Investing

Yes, Bitcoin Is A Speculative Frenzy. No, It’s Not Going Away.

Bitcoin has had a meteoric rise. The price per coin has risen almost 100% year-to-date and close to 500% over the last twelve months. It’s 52-week range is an astounding $3,966 to $57,805 as of this writing. Such a run stirs memories of the 1999‒2000 U.S. internet bubble or even Amsterdam’s tulip speculation craze of 1637. While it is true that Bitcoin lacks any structural ties to a fiat government currency, it does have its merits. In fact, events so far this year are increasing the likelihood that Bitcoin is here to stay.

Bitcoin was originally introduced by the ephemeral Satoshi Nakamoto, author of the Bitcoin: A Peer-to-Peer Electronic Cash System white paper in 2008. To this day, it is unclear if Nakamoto is a single person, a group of authors, or a nom de plume. Initially, it appeared Bitcoin was almost an academic exercise for a small community of global cryptographers. The first Bitcoin, created in January 2009, was essentially worthless.

However, from the outset, it was clear that Bitcoin had several valuable attributes. First, and perhaps most significantly, there is a finite amount of it. Bitcoins are issued when a new block of code is created by ‘miners.’ Currently, there are approximately 18.6M Bitcoins in existence. The production of Bitcoin will cease when the total amount reaches 21M, which is likely to occur in 2140. This is because of the way the Bitcoin blockchain is configured. Every ten minutes, miners discover a new block by solving a cryptographic puzzle, in return for which they receive a fixed reward that halves periodically, reducing the reward toward zero. The most recent halving occurred in May 2020.

In contrast to fiat currencies, which have an ever-expanding supply, Bitcoin is scarce. As such, it should act as a good store of value and offer protection from inflation and currency devaluation, one reason why it is so popular in emerging markets such as Nigeria, Vietnam, and Turkey. This is also important given the current U.S. situation: in response to pandemic-induced economic challenges, there has been significant fiscal and monetary stimulus. The U.S. Federal Reserve’s balance sheet has doubled over the past year to ~$7.5T.

Second, Bitcoin is global and decentralized. It operates outside of traditional currency systems, making it harder for a single government actor to influence it. While tighter regulation, particularly in the U.S., is a risk, Bitcoin’s decentralized nature should insulate it from the vagaries of government policy. Third, although some digital wallets and crypto-exchanges have been hacked, Bitcoin’s utilization of complex encryption and a public and private record of ownership make it relatively secure.

These attributes have solidified Bitcoin as a viable cryptocurrency. It appears here to stay. This has led to increased institutional adoption, which has accelerated over the past twelve months for the following reasons.

First, more than 50% of Bitcoin transactions occur in U.S. dollars. The majority of global participants still view the U.S. dollar as the most ubiquitous and frictionless currency, encouraging Bitcoin’s adoption.

Second, it is becoming easier for retail participants to trade and invest in Bitcoin. Initially, investors were required to create digital wallets at exchanges such as CoinBase and personally track their encryption codes. Now, the likes of PayPal
PYPL
and Robinhood offer Bitcoin trading on their platforms. And it is likely that other large brokerage firms and financial institutions will offer their customers the ability to buy and sell Bitcoins in the future. As this occurs, more new investors should begin to trade the digital currency, cementing its status as a valid financial instrument.

Third, the U.S. corporate world has begun to participate in the Bitcoin ecosystem. This helps legitimize Bitcoin and engenders trust, which underpins our entire monetary system, in the asset. There have been numerous recent examples: Mastercard
MA
recently announced it will support select cryptocurrencies directly on its network, Square
SQ
said in December 2020 that its Cash App customers could receive Bitcoin instead of U.S. dollars from transactions, and Visa
V
recently posited that it will offer crypto software in 2021 to help banks and other financial institutions with digital currency adoption. In addition, The Bank of New York Mellon
BK
, my former employer, the largest custody bank globally, announced in February that it will offer digital asset services allowing its customers to store and trade cryptocurrencies through their sizeable custodian platform.

This is a strong stamp of approval from Wall Street. Increased institutional adoption, combined with Bitcoin’s relatively low correlation with traditional asset classes, suggests to me that it should be included in investors’ asset mix going forward. Though I would suggest, particularly for individual investors, limiting it to a relatively small portion of your total asset allocation.

None of this means that volatility has left Bitcoin prices for good. It has had numerous drawdowns of 20% or greater, with some as large as 80%. While I think another 80% drawdown is improbable in the near future given the number of new supporters and participants, I do think the most recent price spike makes a 20‒30% drawdown likely. To put that into perspective, however, a 20% move would put Bitcoin’s price back near $45,000. So for those looking to invest in Bitcoin, I would suggest scaling into the digital currency gradually.

Ruhell Amin, Equity Research Analyst at William O’Neil + Company, an affiliate of O’Neil Global Advisors, made significant contributions to the writing for this article.

DISCLOSURE:

No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

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