Who goes down if the crypto bubble bursts?

Hold your breath and hope the bubble doesn't burst Keystone

Is bitcoin a bubble waiting to burst? UBS chairman Axel Weber certainly thinks so, as he told NZZ am Sonntag at the weekend. The world’s most famous cryptocurrency is trading at close to $19,000 per token, up from $1,000 at the start of the year. The whole thing is “unstable”, according to Weber.

Others have also called a bubble, including Credit Suisse CEO Tidjane Thiam. So, what if they are right? What if the price of bitcoin pops, deflates and goes down like a lead balloon? Anyone who bought near the top of the market (or perhaps even the middle) is going to lose money.

And then what? Will this bring down banks and small businesses, cost jobs and squeeze credit to barely more than a trickle? It depends on who you ask. Patrick Schueffel, a former banking executive and now a professor at Fribourg’s School of Management, is convinced that cryptocurrencies represent “The Mother of All Pyramids”.

According to Schueffel, the exponential rise in the value of bitcoin and other digital tokens is fueled purely by the irrational exuberance of more speculators piling into the get rich quick scheme. Furthermore, he believes the bitcoin bubble is pushing up the value of other tokens. Added to that, a number of funds and derivatives are popping up on the market that soak up more investor cash.

How much?!

At the end of November, Schueffel expressed his alarm that the value of all bitcoins added together had reached $134 billion, while the top 20 cryptocurrencies were “worth” $222 billion. Bitcoin’s market cap was bigger than the governmental budget of Finland, he opined. And the top 20 cryptos put together outgunned the annual budget of the Kremlin. 

“If we bear in mind that at its height Lehman Brothers had a market capitalization of ‘only’ $60bn, its bankruptcy nevertheless marked a seminal event that intensified into what later on became known as the Global Financial crises. This string of events eventually wiped out assets of approximately $1,300bn,” he wrote.

Oh my! Just a few weeks later, all bitcoins thrown together are now worth $314 billion. All crypto tokens put together now add up to half a trillion dollarsExternal link. 

So could the shadow economy bring down the real economy? Rudolf Minsch, chief economist of the Swiss Business Federation (economiesuisse), is a bit more relaxed about the issue. Investors may get their fingers burned, but the world’s economies will carry on as normal. The real economy would hardly notice, he forecasts.

Bubble ‘ouch’ list

Minsch believes the rapid rise in crypto prices are also driven by pure speculation. The conditions of meeting the underlying goal of providing a faster, cheaper method of conducting financial transactions via blockchain have not even been met, he argues. “Transactions are too expensive and slow,” he told me. 

“The volume of bitcoin is not significant,” he adds. Surely not compared to the $7.6 trillion value of gold reserves at present, never mind fiat currency reserves or the value of derivatives. “History shows us that it is not uncommon for everyone to be eager to try their luck in the same investments at the same time,” says Minsch. “But if the bitcoin bubble does burst, it will not be translated to the real economy.”

Minsch is far more concerned about a potential stock market bubble, which if it bursts could dampen US consumer sentiment. Second on the “bubble ouch list” in Switzerland would be a rapid depression of real estate prices should interest rates rise too quickly.

So who is right? One thing Schueffel fails to mention is that the collapse of Lehman Brothers hardly happened in isolation. Most of the major banks in the world were chock full of worthless mortgage derivatives in 2008. Many were bailed out. Lehman was the only sacrificial lamb.

But he does raise one important point. Is anyone counting the real value of all investments in cryptocurrencies at the moment?