Bitcoin rally sends 3 signals to govts

Bitcoin's price has tripled in just three months, bringing the last 12-month appreciation to more than 400 per cent. Analyzing this rally from the perspective of investors is a good way to understand what has driven this impressive rally and what it says about global finance and money. It also has important messages for governments and central banks, particularly in Europe and the United States, where several officials have warned about the Bitcoin phenomenon.

The widely covered announcements by Tesla and Square that they were buying Bitcoins highlight a broadening process of adoption. More companies are having to consider the possibility that Bitcoin is evolving into a more widely used form of payment and store of value, two key characteristics of money. With that comes a clear message to the public sector, especially in countries with currencies that are used worldwide such as the dollar and the euro: Take a lot more seriously both the technology underpinning cryptocurrencies and, on the more worrisome side, the potential of a growing migration away from traditional money and its implications for the effectiveness of monetary policy and the ability to profit from issuing currency ("seigniorage").

The second driver of Bitcoin's meteoric rise has come from those attracted to it not for positive reasons, such as Tesla and Square, but for negative ones instead. Several are in play here. Some fear inflation and currency debasement. Others have been pushed to Bitcoin in search of a financial risk mitigator when yields on government bonds are low, though a little less so recently, and when their traditional negative correlation with risk assets, such as stocks, has weakened significantly. With that comes higher threats to future financial stability as the risk-mitigating positioning now attracts a more volatile component.

Speculator flows have driven the third influence. Bitcoin is part of a set of assets seen by some as providing the possibility of quick outsized gains. This is part of a more general phenomenon of excessive risk-taking that is playing out in many segments of the financial markets — from record debt issuance and the notable compression of risk spreads on the lowest-rated high yield bonds to the proliferation of celebrity SPACs and the meme stock phenomenon. Here, once again, the message to governments and central banks about the risk of future financial volatility and instability is far from reassuring.

At Bitcoin's birth and during its early childhood, too many were quick to dismiss the phenomenon as short-lived and irrelevant, if not prone to fraud. They have been proved wrong so far. Today, too many officials are inclined to look at in the cryptocurrency in a rather narrow way. They shouldn't. What is happening to the price of Bitcoin is indicative of broader developments that are relevant to the design and effectiveness of policies. (Bloomberg)