Cryptocurrencies - fitting the narrative to the price

CIO Global Blog

11 Apr 2019

Spring has sprung in New York and so have cryptocurrency prices. Bitcoin, the most popular cryptocurrency, has gained 41% YTD, outpacing gains in the broad US equity markets. In fact, the only major market I can find with better YTD performance is the Venezuela CSE General (+429% according to FactSet).

Fig. 1: Bitcoin price

This price action has not gone unnoticed. With bitcoin price rallying, cryptocurrency bulls appear reenergized citing technical indicators such the "super guppy" and "overbought conditions", that they believe should lead to sustained gains following the sharp rally in bitcoin from the December lows. Financial media and crypto market commentators have been busy publishing articles that in our view "fit the narrative to the price," by trying to explain the sudden bitcoin surge in terms of institutional buying, pension fund allocations, central bank stockpiling, or some other non-provable reasons.

But has anything in the world of cryptocurrencies really changed, other than the price? We don't think so.

As we wrote in Cryptocurrencies: Beneath the bubble (12 October 2017), "...Currencies in themselves have no natural value...Currencies only have value when they can buy things that are useful...".

The two most important and largest classes of economic transactions (and therefore most useful) are labor and taxes. In our view, until labor and governments are willing to adopt cryptocurrencies as payment, we don't think they satisfy the first requirement of a currency. Cryptocurrency transaction processing still seems too slow and too expensive, especially given the volatility of many coins.

We similarly believe that cryptocurrencies aren't viable stores of value. Cryptobulls' arguments often hinge on the notion that since most cryptocurrencies have a finite supply, their value cannot be debased over time by central monetary authorities. This may be true, but it ignores the fact that while the supply of any individual cryptocurrency is finite, there is an infinite supply of cryptocurrencies. The volume of initial coin offerings (ICOs) reached USD 22.5bn in 2018, or 3x the cumulative life to date issuance of all ICOs. With unlimited supply, is it any surprise that Bitcoin's price and even its value relative to other cryptocurrencies has been volatile?

So our bottom-line view on cryptocurrencies is unchanged. We do not view cryptocurrencies as currencies. Simply put, bitcoin and its kin are not mediums of exchange and are not stores of value.

We believe our skeptical view has gained more acceptance, but the cryptobull case argument has now somewhat shifted to "OK, bitcoin isn't a currency, but [it] is an asset."

Indeed, many crypto-bulls celebrate that bitcoin and other alt-coins have had their bubble period of irrational expectations and point towards past asset bubbles and their subsequent recoveries as a potential template for cryptoassets. The argument here is that bitcoin has gone through its bubble phase and is ready to rise phoenix-like from the ashes just as other assets and indices did in the past.

This has led to no shortage of charts overlaying cryptocurrencies' crash and recent recovery against other notable market crashes such as the Nasdaq index from 2000 (which we had a front seat for) and other asset/market bubbles. We did a chart, too, just so we didn't feel left out.

Fig. 2: Comparison of post-bubble asset prices

Perhaps asset bubbles do follow a predictable pattern, or perhaps Fig. 2 is just an example of cherry-picking data points and manipulating charts to prove a potentially dubious or coincidental point. We're not opining on the value of bitcoin or any cryptocurrency, but charts like the one above may only tell half the story in our view.

As seen in the table below, bitcoin prices certainly crashed about the same magnitude as other bubbles. But we're struck by how long it took other asset bubbles to recover their peak levels (as long as 22 years for the Dow Jones Industrials) and how pedestrian the annualized returns from trough to the recovery often are. Maybe crypto-bull contingents should consider what happens after the bubble - not every bubble that bursts recovers the old highs. The Nikkei and oil both still remain well below their respective peak levels.

Fig. 3: Comparison of crashes and recoveries

Author:

Kevin Dennean, CFA, Technology & Communication Services Analyst Americas, UBS Financial Services Inc. (UBS FS)