January 3, 2018 / 3:06 PM / 20 days ago

Breakingviews - Hadas: Albanian mania is cautionary crypto tale

By Edward Hadas

LONDON (Reuters Breakingviews) - Bitcoin was a hot topic at this year’s seasonal parties. Financially ignorant people asked what is going on. The most authoritative answers often came from those with little previous interest in investment. It is a familiar pattern.

In financial bubbles, the end is likely near when amateurs become experts. As speculator Bernard Baruch reminisced about the late 1920s: “An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market.”

In one important way, though, this time is different. While the stock market was undoubtedly overvalued before the 1929 crash, almost all the companies were quite profitable. In contrast, there is little of substance supporting electronic tokens such as bitcoin.

All right, there is a story. In some future time, government-backed currencies will be discredited, but computer networks will still be standing strong. Then people who are desperate for sound money will turn to the software elixir of monetary security, the self-regulating blockchain. Bitcoin and other tokens based on this wondrous technology will be immensely valuable, so much so that no current price is too high.

After three decades of global disinflation with almost no consumer losses on bank deposits, that story is nonsensical. Even counting the appeal of anonymous crypto-transactions to criminals, this may well be the weakest justification for an investment craze since the Albanian bubble of 1996.

In that year the Balkan state was swept up in a mania for “investment funds”. These were actually classic Ponzi schemes. They promised extravagant returns of up to 30 percent a month, and could keep going as long as they collected enough new cash to repay the few who wanted to sell out.

The growth was dramatic. Over a few months, the funds sucked in the equivalent of almost half of the nation’s gross domestic product, according to an International Monetary Fund study published in 2000. People sold houses and slaughtered their herds to raise funds to invest.

It all unravelled in early 1997, creating a popular uproar. The government fell, armouries were looted and fighting broke out. The IMF estimates that 2,000 people died. A new government restored civil and monetary order, but Albania’s GDP fell 11 percent in 1997, and did not recover fully for five years. The compound annual GDP growth rate for the previous five years did not return to the pre-mania level of 5 percent until 2001.

Albanian fund buyers were certainly greedy and foolish. Still, after 40 years of isolationist Communist rule, residents could be forgiven for not understanding how financial markets work. Besides, the post-Communist government did nothing to dispel popular illusions during those manic months.

Buyers of bitcoin and its peers have more to be ashamed of. They are certainly not desperately poor, and any ignorance is wilful. The key drawback of crypto-currencies – that they lack any legal function – is glaringly obvious. With a little more digging, potential buyers could also see this market is like a Ponzi promoter’s dream. Almost nobody sells, and new buyers do not care about the price.

Bitcoin’s rise in 2017 – its value increased by the equivalent of 24 percent a month – has overpowered such concerns. Like the Albanians before them, crypto-currency speculators have responded to signals of future wealth with a blind, instinctual frenzy. Technically they remain rational creatures, but greed has overcome their judgement.

There are two differences between Albania then and crypto-world now. First, the current frenzy has stimulated the creation of a complex trading infrastructure with a speed and sophistication that the hucksters of Tirana could hardly have imagined. Newly minted financial experts can dabble in futures contracts, while drawing on dedicated websites, technical analysts and a burgeoning public relations industry.

Second and more happily, the crypto-collapse is set to be much less damaging. The current market capitalisation of the leading 30 pretend monies was more than $640 billion on Jan. 3, according to coinmarketcap.com. That is a lot to pay for almost nothing, but it is well below 1 percent of global GDP.

The speed of the recent ascent should ensure that the amount of borrowing secured by the value of these essentially valueless assets is only a tiny fraction of their nominal worth. When financial prices collapse, bad loans tend to cause most of the damage. The bonfire of the cryptos should therefore hardly cause an economic ripple – as long as it comes fairly soon.

Still – like the Albanian craze of 1996 – this episode provides further evidence of the failures of market-based finance. The standard defence of the system’s reliance on pandering to investors’ greed is that this is the best way to funnel funds into productive investments. Sometimes, though, greed just produces foolishness.

Breakingviews

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