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The Bitcoin bubble, Venezuela, and political risk

Regardless of mainstream reservations, rampant speculation, and a near-certain chance of bust, Bitcoin is here to stay. Cryptocurrencies will transform the way we identify, manage and mitigate political risks across borders – and Venezuela offers a perfect case study.

Understanding the hype

Regular descent into what is only retrospectively described as insanity has been a feature of capitalism for centuries. Speculative euphoria is not new, and won’t die with Bitcoin or its numerousoffshoots.

In any boom or bust cycle, there is always a period of exceptionalism. There is always a reason to suspend our rational faculties over a new commodity, a technological upgrade, a novel financial product. In other words, there is always a timely excuse why this product is different and why it can’t be like anything else.

Today, Bitcoin is that product. The hype surrounding initial coin offerings, mining, block chains and crypto assets is unprecedented – and also incredibly complicated.  We speculate on assets like bitcoin, however, because it’s part of our human nature.

Bitcoin holders are doubling and tripling their initial investment in weeks. Our tendency to believe good times will last forever is frequently magnified by confirmation biases – an innate impulse to collect only the data that confirms one’s existing beliefs. Which explains why Bitcoin holders are swayed by Saxo Bank’s 2018 forecast predicting Bitcoin will reach US$60,000, instead of listening to cautionary remarks by one of Wall Street’s CEOs.

The habit is compounded by what Nobel laureate Daniel Kahneman, describes as intuitive heuristic. When faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution. For instance, “should I invest in Bitcoin?” (which should involve understanding the inner workings of blockchain and price discovery momentum) is replaced by “do I like Bitcoin?” (an appealingly anti-establishment product that everyone is making money on ).

This period can continue for as long as people believe that there is something magical or new about the valuation of cryptocurrencies. There’s no guarantee Bitcoin won’t reach US$1 million, just as there is no guarantee the bubble will burst tomorrow. But if it bursts – and it most likely will – it is very unlikely to go away.

The Dutch tulip mania in 1673, did not spell the end of the flower. The dot-com bubble in 2001 didn’t destroy the internet. The one exception, however, might be Beanie Babies – the 1990s craze that saw one purple stuffed elephant sold for US$3,000.

Bitcoin in Venezuela

Venezuelans are not newcomers to cryptocurrencies. The country has one of the highestconcentrations of Bitcoin miners in the world thanks to electricity subsidies that render the power-crunching practice widely affordable. Yet electricity is perhaps one of the few things Venezuelans are able to afford in a country grappling with widespread food and medicine shortages.

Venezuelans are living though the worst hyperinflation since post-WWI Germany. A third of all Venezuelans reported an average of 8kg in weight loss this year due to rising food prices. The International Monetary Fund further estimates 2018’s inflation rate will reach 2,3000% alongside a 12% contraction in gross domestic product.

Adding to hyperinflation and food shortages is the overall scarcity of cash in the country. Hence, even when accounting for recent volatility in Bitcoin and its many offshoots, it is not difficult to understand why Venezuelans are trading Bolivars (Bs.F) for Bitcoin.

Cryptocurrencies are widely available to anyone with a smartphone, unwound from central banks, which regulate the overall availability of cash. They also allow remittances to bypass state-mandated transfer and convertibility laws that might either prohibit the transfer, or set a conversion rate that would discourage remittances. Bitcoin likewise trades in public spaces: anyone can readily see what a Bitcoin is worth at any point in time (this particular feature resonates in Venezuela where it is illegal to publish the free-market value of the Bolivar).

Enter the Petro

If cryptocurrencies have a lot to offer average Venezuelans, they are also, and for different reasons, appealing to authoritarian regimes.

President Nicolas Maduro announced early December 2017, his intent to launch an oil-backed cryptocurrency called the ‘Petro’. He made no effort to hide the fact that the Petro would circumvent US financial sanctions on Venezuelan government officials and the country’s debt issuance.

Indeed, the Petro could theoretically help President Maduro get around current and future sanctions because it provides an alternative path for sending money. This doesn’t mean global oil and commodity contracts will be based on the Petro anytime soon, but President Maduro’s desire to avoid dollar transactions is not new, and other countries such as Russia and China share his view.

Moreover, the reason it probably won’t be the Petro reflects another form of political risk, in that the Petro will likely be a hotbed of corruption. Part of what makes mainstream investors wary of Bitcoin is its perceived vulnerability to corruption inside the community, and to cyber-attacks that would compromise its value.

Impact on country risk

Be it the Petro or any other cryptocurrency, the rise of peer-to-peer currencies will have an indelibleeffect on country risk at transaction level. Exchange rates, interest rates and rollover risks are all likely to be affected. International monetary regulations will now have to factor in a currency outside a state’s financial policy, or a central bank without a chairperson. The true scale of these risks is hard to assess at present, for very much the same reason the bubble continues to grow: Bitcoin is unprecedented.

This article first ran on Global Risk Insights, and was written by Conrad Petraitis.

 

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