Bitcoin ends dramatic week with 20% slump followed by recovery

Amid warnings of bubbles and infernos, currency hits new high of $16,660, crashes, then recovers to $15,350 as London closed

Bitcoin rounded off a week of frenzied investor speculation with a day of whipsaw trading that knocked nearly 20% off its value at one point, but still left the cryptocurrency changing hands at more than $15,000 (£11,000).

The currency, which was likened to Dante’s Inferno by one senior banker this week, rocketed to a new high of $16,660 overnight before slumping to $13,482 by midday on Friday. As the London markets were closing, bitcoin had recovered some of its losses to trade at $15,350 – having started the week at $10,875 and the year at $966.

Bitcoin is a 'cryptocurrency' – a decentralised tradeable digital asset. Invented in 2008, you store your bitcoins in a digital wallet, and transactions are stored in a public ledger known as the bitcoin blockchain, which prevents the digital currency being double-spent. 

Cryptocurrencies can be used to send transactions between two parties via the use of private and public keys. These transfers can be done with minimal processing cost, allowing users to avoid the fees charged by traditional financial institutions - as well as the oversight and regulation that entails. The lack of any central authority oversight is one of the attractions. 

This means it has attracted a range of backers, from libertarian monetarists who enjoy the idea of a currency with no inflation and no central bank, to drug dealers who like the fact that it is hard (but not impossible) to trace a bitcoin transaction back to a physical person.

The exchange rate has been volatile, with some deeming it a risky investment. In January 2021 the UK's Financial Conduct Authority warned consumers they should be prepared to lose all their money if they invest in schemes promising high returns from digital currencies such as bitcoin.

In practice it has been far more important for the dark economy than it has for most legitimate uses. In November 2021 it hit a record high of more than $68,000, as a growing number of investors backed it as an alternative to other assets during the Covid crisis.

Bitcoin has been criticised for the vast energy reserves and associated carbon footprint of the system. New bitcoins are created by “mining” coins, which is done by using computers to carry out complex calculations. The more bitcoins that have been "mined", the longer it takes to mine new coin, and the more electricity is used in the process.

Bitcoin investors are used to wild fluctuations in its value, with sudden drops immediately followed by a return to its long-term upward trajectory. The cryptocurrency has jumped 40% this week, drawing comparisons with the 17th-century tulip bubble.

There were fresh warnings about the virtual currency on Friday. Jamie Dimon, chief executive of US bank JP Morgan, told broadcaster CNBC: “Everyone has a personal opinion about bitcoin. I remain highly sceptical of it. But as I’ve said previously, I’m open-minded to uses of cryptocurrencies if properly controlled and regulated.”

His remarks follow those of Sir Howard Davies, chairman of Royal Bank of Scotland, who painted an apocalyptic picture for bitcoin. “Put up the sign from Dante’s Inferno – ‘Abandon hope all ye who enter here’ – I think that’s probably what’s needed,” Davies said.

Nobel-prize-winning economist Joseph Stiglitz has previously argued that the currency should be outlawed.

bitcoin graphic

Part of the rally in bitcoin can be explained by the planned launch on Sunday of a new product on the Chicago Board Options Exchange, which specialises in complex derivatives contracts. The CBOE is launching a futures contract that will allow traders to take bets – or protect themselves from movements – on the price of bitcoin in the future.

But JP Morgan is said to be among two major US banks, the other being Citi, which is initially holding back from getting involved in the new product, illustrating the lingering anxiety about virtual currencies, which are not backed by central banks.

JP Morgan and Citi would not comment on a report in the Financial Times that they were not going to get involved initially in clearing the new product, which involves standing between the parties involved in a transaction.

A spokesperson for the CBOE said the exchange was comfortable with the position before Sunday’s launch. US investment bank Goldman Sachs said it was “evaluating the specifications and risk attributes for the bitcoin futures contracts as part of our standard due diligence process”.

The FT has previously reported that Wall Street banks had written to US regulators to warn that the system was ill-prepared for bitcoin products.

Another futures contract is expected to be launched before the end of the year and Daniele Bianchi, assistant professor of finance at Warwick Business School, said their launch was a way to make bitcoin more mainstream. “It is evident that what is driving the price of bitcoin at the moment is its legitimacy as an investment asset,” he said.

“Although many commentators argue that bitcoin is a pure bubble, the reality is more likely that people investing in bitcoin are primarily investing in the blockchain as a technology at the forefront of innovation in financial markets.”

But James Lockyer, a technology equity research analyst at stockbroker Peel Hunt, who has dabbled in bitcoin himself, said: “Bitcoin is in a bubble at the moment.”

He said that while there were comparisons with the tulip frenzy in the Netherlands in the 1630s, when bulb prices reportedly rose more than 1,000% in a month, there were also differences.

“For tulips, they failed the main attributes of currency (including divisibility, imperishability, and homogeneity), and hence once the realisation that there wasn’t enough intrinsic value surfaced, the price plummeted. For bitcoin, it does meet a lot more of these main attributes, but whether it will ever meet the ‘general acceptability’ attribute is yet to be seen,” said Lockyer.

Amid calls for central banks to step in regulate bitcoin and other cryptocurrencies, Andrew Kenningham, chief global economist at consultancy Capital Economics, said the overall value of bitcoins was not enough to cause alarm. “If the price of bitcoin fell to zero today, the paper losses would be the equivalent to a 0.65% fall in US equity prices,” he said.

Contributor

Jill Treanor

The GuardianTramp

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