By Dr Enock Nyorekwa Twinoburyo
Any bubble in the history of markets has been characterised by rapid and exponential growth in the respective product prices.
This was the case with several financial crises including most recent in 2008.
Any product with a steep yield curve (long term rates are much higher than short term) is usually premised on short term sustained hikes in product valuation.
But when the price increase is much faster than general income growth, eventually the product faces deflation (price decline).
Sometimes this starts with a disinflation (reducing rate of growth in prices). Price declines tend to lead to downsizing of market capitalisation and respective share price collapse if the product firms are listed on the stock exchange.
The global buzz is on cryptocurrencies -commonly known as “digital gold”. These are digital currencies operating through decentralised network not controlled by any central bank like it is for any form of fiat money like the Uganda shilling.
The digital currencies rely on encrypted computer systems (cryptology) to manage the respective trade, control the supply and secure the transactions from any potential fraud.
Bitcoin introduced in 2009 was the first digital currency to predominate the cryptocurrency domain.
In July 2010; the Bitcoin price was just USD 0.06. Bitcoin price crossed USD 10,000 mark in November 2017 reaching just USD 12,000 in December 2017 from below 5000 in September 2017 and USD 2500 in May 2017.
In just 2017, Bitcoin price has exhibited triple digit growth, which is unmatched by any income growth, which is the first signal of potential bubble burst.
This means that the yield curve of bitcoin is becoming relatively flat. In 2017 alone, on four different times, the price of Bitcoin has fallen by over 25% and bouncing back exhibiting elements of random walk.
Additionally Bitcoin has fixed supply of 21 million Bitcoins which can be mined. However, the coins can be divisible into smaller parts and the smallest is one hundred millionth of a bitcoin.
Again looking at the history of Bitcoin price, 2014 marked a structural break from rapid hike in bitcoin price in 2013. The price had remained under USD 15 between 2010 and December 2012 when it started rising – reaching USD 980 in November 2013.
Thereafter the price declined reaching USD 230 in September 2015 and closing 2016 are less than the historical high experienced in 2013.
Recent empirical work by Gandal and others (2017) suggests that the 2013 Bitcoin price spiral was associated with a high in fraudulent trades and the lack of regulation in a decentralised network makes cryptocurrencies to remain susceptible to constant attacks by financially motivated criminals.
In some cases air transactions were carried out and others duplication of the trades were noted. They add that the markets of these crypto currencies are thin and subject to manipulation which could be the explanation for the meteoric rise seen in 2017.
The lack of regulation and access to anonymised data by central banks suggests the use of digital currencies for the transaction and precautionary objectives of money is limited but rather held largely held as store or value for speculative purposes.
As is with land, the higher the price, the more investors expect the price to rise. This also means there is a risk of people moving from productive investments into such currencies, and this needless to mention has an impact on the productive capacity.
This central banks need to monitor. When asked at the IMF regional outlook presentation in Uganda on the 4th of December 2017 about digital currencies, the Deputy Governor Dr. Loius Kasekende intimated they are studying the realm of digital currencies and as such have no formal position yet.
In February 2017, Bank of Uganda issued a statement of caution on the use/investment in cryptocurrencies.
China’s central bank followed by the Reserve Bank of India (RBI) in the first of week of December 2017 warned investors against betting on bitcoin and other cryptocurrencies.
While majority of countries are totally against crypto currencies, few countries officially recognize cryptocurrency as legal currency.
The Bank of International Settlements (BIS) and also IMF they have intimated that central banks must closely monitor digital currency space given the potential associated risks of financial instability.
The inevitable state regulation of the cryptocurrencies may be the final nail into the bubble.
Let’s not forget that the central banks may innovate towards digital currencies, a debate that started in the 1980s. My best 2018 will be like 2014 for Bitcoin