Beyond the Bitcoin Bubble, the Benefits of Blockchain

08/03/2018

Summary

As a currency and asset class, bitcoin has potentially fatal flaws – which is why we believe it’s a matter of when, not if, the bitcoin bubble will pop. Yet the blockchain technology that powers cryptocurrencies could bring significant benefits to investors.


Key takeaways

  • Between December 2017 and February 2018, bitcoin’s price fell by around half, but this probably isn’t the end of the bitcoin bubble
  • Bitcoin meets all of the essential criteria for any asset-class bubble, including overtrading, a lack of regulation and the potential for swindles
  • Bitcoin has no intrinsic value: it is a claim on nobody – unlike sovereign bonds, equities or paper money – and doesn’t generate any income
  • We don’t view bitcoin as a currency due to its high transaction costs, tremendous price volatility and inability to be a true store of value
  • Despite our concerns about bitcoin, its underlying blockchain technology has merit – particularly its ability to reduce financial-transaction costs

The weeks before Christmas 2017 marked the heyday of bitcoin speculators. Bitcoin futures made their trading debut at two of the world’s leading options exchanges – the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) – and prices in the spot and futures market hit an all-time high on 18 December, closing in on USD 20,000.

Yet soon thereafter, prices plummeted and never recovered: at approximately USD 10,000 at the end of February, one bitcoin is now worth about half of what it was only two months ago.

So is this the end of the hype about bitcoin as the future of global currencies? Probably not yet, since speculation in bitcoin and similar instruments appears set to continue for some time. Yet from our perspective, bitcoin has serious flaws: its trajectory resembles a textbook case of a financial-market bubble, and it is lacking several key qualities that would qualify it as a currency.

Bitcoin’s bubble behaviour

The hyperbolic price movements of bitcoin since its early 2009 inception have been very bubble-like in nature. When one compares bitcoin’s five-year price momentum (adjusted for inflation) against that of previous asset bubbles, bitcoin dwarfs the runners-up – the Mississippi bubble of 1720 and the Amsterdam Tulip Mania of 1637. And among more recent examples, bitcoin far surpasses the IT bubble of the 1990s and the Japan bubble of the 1980s.

Compared with Other Bubbles, Bitcoin Is almost off the Charts
Five-year price momentum of bitcoin vs. historic asset bubbles; priced monthly; logarithmic scale

 

Source: AllianzGI; Datastream; Peter Garber (1990), “Famous First Bubbles”; Federal Reserve Economic Data; Robert J. Shiller (2000), Irrational Exuberance; Earl Thompson (2007), “The Tulipmania: Fact or Artifact?” Data as at January 2018.

Moreover, bitcoin ticks all of the boxes that we consider to be essential criteria of any asset bubble:

  • “New-era” thinking. Bitcoin is perceived to be an entirely new kind of currency and a monetary innovation in the internet age.
  • Overtrading. Trading volumes have increased by almost fivefold in the last five years, according to BIS data.
  • Ultra-easy monetary conditions. Accommodative policy is still in place globally, despite a series of rate hikes by the US Federal Reserve.
  • A lack of financial regulation. The “Wild West” bitcoin environment is only gradually being addressed by regulators around the world.
  • The launch of related financial instruments. New products related to the bubbling asset class are popping up – from CBOE and CME futures contracts to the launch of “ICOs” (initial coin offerings).
  • Rising leverage. Not only has private-sector leverage increased to record highs globally, but leveraged speculation in bitcoin is increasing.
  • Swindles. Bitcoin has become the instrument of choice for many criminals, thanks to its ability to exist entirely outside of traditional banking channels.
  • Significant overvaluation. Many other asset classes are pricey in today’s market, but bitcoin’s valuation seems to be without peer.

This brings us to a key question: what is the fair value of a bitcoin? In our view, its intrinsic value must be zero: a bitcoin is a claim on nobody – in contrast to, for instance, sovereign bonds, equities or paper money – and it does not generate any income stream. Admittedly, one could make the same argument about gold, but gold has been widely accepted by humankind as a thing of value for more than two-and-a-half thousand years – compared to less than a decade for bitcoin.

One could argue that bitcoin’s price developments are indicative of a certain amount of overheating in other asset classes:

  • The S&P 500 index’s cyclically adjusted price-to-earnings ratio is around twice its long-term average.
  • Spreads in many high-yield and investment-grade bonds globally are razor-thin.
  • House prices are significantly overvalued in many markets that were not severely hit by the global financial crisis in the first place – notably Canada, Sweden, Australia and Hong Kong.

Nevertheless, despite the fact that bitcoin is not the only overvalued asset class, it appears to us that bitcoin mania is a textbook-like bubble – and one that is probably just about to burst.

So would the end of the bitcoin bubble matter for investors in conventional asset classes, such as fixed income or equities? We don’t believe so. In our view, bitcoin’s demise would have few spillover effects on the “real world”, since the market for this cryptocurrency is still quite small in size. As a result, we believe that the risks to financial stability stemming from bitcoin are negligible – at least as of today.

Not a currency – and not ESG-friendly

So if bitcoin is flawed enough not to be considered a proper asset class, can it at least serve the purpose of being a currency? We believe the answer is no for several reasons:

  • First, given the high cost of conducting transactions in bitcoin, it could only be used for paying big-ticket items.
  • Second, given bitcoin’s tremendous price volatility, it does not qualify as a numeraire – a commonly accepted benchmark used to assign value to goods and services.
  • Third, considering all the arguments we have previously presented, it seems all but impossible to use bitcoin as a store of value.

Moreover, if we consider environmental, social and governance (ESG) factors, bitcoin is certainly not an instrument we favour. The energy consumption related to bitcoin production in a single year is equivalent to the annual energy consumption of Ireland – a worrisome trend that seems to be rising.

Blockchain has its benefits

Despite our concerns about bitcoin, its underlying blockchain (or distributed-ledger) technology clearly has potential merits – not least of which is blockchain’s ability to reduce significantly the costs of verifying transactions and networking. This is prompting a range of financial institutions, including central banks, to explore blockchain more closely and to evaluate practical applications – including conducting financial transactions.

It is this aspect of cryptocurrencies in general – and not the specific cryptocurrency du jour – that we as an asset-management firm find to be the most interesting.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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Building the case for green bonds

14/03/2018

Summary

The global green bond market has been booming over the last years with an exponential growth of new issues from various types of new actors. It has reached approximately USD 250bn with already more than USD 150 bn of new issuance last year.

After 2013 when corporates started to use the asset class in order to finance their energy transition, sovereigns are now coming to the market following the path initiated with Poland which paved the way in December 2016. During 2017, France became the second nation to issue a sovereign green bond before Fiji became the first Pacific Island nation and emerging economy to do so.

Green Bond new issues by type of issuer from 2013 to 2018 (USD bn)

Source: Allianz Global Investors, Climate Bonds Initiative. Data as of 13/02/2018

Defining the green bond market characteristics

Green bonds are standard bonds with a use of proceeds fully dedicated to projects with environmental benefits focusing on climate change mitigation/adaptation. They can be issued by public or private sector entities and respond to a desire for products offering the opportunity to finance projects with tangible positive impacts. There is currently no clear difference in pricing between green and non-green bonds from the same issuer with the same maturity. The global green bond market yield and duration are today quite close to those of the global core fixed income market.

Source: Allianz Global Investors, Bloomberg, Global Green Bonds represented by the Bloomberg Barclays MSCI Green Bond index, Global Aggregate represented by the Bloomberg Barclays Global Aggregate Index. Data as of 08/03/2018

In terms of performance, the historical correlation between a global green bond and a global aggregate benchmark is very strong, more than 90%. The green bond universe, represented by the Bloomberg Barclays MSCI Green Bond index even tends to outperform the broad global bond market measured by the Bloomberg Barclays Global Aggregate Bond index over the last years with a comparable volatility as illustrated below (Returns hedged, in USD for the 1st graph, in EUR for the 2nd):








Source: Allianz Global Investors, Bloomberg, Global Green Bonds represented by the Bloomberg Barclays MSCI Green Bond index, Global Aggregate represented by the Bloomberg Barclays Global Aggregate Index. Data as of 07/03/2018

How to integrate green bonds in an asset allocation?

Considering the high correlation between green bonds and core fixed income, investors have the possibility to reallocate part of their core fixed income allocation to green bonds in order to increase diversification and “green” their portfolio with a minimal impact on the risk/return profile of their portfolio. Diversification can notably be achieved thanks to the differences between both universes notably in terms of currency or sector exposure. Issuers from the Corporate sector represent for example 32% of the green bond universe vs 18% in the Bloomberg Barclays Global Aggregate Index. Green bonds are therefore an opportunity for investors to integrate climate risk mitigation in a core fixed income allocation without changing too much the overall risk/return profile of their portfolio.




Source: Allianz Global Investors, Bloomberg, Global Green Bonds represented by the Bloomberg Barclays MSCI Green Bond index, Global Aggregate represented by the Bloomberg Barclays Global Aggregate Index. Data as of 08/03/2018

Why does active management matter?

An active manager has the capacity to generate financial and societal alpha through the green bond selection process. On the green bond market, it is essential to be able to run an analysis to identify bonds financing projects with a clear positive impact on the financing of the energy transition. As of today, not all green-labelled bonds do have this clear positive impact.

In a recent example, an oil and gas company issued a green bond aimed at funding projects focusing on energy efficiency and low emissions technologies. The bond proceeds were used to reduce the CO² emissions of the company’s chemical and refinery facilities. While this company’s bond did not directly invest in increasing fossil fuel output, refineries are still processing fossil fuels and any investment in making refineries more efficient, as this bond is aiming to, will likely extend plant operating lifetimes and therefore indirectly increase emissions over time. It is the role of the active manager to evaluate whether or not this kind of bond can be considered as eligible in a green bond strategy.



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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