By Tom Wickers, Hottinger & Co.
Bitcoin peaked at $49,376 last week. To put that into context that is almost a quintupling of price in a year[i]. Were there many other assets that provided similar returns over that period? Surprisingly there were plenty. Tesla, Wayfair and Novavax are a few of the stocks that have rocketed for one reason or another and retail investor influence on the likes of GameStop will be infamous for years to come. To avoid appearing as a disgruntled non-participant, I will refrain from making the association between some of these investments and jaunts to your local bookies. In seriousness, it is the job of reasonable investors to continually reassess whether they have missed a trick and whether there are more tricks to be had. Announcements of adoption from the likes of Paypal, Mastercard and Elon Musk have led to prolonged upwards price momentum and hope of widespread use. As such, Bitcoin has once again captured the attentions of media, companies and investment houses and the same question plays on most of their lips; are we seeing a repeat of 2017 or something more?
Figure 1: The price of Bitcoin in USD. Cryptocurrencies have recently reached prices of over twice their 2017 “bubble” peak.
Cryptocurrencies have been in circulation for over ten years. Since then, they have amassed a total market value of over one trillion dollars[ii], a large part of which has accumulated in the past six months. The details of crypto creation and transactions are complex, however the same can be said for our traditional and electronic money systems. Regardless of the structure or blockchain used, cryptocurrencies aim to do the same thing – make transactions more direct, efficient and decentralised, much like what the majority of fintech companies aspire to do in their respective sectors. Unfortunately, these valuable attributes act as a double-edged sword in several ways. For example, the removal of governance means that crypto has developed a shady reputation for housing fraud and money-laundering.
Crypto transactions are anonymous and generally cannot be reversed, which is risky for the average consumer and creates frictions with the direction financial regulation has been moving. Contrarily, an early study on the past year of financial crime in cryptocurrency estimates that only 0.34% of transactions were related to criminal activity, the lowest proportional figure in recent years and lower than 2019 in nominal terms[iii]. The concern hidden within these figures is that two criminal activities which benefit greatly from transaction anonymity have continued to grow: the darknet and ransomware. Artificial Intelligence monitoring has been suggested as a potential remedy, yet it remains to be seen whether regulators and cryptocurrencies can resolve the policing conundrum whilst retaining decentralised identities and low transaction cost. Regulation, classifications and investigations have been expectedly prevalent and are widely predicted to be cryptocurrency’s making or undoing. Backing from regulators and governments would be a powerful device for widespread adoption and reductions in volatility. Nonetheless, endorsement will not be given lightly and may only be given to an asset that is structurally quite different to the current main players in the market.
Cryptocurrencies are pitched as the next gold. Bitcoin has a finite nature with a maximum of 21 million coins to be allowed in circulation and is not tied to a currency. As such, like gold, crypto should be disassociated from inflation, monetary policy and potentially from economic shocks. Should volatility stabilise, the traits of Bitcoin could become a gold substitute and some analysts put a $500,000 price tag on the coins in this scenario[iv]. Inflation disassociation may be on the cards, however, cryptocurrencies will always be reliant on government policy, perhaps more so than traditional assets. To say that a cryptocurrency is and will be fully decentralised is to live in an anarchic wonderland. Bitcoin and Ethereum may be global in aspirations, but governments still have control over marketable products and the restrictions placed on them. As such, cryptocurrencies still hold large amounts of political risk. China possesses more than 50% of the world’s cryptocurrency mining capacity[v]. If their infrastructure were hampered indirectly or directly through regulation, there would be severe disruption to transaction recording and prices. This highlights that the risk in cryptocurrencies is not just in regulators but also in large crypto institutions. Mining is oligopolistic in nature, and transactions are facilitated through concentrated mechanisms and exchanges. Tether, a stable coin tied to the dollar using asset-backing, accounts for the majority of trading between cryptocurrencies and effectively facilitates the market at the moment. Tether is also under investigation in New York under allegations of fraud and there could be wide-ranging ramifications for all cryptocurrencies should any lines of thread begin to unravel.
Figure 2: 30-day price volatility of currencies and assets. Bitcoin has long demonstrated extreme levels of volatility, even when compared to small cap equities and the South African Rand.
As mentioned, a key requirement for cryptocurrency to reach its full potential as an alternative asset class is volatility stabilisation. However, as shown by Figure 2, the volatility of Bitcoin is still on average more than four times as high as that of other volatile currencies and assets. This is because the current valuation of Bitcoin is not dissimilar to that of a many unicorn stocks; there is a division between investors as to whether it should hold any intrinsic value at all. It is easy to see the argument for zero value; cryptocurrencies are generally not backed by an asset, making them a digital figure with no government support. That said, it should not be forgotten that value is fickle. It does not need to depend on input materials or labour, but relies upon the beliefs of the many, which has been demonstrated globally in several cases of hyperinflation over the years. The more investors that believe in a value, the less volatile the price will be. The difficulty for cryptos in achieving ‘stable status’ is that other value stores, the likes of cash and gold, have either had government support to help assure their value or have had the benefit of indoctrination over millennia. Adoption by some institutions goes some way to providing the required price confidence Bitcoin needs, yet the current commitments are supple and but one step in what will continue to be a difficult climb.
To call the recent performance of Bitcoin a bubble is audacious. Not only are bubbles difficult to label until they burst, the anonymous nature of crypto transactions makes it even harder to determine alarming investor behaviour. Metrics such as active addresses and trade volumes appear mostly healthy[vi], but could easily be fabricated by a few big players. Equally, Bitcoin’s continued rise to become a financial staple is not as certain as some analysts and investors may like to think. Instead, crypto should be acknowledged for what it is, a highly speculative play, to be bought in the knowledge that there is a substantial chance you could lose everything[vii].
[vii] Other reading:
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