On June 4, 2017, in my fortnightly column, I wrote about cryptocurrencies, particularly bitcoin, whose price was then $2,550. The aim of the column, by means of analogy and examples, was to sketch out how bitcoin works. What became evident from a few reader responses was that there was a great hunger to learn more, to understand the bells and whistles of cryptocurrencies.
By December 2017, bitcoin’s price on exchanges had catapulted to what seemed like an astronomical amount — $19,500 per bitcoin — for a digital asset whose utility was still unclear to most. In India, most policy-makers were largely unconcerned or dismissive. Kirit Somaiya, a politician from Mumbai, unironically summed up his view, “Today, bitcoin has come, tomorrow ‘chandi-coin’ will come, third day, ‘plastic-coin’ will come.” As if to confirm his derision, what followed was a spectacular price decline throughout 2018.
Crisis of confidence
Firms laid off employees and shut shop, entrepreneurs licked their bruised egos, scam artists slunk away, speculators moved to other asset classes, and investors underwent a crisis of confidence. Only the true believers persisted in building technologies, tinkering with protocols, and improving commercial offerings. By December 2018, the price of bitcoin had dropped to $3,300. Over the last few months, the price of bitcoin has straggled upwards, like a drunk working up the courage to become a teetotaller, and as of writing this column, the price is around $7,100, an appreciation of over 300% from the day the last column appeared.
Predictably, critics abound. From Warren Buffett who thinks bitcoin is a Ponzi scheme to Nobel prize winner Joseph Stiglitz who says cryptocurrencies ought to be outlawed to the academic Nouriel Roubini who thinks the underlying technology of blockchains is merely a glorified database. Many have found great comfort in this antipathy; yet their scepticism reminds me of those who in the 1990s said that selling goods on the Internet was a pipe dream, especially when data trickled in through telephone modems. In short, prejudice towards something so counter-intuitive, so unsettling to the status quo, and so volatile in manifestation as a cryptocurrency is easy to come by. However, this would be to misread the three great trends playing out on different time scales.
The first is an immediate, and thus the most visible, factor: the hunt for yield. Since the 2008 credit crises, central banks have provided through various institutional channels billions of dollars of liquidity and kept interest rates low. These have contributed to inflated asset valuations and in fixed income assets (such as bonds) depressed returns on investments (or yields). Institutional players — obscure but behemoth Japanese banks, asset management firms servicing an ageing demographic in Western societies — are all on the lookout for new venues to juice their traditional portfolios.
The second is a historic, but persistent, problem. This is the scarcity of ‘safe assets’ in the world. Safe assets refer to those one can invest in with a high degree of reliability that they will perform as expected without risk of governmental expropriation or loss of capital due to risk of inflation. As many of the world’s developing countries grow rich, they end up saving more.
However, these savings typically seek domestic or foreign safe financial assets; but in the absence of institutional quality, deep markets, and efficient legal regimes, the ability of countries to “produce” safe assets remains limited.
Predictably, the search for store of value that can be safely held, away from any arbitrary government diktat such as demonetisation, is omnipresent.
The third is a structural feature of the bitcoin network itself, which caps the amount of bitcoins to be issued at 21 million. With a sizeable portion of bitcoins lost to forgotten passwords, misplaced private keys, and other human reasons, the amount of available bitcoins is smaller than 21 million. What we thus have in bitcoin is a unique asset that comes in an age of diminished returns of investment elsewhere, increased demand for safe assets, and a deflationary supply.
In light of all this, it’s not surprising that blue chip financial services firms like Fidelity, which manages trillions of dollars in retirement assets of Americans, is expected to announce the opening of cryptocurrency trading with custodial safekeeping.
We are today at the precipice of an asset valuation boom, unlike any we have seen since the 19th century, when oil and gas became tradeable commodities with a logic of their own. Like then, there are bound to be excesses and criminal activities, episodes of irrational exuberance followed by a chastening. But we’ll also see maturation of the industry, newer technologies, and smarter regulatory frameworks.
And, perhaps most dramatically, the slow arrival of institutional investment money. The footfalls of the herd is there to hear for those who listen carefully.
Keerthik Sasidharan is a writer and lives in New York City.