The recent Bitcoin bubble wasn’t the first, and it might not be the last. Once in 2011 and twice in 2013, the price soared and then crashed. Then it happened again and again.
Each peak was bigger than the last. If you think there will be another, even bigger bubble somewhere down the line, then maybe any losses you took in the recent bubble may be made whole in time.
Why has Bitcoin been subject to repeated bubbles? One reason is lack of liquidity - since relatively few people owned and traded the cryptocurrency in years past, even a small buying surge could push the price up dramatically, and even a modest pullback could send it crashing.
A second reason is that Bitcoin was, at least until recently, a new asset. Speculators had no real idea how many potential cryptocurrency investors were out there. Economic theory shows that this can easily lead to an overshoot, where even rational investors temporarily push an asset’s price beyond its long-term sustainable value.
But there’s a third reason for Bitcoin’s bubbliness - it was hard to bet against it.
Basic finance theory says that if there’s no way to invest and profit from an asset's decline, the price is determined by the most optimistic buyer. If some traders think Bitcoin is overpriced, but have no way to bet on their belief, they will just sell their stake and sit out of the market. Everyone who remains will be an optimist, and they will buy Bitcoin for the high price they believe it’s worth.
This mechanism is a key part of almost every theory of financial bubbles. A famous 1978 paper by J Michael Harrison and David Kreps showed how without short-selling, differing levels of optimism and pessimism would cause even rational agents to push asset prices above fundamental values. A later model of bubbles and crashes by Dilip Abreu and Markus Brunnermeier also featured a limit on short-selling, as did another by Jose Scheinkman and Wei Xiong. In a short sale, an investor borrows an asset such as a stock or bond and sells it, hoping to buy it back for less to return to the lender and pocket the difference as a gain.
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Read more:
How the world’s governments are handling cryptocurrencies
'It was fun but I would never do it again’: UAE Bitcoin investors confess
Rookie crypto investors are ignoring the risks
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In 1997, Andrei Shleifer and Robert Vishny proposed to make this sort of constraint, which they grouped under the general heading of “limits to arbitrage,” a unifying theory of financial market failures. Research on just why and how smart, well-informed traders are unable to cancel out bubbles continues to this day.
Limits to arbitrage can help explain why Bitcoin has been so bubble-prone. Until recently, it was easy enough to take a long position, but expensive and risky to bet against the cryptocurrency. Things really changed in December, when US regulators allowed the trading of Bitcoin futures. That move came in the middle of a historic runup in the price of Bitcoin and other cryptocurrencies. But as soon as futures contracts began to trade, an interesting thing happened - futures prices suggested that Bitcoin’s growth would slow.
What happened next is historic. Bitcoin’s price crashed from a high of about $19,000 to less than $7,000 as of the writing of this article.
Was this a coincidence? Maybe. The huge surge in demand for Bitcoin both inflated the bubble and caused a demand for a futures market. But the timing of the crash, right after the introduction of futures markets, is eerie. It mirrors the result of a 2006 paper by economists Charles Noussair and Steven Tucker, who introduced a futures market into a trading experiment.
We find that when futures markets are present, bubbles do not occur in [our experimental asset] markets. The futures markets seem to reduce the speculation and the decision errors that appear to give rise to price bubbles in experimental asset markets.
A few students trading an imaginary stock in a laboratory is not the same as millions of real people trading tens of billions of dollars worth of Bitcoin. But this is a case when theory, lab experiments and practical experience align to a spooky degree. The housing bubble is another example where betting against the asset in question was extremely difficult.
This suggests that there’s a good and easy way for regulators to reduce the incidence of bubbles. Whenever a new asset is created or a bunch of new investors enters the market, allow more futures trading and other exchanges that let pessimists publicly register their pessimistic beliefs. That won’t totally prevent all bubbles - the late 1990s technology stock bubble, for instance, happened in spite of the existence of stock futures markets.
But it would certainly help. Keeping pessimists out of the market is a recipe for repeated bubbles and crashes, as overoptimistic speculators rampage unchecked. Given a level playing field, the bears can restrain the bulls.
Noah Smith is a columnist for Bloomberg View
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Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.
Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.
“Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.
Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.
“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.
Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.
From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.
Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.
BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.
Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.
Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.
“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.
Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.
“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.
“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”
The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”
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