sometimes, if not often, violent. As a reminder: in June the BTC broke the $3,000 glass ceiling. It has since continued to improve despite a serious setback in mid-September when it fell by 40% – which it has since resumed. The reason for this momentary decline? The Chinese Central Bank had called on the virtual currency exchange platforms based in Beijing and Shanghai to stop their market operations on ICOs, which it accused of fuelling “ tax fraud and illegal fundraising“. This decision had a very strong impact on the BTC price but speculation has been so high since its price soared.
ICOs, another barbaric term for the uninitiated but increasingly heard. Escaping any regulation, “Initial Coin Offerings” – a term modelled on that of IPOs, which refers to initial public offerings – now compete with the traditional means of financing start-ups. Thus 228 projects were financed by this means for an amount of $3.6 billion.
Now let’s put this model into perspective; in 2016 OCI raised $96 million. As such, the 2017 capital raisings exceed those made by Venture Capital worldwide…No comment. This capital raised is then exchanged for BTCs on trading platforms (broker). But in reality, the value of the tokens issued is even more unstable than in a traditional IPO. Thus, as in the casino, the price of a token can collapse during the day and therefore the capital loss is total.
However, the enthusiasm for the virtual currency is not waning. Thus, since October, the BTC has more than doubled in value. One of the reasons for this movement is the launch of a futures contract by the Chicago Mercantile Exchange (CME) that could provide additional liquidity to the BTC.
Unfortunately, not everything is rosy on the futures markets. These markets are based on clearing houses that are the buyers of all sellers and sellers of all buyers. Their existence limits the risk of default of its compensated customers. For this system to work, operators must put funds into their accounts and each trading day the amount to be paid into this account is revalued. This technique is called: margin call. In any event, while the buyer of a cryptocurrency futures contract or call option could be required to put 100% of the value to ensure security, the determination of the margin requirement for the seller is impossible.
We note that the haste of this launch is dangerous for investors and these findings are corroborated by various “barons” of the futures markets.
Are we in a bubble?
To answer this question, graphics and small speeches are better than large palaver:
1. The main bubbles of the last 500 years:
The Tulip crisis was based on the sudden craze for tulips in the north of the United Provinces in the middle of the 17th century, which led to an excessive increase and then a collapse in the price of tulip onions. At the height of the Tulip madness in February 1637, bulbs were trading at ten times the annual salary of a skilled craftsman. This crisis has remained in the memories and is still taught in university. If we look at the graph below and everything else equals the trend taken on the BTC is the same as that of this famous Tulip….
2. Evolution of demand on google and behavioural relationship of small carriers:
There is an explosion of Google queries concerning Bitcoin and the degree of correlation between the evolution of BTC and queries is 91%. However, history teaches us that small investors are generally the last to enter a market and that they generally enter at the end of the bullish period as shown in the graph below:
It is clear that the ease of access and the desire to set up derivatives linked to the BTC have contributed to its development.
Now, there is cause for concern about the speed and strength with which the BTC has evolved.
Three concerns must be taken into account:
1. As ETFs and futures contracts on BTC will be launched, to what extent is this information integrated into the prices? In this case, institutional investors already have BTCs on their balance sheets in order to capitalize on these announcement effects. On the day of launch, these same operators may sell their positions.
As an example, we can cite the words of Jamie Dimon (CEO of JPMorgan) who considered this currency as speculative and tried to dissuade traders from buying it. However, Jamie Dimon himself proposes to sell BTCs as soon as the futures contracts are launched… look for the error!
In finance, we call it: Buy the rumor, sell the news (Buy the rumor and sell the news)
2. Concerns about the Fed’s (US central bank) valuation of the BTC highlight other concerns. Are the authorities prepared to admit that illegal funds are entering the economic and financial system or the tax system, it is not said that a public tightening on this subject is not being put in place as China has already done? The latest statements by European central banks point in this direction.
CEB: The European Central Bank is very virulent, comparing the speculative bubble surrounding the Bitcoins to the tulip crisis that hit the Netherlands in the 17th century and defining Bitcoin as a “tulip” rather than a real currency.
Bundesbank: It considers this cryptocurrency to be a “speculative game rather than a real means of payment”.
3. Finally, the third reservation is: This crypto currency is not based on anything! No real assets are backed up. In other words, when you buy a bond, a house etc. in case of a decline it remains the underlying real asset. The opposite is true for the BTC: let’s explain to ourselves: the crypto currency exists, it can be materialized if we exchange it in Euro or in Dollar but what are its fundamentals, how to explain that the market can gain 15% in one day and lose 15 the next day. The comments collected in the market give objective prices, but does it justify a BTC value of 15000 or 50000$… Nothing!!!
The purpose of this paper is not to provide investment guidance. However, caution should be exercised with this type of product.