Bitcoin, bulbs and bubbles

Bitcoin is probably the most well-known cryptocurrency and has been rallying ever since Donald Trump’s election victory at the beginning of November 2024. It is up over 45% and has briefly broken through the $100,000 (£79,026) mark.¹

The returns since bitcoin’s release in 2009 are staggering, with the price then around $0.05, leading to investors experiencing FOMO – fear of missing out. While the performance is impressive, this should not be taken as a guide to how it will do in the future. 

Bitcoin is a digital currency and was invented in 2008 by Satoshi Nakamoto, an unknown person or persons. Unlike previous digital currencies the objective was for Bitcoin to be decentralised.

This means that instead of relying on banks to record and verify transactions all users of bitcoin would digitally record all transactions at the same time, making it impossible for someone to submit a false transaction. This approach also means that no-one person, organisation or government can control or charge fees from bitcoin transactions. The aim is to make transactions cheaper and faster.

The primary catalyst for bitcoin’s rally is Trump’s election victory. He has gone on record declaring he wants to make the US the crypto capital of the world and would like the US to have a “strategic bitcoin reserve”. This rhetoric will likely attract investors who believe the US government will come in and buy bitcoin driving the price higher.  

The fact Trump is surrounded by crypto fans including businessman Elon Musk, politician Robert Kennedy Jr and Paypal founder Peter Theil, has probably further fuelled this view. Others theorise that fear is driving up the price of bitcoin. So should, as some believe, Trump become a dictator, bitcoin could be used to allow those Americans to take their wealth out of the country. 

Bitcoin is sometimes viewed as a way to protect your wealth, often seen by advocates as an alternative to gold. But there are significant risks associated with investing in cryptocurrencies like bitcoin. These include price volatility, lack of regulation in the cryptocurrency market, and that cryptocurrencies value is not backed by any physical asset or government, making it highly speculative.  

Until bitcoin becomes fully proven as an investment option it is still high risk. If it is deemed sustainable it could also be subject to regulation, which would bring advantages and disadvantages, depending on what rules the government introduces.  

There is a limited supply of bitcoin with the current structure only allowing for 21 million to be mined. As with any rare ‘commodity’ there are people who buy bitcoin and store it for the long term.

The big buyers are known as ‘whales’, due to the size of their holdings. Whales, like any large investor can influence and control the price of bitcoin. For example, by buying it and reducing the supply they could potentially drive up the price. However, if one chooses to sell their bitcoin holding they might cause the market to crash. Unlike other investments bitcoin is largely unregulated which could mean large investors and influencers are not as prevented from trying to manipulate the market and drive the price higher or lower.

What do tulip bulbs and bitcoin have in common? Bitcoin is often compared to the Tulip mania, which took hold of the Netherlands in the 1600s, when the price of some bulbs reached extraordinary levels as they became fashionable. It’s widely viewed as the first financial asset bubble. Prices of tulip bulbs rose, not because they were valuable but, because investors thought they could sell them for more. Contrary to popular belief the tulip bubble didn’t do that much damage. The Dutch economy did not collapse and no-one went bankrupt.

Only time will tell if it is in a bubble, however bitcoin’s similarities with Tulip mania is that both have been subject to sensational headlines that don’t necessarily reflect reality and prices have risen on expectations that they will rise in the future.

So, will this crypto crash? The true value of bitcoin is hard to measure. As with gold or the US dollar it doesn’t have any intrinsic value – it is only worth what people are willing to pay for it, making it hard to say whether it is currently in a bubble or not.

A rising bitcoin price could have a ‘wealth effect’. The premise is consumers tend to spend more when broadly held assets like real estate and shares are rising in value. The evidence of this wealth effect is usually stronger in property prices than stock market valuations.²

Although bitcoin is not as widely held there is still the potential for a boost. The meteoric rise in the price of bitcoin is much greater than anything seen in property or stock markets and the cryptocurrency is most popular with a younger generation more likely to spend and consume.

It is easy to dismiss bitcoin as a fad, but its popularity has continued to grow despite many setbacks. The lack of an intrinsic value doesn’t mean it is worthless. It is being accepted and used as a means of exchange, with countries like El Salvador using it as a form of legal tender.

There has been growing interest in it from investment banks even JPMorgan Chase has got involved despite the fact their CEO, Jamie Dimon, branded bitcoin “worse than tulip bulbs”.³

The UK regulators have yet to be convinced about the merits of cryptocurrencies and they are not an investment Evelyn Partners currently offers. The Financial Conduct Authority (FCA) has banned the sale of more complex instruments like cryptocurrency derivatives saying it “considers these products to be ill-suited for retail consumers due to the harm they pose.”  

While investments in cryptocurrency derivatives (a financial instrument whose value is based on price movements of an underlying asset), along with related investments such as crypto exchange-traded products are unavailable to UK retail investors.

However, UK investors can buy and sell cryptocurrencies on cryptocurrency exchanges. These come with risks too. In 2022 FTX, a Bahama-based cryptocurrency exchange, collapsed owing investors as much as $8 billion. At the time it was the third largest exchange by volume and had over one million users.⁴

The UK Government has also unveiled plans to crack down on misleading cryptocurrency investments, which come in various forms, but many typically try to trick people into parting with their digital assets in return for an often-overinflated and unrealistic return.

Traditional investments, such as equities and bonds are considered safer than bitcoin because they are typically backed by established financial institutions and regulatory frameworks. In the UK, the Financial Services Compensation Scheme (FSCS) protects your money up to £85,000 per person in the event of a bank, building society or credit union failure. This protection does not extend to cryptocurrencies.

However, despite such protections, investors can also lose money and get back less than what they invested when it comes to traditional investments.  

While bitcoin offers high potential returns its speculative nature means it is a high-risk investment and it may not be suitable for everyone. You must be prepared to lose all the money you invest. If you invest in bitcoin you may want to talk to your usual Evelyn Partners contact about how diversifying your traditional investments could help to mitigate some of these risks of exposure to cryptocurrency risk.  

1. Cryptonews.com, Bitcoin soars to 100k what drove the price up and what's next, 5 December 2024
2. Nber.org, Comparing Wealth Effects: The stock market versus the housing market, November 2002
3. FT.com, JPMorgan’s Jamie Dimon calls bitcoin a fraud, worse than tulip bulbs, 12 September 2017
4. New York Times, FTX files for bankruptcy as CEO Sam Bankman-Fried resigns, November 2022