Interlude: Remember this: Greed drives bubbles

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on December 25, 2017 - December 31, 2017.
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Having grown up in an era peppered with some of the world’s worst economic crises, I am naturally extremely cautious (some may even say paranoid) when it comes to investing my hard-earned money in a certain asset class — especially one that may not even be categorised as such.

What am I talking about? Cryptocurrencies, if you haven’t already guessed. The financial world is gripped by what is now termed as crypto mania.

Over the past year, cryptocurrencies — led by bitcoin — have outperformed every other asset class in the world by a wide, wide margin. Overall, these digital currencies have risen more than 6,000%. Global stocks? A mere 20%.

Every day, more and more investors all over the world are jumping onto this gravy train. To quote a recent news headline, “Even Grandma is in”.

To date, bitcoin has risen more than 1,000% and ethereum by a more confounding 6,000%. Dash, Zcash, Ripple, Litecoin and Monero are some of the other tokens in the crypto world.

Bitcoin futures were recently launched by the CBOE (Chicago Board Options Exchange) Futures Exchange while initial coin offerings (ICOs) are on the rise. There are projections that the total value of cryptocurrencies could hit US$2 trillion next year.

Gravity aside, the upward trend defies basic economic tenets. It is crazy. Mad. Cryptocurrencies are not real money. They are not regulated. They are not legal tender. How do you value something that has no interest rate, no earnings, no cash flow and no reserves? The economy, and how it is performing, appears to have nothing to do with it.

Euphoria, history has shown, can be a dangerous thing. It clouds the mind and, even worse, it can cause many intelligent and logical-thinking people to behave in an irrational manner. Think the 1997/98 Asian financial crisis and the 2008 global financial crisis. What do they have in common? Irrational euphoria!

Remember the dotcom boom and bust? It is a better parallel to what is happening now in the crypto world. The 1990s saw the rise of the World Wide Web and the initial public offerings of internet companies flooded the markets the world over. Their share prices skyrocketed and any company with a dotcom attached to it was chased up.

Never mind the lack of fundamentals and profit track record. The bubble lasted two years, then came the bust. Many of the dotcom companies incurred huge losses. No surprises there. Investors lost their shirts and more. Again, no surprises.

We are now seeing history repeat itself. And no, in case you think it is, this time it will not be different. Just like it wasn’t different when each financial crisis imploded in the past.

The crypto bubble, even as we speak, is still growing. As always, when the fever is running high, there are two camps with differing views. The first group comprises sceptics like me, worried that at some point, the bubble will burst and it will be very painful.

The other camp comprises crypto enthusiasts (the bigger camp by far and growing by the day), who are convinced that the bull run still has legs. After all, the money that has been poured into cryptocurrencies is just a fraction of what is in stocks and bonds.

Some of these optimists know history and how speculative mania always comes to a bad and bloody end. But they think it will be different this time. Here is the thing, it never is.

Interestingly, recent rhetoric on cryptocurrencies from Bank Negara Malaysia and the US Securities and Exchange Commission runs along the same vein — the digital currencies are not regulated and investors have to assess the risks for themselves. Bank Negara, for example, warns of price volatility, lack of a deep market and the vulnerability of cryptocurrencies to cyberattacks.

Unashamedly a baby boomer who knows too little about technology, I prefer assets that can be valued and whose prospects are based on real economic activity. Yes, we have read about blockchain and such. But how many of us really understand the technology?

For sure, many people have made a lot of money investing in bitcoin and other cryptocurrencies. But greed drives bubbles. Investors should be wary about an asset class that, to me, is really not based on anything solid. But then again, there will always be a greater fool out there, somewhere. My advice for 2018: don’t be that greater fool.