Forces driving Bitcoin craze
By Kim Jae-kyoung
Massimo Massa INSEAD professor
SINGAPORE ― Bitcoin, the leading digital currency, went through a chaotic run last week. It surpassed through the $19,000 mark Thursday for the first time before falling more than 20 percent to the $15,000 level on the Coinbase exchange in the U.S.
Despite the crazy run, investors are taking little heed of a warning over a bubble and the possibility of fraud. They are rushing to buy decentralized virtual currencies to take windfall gains.
Then, what is driving the craze for cryptocurrencies, particularly Bitcoin?
Massimo Massa, a professor of finance at INSEAD, said that the craze is propelled by a mix of three key factors ― lower yields, speculation and Bitcoin’s feature allowing currency movement without government intervention.
First, he said that interest rates are very low and most markets are overvalued. So he believes that most asset classes, including the U.S. dollar, the euro and real estate, are already priced high.
“Traditional asset classes are not going to give the return people expect,” Massa said in a recent interview. He also serves as the Rothschild Chaired Professor of Banking at the INSEAD Singapore Campus.
“Bitcoin is a relatively new class, and a lot of people see Bitcoin as a possibility of high return,” he added.
Secondly, he thinks that speculation is a major driving force behind the Bitcoin fever. He compares what’s happening around Bitcoin to the Madoff Investment Scandal, one of the largest scams ever, discovered in 2008.
The scandal was named after Bernard Madoff, a famous American fund manager who executed the largest Ponzi scheme in history, defrauding thousands of investors of tens of billions of dollars over the course of at least 17 years.
“A bunch of people realize this is a speculative asset, hoping to get out before the music stops, which is somehow the same story as Madoff,” he said.
“People in the field knew what was supposed to happen but everybody participated in the Phonzi scheme hoping to get out before it was too late,” he added. “This is similar to Bitcoin. They want to make money and retire before it collapses.”
Thirdly, he said that a growing number of investors, particularly the Chinese, are using Bitcoin as a new tool to move their assets from one place to another.
This means that people use Bitcoin to circumvent currency controls imposed by financial authorities. Decentralized currencies like Bitcoin operate as a payment system with no central bank and are exchanged using encryption.
“Bitcoin has become a very nice way of shifting from one market to another asset,” he said.
“So it is the mix of these three components ― very low yield or pressure to get a higher yield, speculation by market players and the export of currency without the control of central banks,” he added.
Blockchain, not Bitcoin
Regarding the U.S. Federal Reserve’s move to create its own digital currency, Massa said that it should be seen as an attempt to take the lead in the emerging digital coin market.
William Dudley, president of the Federal Reserve Bank of New York, recently said that the U.S. Federal Reserve has begun to think about its own digital currency.
“It does not surprise me. The reason is very simple. It is like saying, ‘Before somebody else does it, let me do it myself,’” he said.
This suggests that the U.S. wants to set the tone in the new asset class market before its rivals, such as China and Russia, take action.
However, he made it clear that what central banks, including the U.S. Fed, are interested in is not Bitcoin, but blockchain, a public ledger of all cryptocurrency transactions that powers virtual currencies.
“I don’t think that Bitcoin is the most important part of cryptocurrency. Central banks care a lot about blockchain because it’s an alternative way of doing settlements, and settlements are the backbone of the banking system,” he said.
“Central banks control banks through settlements because that’s exactly where central bank intervention takes place.”
The Singapore-based economist said that one good way of predicting the future course of Bitcoin is looking closely into interest rates.
From his perspective, since yields are very low now, it is expected that more central banks are going to continue to increase interest rates.
“The question is what is going to be the impact of a change in interest rates and real rates on all assets, including Bitcoin,” he said.
“Once real rates are adjusted to a more profitable level, investors may move away from Bitcoin into fixed income.”