Is Bitcoin A Risk To Wider Financial Markets?

It’s up, it’s down, it bounces all around. But what of those who are not invested in Bitcoin? Those who are looking forward to 2018 and wondering what will happen in ‘normal’ financial markets – does Bitcoin matter to them? Possibly.

There has been plenty of debate on whether cryptocurrencies are ‘systemically important’ – i.e. whether they pose a risk to wider financial markets if (when?) they crash. Garrick Hileman, an economic historian at the University of Cambridge says he ‘can imagine scenarios…where they do become systemically important", while being clear that this is not his central thesis.

In theory, of course, Bitcoin and the other cryptocurrencies are tiny – it creates no systemic risk if one company’s share price slumps, in the same way it didn’t cause a problem when Provident Financial or Dixons Carphone saw savage falls earlier this year. Cryptocurrencies are just another sector, as vulnerable or invulnerable to highs and lows as any other.

Much of the debate focuses on the extent to which investors have borrowed to invest on cryptocurrencies. Richard Buxton, chief executive at Old Mutual Global Investors, says: “Bitcoin, of itself is too small to pose a systemic risk. However, it would depend on how much leverage there is based on it.” It is through leverage, via derivatives, that problems spread through the financial system.

Certainly there are signs of leverage being introduced. The Financial Times recently reported that bitFlyer, the Tokyo-based Bitcoin exchange, is seeing leverage of up to 15x. Trading on bitFlyer is roughly 25 per cent in actual bitcoin and 75 per cent in derivatives.

This would be worrying, but at the moment, Bitcoin derivatives are nascent. In October, LedgerX, an institutional trading and clearing platform, began trading bitcoin options and then the Chicago Mercantile Exchange and Cboe rolled out bitcoin futures. The next logical step is Bitcoin ETFs, though regulatory approval has proved elusive. Should this be approved, it becomes easier to introduce leverage, but this hasn’t happened yet. Buxton believes this is a far greater problem for other ETF-assets, where if all investors press the sell-button, the weaknesses will be exposed.