Why investors have nothing to fear from a bursting of the bitcoin bubble, in one chart

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bubbles
Reuters/Elijah
Nouvelage


Bitcoin remains the talk of financial markets.

Its stratospheric price rise this year, shown in the chart below
from Capital Economics, helps explain why there’s just so much
interest at present.


Bitcoin Chart 1Capital
Economics

Phenomenal, right?

Aside from speculation as to why prices have surged so far so
fast, the other major talking point is whether bitcoin is a
bubble, destined to pop like other asset bubbles such as tulip
prices and tech stocks in the past.

While that debate is unlikely to be resolved in the near-term, to
Andrew Kenningham, chief global economist at Capital Economics,
even if bitcoin is in a bubble, its subsequent popping — should
that actually eventuate — will have little ramifications for
broader asset markets, the banking system or the global economy.

“There are several channels through which a bursting asset price
bubble can, in principle, have macroeconomic consequences, but
none are a major risk in the case of bitcoin,” he says.

“First, there may be a hit to household spending as people who
have invested suffer losses. But bitcoin’s market capitalization
is too small for this to be a worry. It is currently around $240
billion, which is much smaller than the total value of gold
outstanding at $US8 trillion or the value of Apple at $900
billion.

“If the price of bitcoin fell to zero today, the paper losses
would be equivalent to a 0.6% fall in US equity prices. As most
investors have bought bitcoin at much lower prices, the relevant
losses would arguably be smaller.”

This chart from Capital Economics compares the current net value
of Bitcoin compared to other more established asset markets.


Bitcoin Chart 2Capital
Economics

Given its relatively small value in the broader scheme of things,
Kenningham says a popping of the bitcoin bubble will have few, if
any, ramifications for the global banking system.

“While a bursting bubble can affect the economy via the banking
sector, this is not much of a risk either, precisely because
bitcoin is held and traded outside the banking sector,” he says.

“Also, there is no evidence that people are taking out huge,
sub-prime mortgages to finance their speculation in
cryptocurrencies.”

And, given that view, Kenningham says any unwind in the bitcoin
price is unlikely have any broader consequences for financial
markets or the economy.

“A slump in bitcoin prices should not have much effect on wider
investor and business confidence either,” he says.

“As we have pointed out elsewhere, there is no correlation
between the prices of bitcoin and other risky assets, so a fall
in its price should not affect wider financial conditions. And
nor would it tell us anything about wider market sentiment.

“Unlike the bubbles in the tech sector in the late-1990s and in
US residential property a few years later, a bursting of the
bitcoin bubble should not have systemic, macroeconomic
implications.

“The total value of bitcoin is still too small, and it has few
links with the wider economy,” he concludes.

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