Is the Bitcoin Bubble Bursting - And Will It Take Other Markets With It?

Professional investors may have thought there was an opportunity to be gained from retail investors headlong rush into cryptocurrencies.

But tax law changes benefitting repatriation of financial assets and other cyclical phenomenon have combined to roil the markets.

Bitcoin et al will survive in some form, probably under regulation, but in the meantime, prediction remains hard, even with great data. JL



Eric Lam, Lionel Laurent and colleagues report in Bloomberg:

Bitcoin lost  48% from its Dec. 18 high. The cryptocurrency’s 60-fold increase during the past three years dwarfed the Nasdaq Composite Index’s gain during the headiest days of the 1990s. It outstripped the Mississippi and South Sea bubbles of the 1700s. It even topped the Dutch tulipmania of the 1630s. “Having no clear fundamental value and largely unregulated markets, coupled with a storyline conducive to delusions of grandeur, makes this the very essence of a bubble,”
Bitcoin’s recent wobbles have given fresh urgency to a question that’s gripped market observers for much of the past year: Will the cryptocurrency go down as one of history’s most infamous bubbles, alongside tulipmania and the dot-com craze?
The magnitude of Bitcoin’s boom (before it lost as much as 48 percent from its Dec. 18 high) suggests investors have reason to be worried.

As the chart shows, the cryptocurrency’s nearly 60-fold increase during the past three years was truly extraordinary.

It dwarfed the Nasdaq Composite Index’s gain during the headiest days of the 1990s. Going further back, it comfortably outstripped the Mississippi and South Sea bubbles of the 1700s. It even topped the Dutch tulipmania of the 1630s, though that last comparison should be taken with a grain of salt given the scarcity of recorded tulip values. (The chart includes prices for just one varietal; consistent post-peak figures were unavailable.)

Bulls say that Bitcoin’s boom is far from over, and that there’s more to analyzing a market than just measuring price gains. While the recent tumble has alarmed some investors, the cryptocurrency has bounced back from several previous swoons exceeding 50 percent. If Bitcoin did become a widely-accepted form of digital gold, as predicted by Cameron Winklevoss of Facebook fame, it could have a lot further to surge.

There’s also more than one way to slice a rally. On an annualized basis, Bitcoin’s three-year rise has been slower than the gains seen during several of history’s biggest manias -- most notably the Mississippi and South Sea bubbles.
Still, skeptics abound. Howard Wang of New York-based Convoy Investments LLC and Jeremy Grantham of GMO LLC have analyzed Bitcoin’s advance relative to past frenzies and concluded that it’s unsustainable. Grantham, who helps oversee about $74 billion as GMO’s chief investment strategist, summed up his concerns in a Jan. 3 letter to investors:

“Having no clear fundamental value and largely unregulated markets, coupled with a storyline conducive to delusions of grandeur, makes this more than anything we can find in the history books the very essence of a bubble,” he wrote.
The strategist has a mixed record of success with such warnings. While Grantham was correct to call the 1990s surge in tech stocks a bubble, he exited too soon and missed out of some of the market’s biggest gains.
Only time will tell whether Grantham and other bears are right, wrong, or just too early when it comes to Bitcoin.

Hedge fund managers have been lying awake at night for years worrying about poor performance, weak volatility and whether it might be time to just move on and do something else -- like get into Bitcoin maybe.
The allure of 1,000 percent returns in a market of unsophisticated punters who behave in herd-like ways is undeniable. But how long before crypto fund managers start having their own bedtime terrors?
Beating the stock market with a bitcoin in your pocket wasn't very difficult in 2017, but it's been getting much harder since.

The array of alternatives to Bitcoin out there doesn't make it much easier to find the next big hit, either. Frenzied speculation has seen Ripple tumble 60 percent in 10 days and Litecoin by 35 percent. A 2 percent increase for the boring old S&P 500 doesn't seem so bad.
While hedge funds should be better placed versus the retail crowd dominating the crypto markets -- given they're supposed to hedge, after all -- there aren't too many ways to profit from an indiscriminate selloff across crypto-land.

This is not a mature market that can easily accommodate short-selling or derivatives. Bitcoin is the exception, with futures contracts allowing traders to profit from recent falls. But the bullish side of the trade has lost money. And most of the crypto-focused hedge funds surveyed by Bloomberg News traded more than just Bitcoin. They got into this market because it was booming.
Then there's the question of client sentiment. Managers of the Altana Digital Currency Fund last year warned customers that they should invest only a "fraction" of their net worth. So maybe these clients have deep enough pockets to ride the rough with the smooth.
But at what point do investors start to wonder if their fund's 1,496-percent gain last year is as good as it ever gets? If the offer on the table is for clients to redeem their holdings every quarter, or every month, how long before they decide to take it up? Just because you've invested what you can afford to lose, it doesn't mean you'd want to lose it.

The hedge fund industry has had an awkward few years trying to justify rich fees and weak performance. Bitcoin and cryptocurrencies seem to offer an escape to managers and clients alike: Mind-boggling profit, a market full of amateurs and arbitrage opportunities galore.
Maybe the smart money is sharp enough to navigate 1,000 volatile currencies. But there's a chance that the returns on offer won't justify the risks being taken, which in some cases include leverage. Mike Novogratz, who delayed his planned crypto hedge fund last month, might be the one sleeping soundest.