Bitcoin's move to mainstream carries new financial risks: Don Pittis

Investing often descends into a kind of immoderate zeal, but there are signs the digital currency craze has the potential to threaten the wider global economy if left unchecked.

Just as we've seen with the current passion for bitcoin, part of that single-minded enthusiasm includes the fierce rejection of criticism.

At the end of last week, even as the digital currency was rising and then crashing by more than $1,000 in a day, true believers rebuffed any suggestion the market was strange or dangerous.

"I believe it is going to be the No. 1 currency within ten years," bitcoin bull Ronnie Moas told CBC last week. "That would put the valuation at $6 trillion and that would exactly be where China and gold is today."

As a quirky, if risky, plaything for a narrowly circumscribed group of technology enthusiasts, the ups and downs of bitcoin, driven by fervid comments from folks like Moas, have had little effect on the wider economy.

But bitcoin and its many imitators are now going through a transition from fringe to mainstream. 

Last night, America's largest options exchange market, the Chicago Board Options Exchange, began trading bitcoin futures. Next week, the larger and more established Chicago Mercantile Exchange begins a bitcoin-based market of its own.

And suddenly, we may be reaching a dangerous point, one where the unregulated trade in digital currencies — which many have described as the modern example of a financial mania like the South Sea Bubble and the 17th century Dutch tulip bulb craze — will be in a position to potentially destabilize the entire global economy.

That certainly doesn't mean a cryptocurrency-led economic collapse is inevitable. Nor does it mean bitcoin and its ilk are without value.

Bitcoin bugs

I remember receiving some verbal attacks in the earlier days of bitcoin when I compared bitcoins to gold. The attacks didn't come from bitcoin traders, who were then a much tinier group, but from those derisively described by mainstream investors as "gold bugs."

The 2013 column, called Gold and bits, two sides of the same coin, pointed out that for all the criticism the digital currency was getting at the time, bitcoin was no less credible than gold as a speculative asset.

Yes, gold has what's known as a value-in-use in electronics and chemistry, but the price people were willing to pay for gold as a financial asset was so enormous in comparison that gold's speculative monetary value became completely unrelated.

• What is bitcoin and why is it surging?

In the same way, aside from the notional value of bitcoin as a clandestine means of exchange, its entire value is based on what people are willing to pay for it. And just as with gold's relationship to platinum or silver, the fact that there are substitutes such as Ethereum or IOTA does not necessarily reduce the enthusiasm of bitcoin bugs.

Of course, there are many differences between gold and bitcoins. For one, gold is widely held by governments and institutions that have a hand in setting prices.

Bitcoin doesn't even have a single price, trading hundreds of dollars apart on different U.S. exchanges and with even wider spreads internationally. Up to now, bitcoin has hardly been worth regulating.

• Bitcoin value tops $1,000 US for first time since 2013

When bitcoin crashed from more than $1,100 US in 2013 to just more than $200 in 2015, the world's financial markets didn't notice. There are good reasons to expect a similar, or potentially greater, future crash in the price of bitcoin could be far more destabilizing.

A bigger share of GDP

For one thing, while the number of bitcoins grows slowly due to the mining process, the absolute value of bitcoins in circulation is exploding as prices are bid up. Trading could reach a stasis point, but because of the way the market is constructed, Financial Times commentator Izabella Kaminska imagines an extreme case where bitcoin rises to the value of world GDP because there is no reason for anyone to sell.

A fringe interest not long ago, bitcoins have begun creeping their way into conventional investment portfolios through hedge funds. Futures trading on two Chicago exchanges will increase their credibility, and thus their proliferation. As various large banks have complained, that could leave them on the hook to cover trades gone wrong.

And the global financial stake is expanding beyond trading in the digital currencies themselves. As the financial firm GMP said last week, Canadian exchanges are becoming a hotbed of new cryptocurrency-related company listings, with more than 50 about to launch.

Like the early internet    

"The level of activity in this market, of quality plays, quality teams, is as high as I've seen since the internet age," GMP CEO Harris Fricker told the business news service Bloomberg. "Canada's place in this is dramatically more important than what it was in the first phase of the internet."

Harking back to the earlier phases of the internet and the dot-com crash that followed may not be entirely reassuring.

• Canadian couple pours life savings into bitcoin mine
• Teen makes over $500K betting on bitcoin's less famous cousin

One of the biggest objections to gold bugs in the world of investing is that speculating on gold creates very little real economic value. When the price plunges, there is nothing of value left behind. Bitcoin is the same.

But perhaps there is a greater danger yet.

In a world where the main forms of investment have seen hot money bidding up the price of houses, stocks and other investments, bitcoin has become the idealized example, the epitome, of what seems to be an irrational speculative trend. That makes it a psychological leader. 

The longer the bitcoin boom lasts and the more deeply unregulated digital currencies become entrenched in the wider global economy, the greater the danger that an ultimate bitcoin crash could precipitate a far-reaching economic catastrophe.

Follow Don on Twitter @don_pittis

More analysis from Don Pittis