Financial Mail - Investors Monthly
TRACING THE UPS AND DOWNS OF BITCOIN
Cryptocurrency’s best-known brand is hugely volatile but is gathering support as a safe-haven alternative to gold, writes The Finance Ghost
We find ourselves in a parallel universe, where stimulus (“stimmy”) and currency debasement is driving asset prices while much of the underlying economic data continues to keep finance ministers up at night.
With the largest derivatives market in the world, there is a locust swarm of inexperienced traders in the US who are using risky, highly leveraged instruments to take positions in stocks. If you’ve seen any of the videos doing the rounds on social network TikTok, you’ll realise how clueless many of these investors are.
Within their ranks, though, there are experienced and talented traders making eyewatering amounts of money. Recent events around the Reddit social media platform, the GameStop short squeeze and the incredible profits made by “Roaring Kitty” (real name Keith Gill), among others, will define an era in the market and create legal precedent.
Of course, increased participation by retail investors in the market is great. That’s what we all want to see, as people take an interest in trading and investing and learn along the way. However, the volatility we are now seeing in certain asset classes is extraordinary.
The problem with extensive stimulus is that many recipients use it to make risky bets. If you’re going to trade with money given to you by the government, you may as well shoot for the stars, right? Human psychology 101.
So it’s unsurprising that cult companies like Tesla or assets like bitcoin broke records in late 2020. While Tesla seems to have consolidated its gains, bitcoin continues to jump around like a Jack Russell after a long drive in a car.
These two assets are linked now, after Elon Musk punted $1.5bn of Tesla shareholders’ money into bitcoin. While it is debatable whether Musk’s play could be termed “institutional acceptance”, there is a growing need for serious investors to form a view on bitcoin and crypto in general.
The market capitalisation of all coins in issue is more than $1.3-trillion. These coins can
Positive sentiment towards blockchain technology tends to have a knock-on effect on the prices of the leading coins, even though they are distinct concepts
Bitcoin got off to an incredible start in 2020, adding another 50% to its price in the first six weeks or so
experience double-digit swings daily, but that’s a big number regardless. As a reference point, the value of all mined gold is estimated to be somewhere between $10 and $13trillion.
Bitcoin is responsible for nearly two-thirds of the total value of all coins. In a distant second place, we find ethereum at about 15% of the total market. Beyond that, it’s the Wild West.
Coinmarketcap.com lists no fewer than 8,417 different coins. If ever there was an asset class with a long tail, this is it. Much like a Google search, it’s probably not worth looking beyond the first page of results.
There is a bigger blockchain story as well, with the technology widely expected to disrupt existing industries. Financial services intermediaries face the greatest risk of disruption, with a decentralised ledger potentially able to remove various links in the payments chain. Banks and advisory firms have hired specialists in this area to advise on how industries may be affected by this technology.
Positive sentiment towards blockchain technology tends to have a knock-on effect on the prices of the leading coins, even though they are distinct concepts. Coins work using blockchain technology, but blockchain technology doesn’t necessarily need these specific coins to be useful.
Despite the clearly risky backdrop, some institutional investors and respected Wall Street names have been climbing into bitcoin in particular. Ethereum is used by investors to take a view on blockchain’s transaction opportunities, specifically designed to drive utility in this space.
Bitcoin is not great for small transactions but is the most secure of all coins, so it is seen more as a store of value or an inflation hedge, which makes more sense as part of institutional portfolios. This institutional interest is relatively new. It wasn’t there in 2017 when the world went bitcoin-mad for the first time.
During that bubble, social media feeds were full of people trading in bitcoin, with their only other confirmed business experience being a leading role in the high school boerewors sale. Uber drivers recommended bitcoin to their clients. Cringeworthy videos emerged online, selling structures that were as false as the white teeth that dominated those videos.
Bitcoin rallied to nearly $20,000 in 2017, a 20-times return in a single year. By the end of 2018, it was back to $4,000 and there was blood on the streets.
Bruised and broken, the high school boerewors investment club moved on to forex options.
2019 was a far more sensible year for bitcoin after the mess of 2017/2018, with steady gains rather than a parabolic increase followed by disaster. Ending the year at more than $7,000 meant bitcoin investors nearly doubled their money in 2019, a remarkable return though tame by bitcoin standards.
Bitcoin got off to an incredible start in 2020, adding another 50% to its price in the first six weeks or so. Despite supposedly being a safe-haven asset that one would flock to in event of crisis, bitcoin didn’t fare well in the March 2020 market crash. From midFebruary to mid-March, it fell more than 50% to below $5,000. It recovered to pre-crisis levels by September 2020, before an outrageous rally until early January 2021 that peaked at $40,000.
There aren’t many certainties with bitcoin, other than the certainty of volatility. It’s a dream trading instrument for those who thrive on sharp market moves. After making headlines for breaking through $40,000, bitcoin was back below $31,000 less than two weeks later.
“But this time, it’s different,” must rank among the most famous of last words in the investment industry. Could it be different just because institutions have entered the fray? Has the bitcoin market started to mature?
BlackRock, the world’s largest asset manager, has filed paperwork to add bitcoin futures as eligible investments in two funds (BlackRock Strategic Income Opportunities and BlackRock Global Allocation Fund).
The Grayscale Bitcoin Trust has enjoyed substantial inflows and looks after more than $11.5bn in bitcoin. Grayscale reports that more than 80% of those funds comes from institutional investors.
The largest institutional investor in Grayscale is believed to be ARK Invest, the asset management firm that has turned Cathie Wood into a household name among invest
PayPal has been a major driver of bitcoin’s valuation, incorporating crypto into its business, including in its popular peer-to-peer payments app, Venmo
ment professionals. Chasing the most hyped-up of all companies and focusing on justifying their enormous multiples, ARK also has significant bitcoin exposure in its Next Generation Internet ETF.
It’s not just asset managers. Software firms MicroStrategy and Square have also pumped money into buying bitcoin. PayPal has been a major driver of bitcoin’s valuation, incorporating crypto into its business, including in its popular peerto-peer payments app, Venmo.
Against this positive backdrop, there are negative stories such as the ongoing investigation into Tether, which started as a “stablecoin” pegged to the US dollar but has since become opaque and complicated. Many believe arbitrage trading with Tether has been a recent driver of the bitcoin price.
In terms of institutional asset management, the obvious comparison is gold as the world’s accepted safe-haven asset. While bitcoin surged 50% in the opening weeks of 2020, gold added around 6.5%. However, gold fell only 12% in response to the lockdown crisis, while Bitcoin halved.
Gold is clearly less volatile than bitcoin and comes with decades of familiarity among institutional managers. Leaving bitcoin’s potential transactional value aside (which remains unproven and is probably more appropriate for ethereum anyway), the coin’s bull case is largely rooted in its position as an alternative to gold.
JPMorgan strategists noted in January they believed bitcoin could trade as high as $146,000 if it achieves widespread acceptance as a safe-haven asset. To form your own view, you would need to assume how much of gold’s safe-haven value shifts to bitcoin instead. Using bitcoin’s digital scarcity (limited to 21million coins), you can work out a price from there.
This is the simplest method and probably the most logical. Another potentially sensible approach is to look at the cost of production. Each bitcoin is harder to mine than the last, which is why it will take a long time to mine the remaining few million bitcoins.
This comes with a huge cost of computing power and electricity (making bitcoin terrible for the environment, something that Musk has conveniently ignored) which needs to be recouped by the value of bitcoins mined. If the value drops, mining slows down and scarcity goes up. If this can be properly estimated, it may provide a useful price floor.
Other methods try to use velocity of money or Metcalfe’s Law (a framework for trying to value a network effect). Good luck with those.
While there is a concern that bitcoin could simply go to zero, this is also true for equities. Just ask Comair shareholders. The risk of going to zero is arguably an argument for diversification, not for avoidance.
Perhaps the best bull case is that bitcoin appeals to millennials in the same way that gold appeals to older generations.
In both cases, the assets have value because people believe they have value. Only a small percentage of gold is used for industrial and jewellery applications.
The technology sector has minted numerous millionaires over the past decade, many of whom are young.
Tech enthusiasts and entrepreneurs love anything disruptive, so they naturally gravitate towards bitcoin and blockchain technology. To further compound the effect, many of the younger investors with stimmy in their pockets will simply follow whatever their tech heroes are doing.
Combined with institutional interest, this is a powerful underpin for bitcoin. Despite the huge volatility in bitcoin, the multiyear trend is becoming more difficult to ignore.