By: Ryk de Klerk THE SPECTACULAR rise in the prices – or exchange rates, as some would like to call them – of Bitcoin and other cryptocurrencies since the massive sell-off as a result of the outbreak of the Covid-19 pandemic was and still is mind-boggling.Bitcoin’s price rose more than eleven-fold to more than $60 000 (about R896 304) over the past weekend from a low of $5 300 at the height of the Covid-19 financial crisis.Bear in mind that, after the big bubble in Bitcoin burst in December 2017, it was in a bear market relative to the Nasdaq index until it escaped the bear’s claws only in October last year.During that period, Bitcoin underperformed the Nasdaq by about 63 percent and at its worst by 83 percent in February 2019 since its top in December 2017.The last big bubble in Bitcoin was fuelled by retail interest on mainstream news and the talk of the town.The prick of the bubble saw Bitcoin’s price collapse to about $3 000 from more than $20 000.In the run-up to the bubble, one of the all-time greats of currency trading and speculation, George Soros, in 2018 warned that Bitcoin was not a currency at all, as “a currency is supposed to be a stable store of value”, and implied that Bitcoin’s valuation was tied fundamentally to speculation.
In his words, “Cryptocurrency is a misnomer and is a typical bubble, which is always based on some kind of misunderstanding.” In September 2017, JP Morgan’s chief executive, Jamie Dimon, called Bitcoin a fraud.
When Bitcoin picked itself up from the floor after the low in February 2019, digital currency global news agency Coin Rivet reported that retail investors were barely affected by mainstream news, and Bitcoin’s recovery “has gone under the radar outside the crypto community”.Yes, the big money took over the show.
And how! At the time of Bitcoin’s escape from the bear’s claws in October last year, JP Morgan, the largest US bank by assets, suddenly turned very bullish on Bitcoin.At almost the same time, a closely followed Wall Street legend, Bill Miller, a famous seasoned value investor and philanthropist, strongly recommended Bitcoin, while billionaire US investor Stanley Druckenmiller, who, according to Forbes, made it big as a hedge fund manager and worked for Soros until 2000, revealed that he had “warmed up to” the cryptocurrency as a store of value.
In the same month, payments giant PayPal announced it would allow its users to buy and spend Bitcoin and some other major cryptocurrencies.Coincidence? The good news kept on coming with the adoption of Bitcoin by Visa, Mastercard, Tesla and many more, resulting in Bitcoin trading at a record $60 000 over the weekend – up a staggering fivefold since mid-October last year.Bitcoin only surpassed the Nasdaq’s performance since December 2017 in the first quarter of this year, but it powered ahead since then, outperforming the Nasdaq by about 60 percent.The big question is, how high it can go? My own analysis confirms Bill Miller’s argument that, like any commodity and other assets, it is simply supply and demand.
Since 2015, the growth in mined supply was steadily reduced as scheduled and was one of the factors driving Bitcoin’s price to bubble levels in 2017.Last year, Bitcoin went through a scheduled supply cut, resulting in the three-month smoothed growth rate in mined supply falling to about 0.5 percent compared with about 1.1 percent a year ago.The adoption of Bitcoin as payment method and the launch of cryptocurrency-related investment products such as exchange traded funds mean the demand for Bitcoin is and will be growing faster than the supply.Bear in mind that Bitcoin’s supply is capped at 21 million, and once all the Bitcoins have been unlocked by the Bitcoin miners, world supply will be tapped out.Currently, 18.6 million Bitcoins have been mined, leaving only 2.4 million yet to be introduced into circulation.The increasing participation of financial institutions such as banks and exchanges such as CME and CBOE is laying the groundwork for the cryptocurrency market to be accepted, sooner than later, as an asset class by the savings industry.As things stand, I will not be surprised if the current rally in Bitcoin could take us to $100 000, or even much higher.Even Soros had a change of opinion on Bitcoin.
The Soros Investment Fund has joined a $200 million growth capital round for NYDIG that will be working with its investment partners on Bitcoin-related strategic initiatives spanning investment management, insurance, banking and clean energy.The process of mining Bitcoins is not easy and requires super computers to come up with complex computational solutions.Furthermore, it is costly, as a recent study by Cambridge University indicated that Bitcoin uses more electricity a year than the entire country of Argentina or Norway.The cost of mining and the increase in the difficulty to mine Bitcoins will probably underscore the future prices of the cryptocurrency.The downside risks are high though.Nothing goes up in a straight line, and at some stage some of the major players may decide to take profits.
Furthermore, I expect the regulation of cryptocurrencies to be tightened worldwide.Gary Gensler is President Joe Biden’s pick to lead the US Securities and Exchange Commission (SEC) and is a professor at Massachusetts Institute of Technology who teaches cryptocurrencies.
He previously served as the chairperson of the Commodity Futures Trading Commission.At least he has a sobering take on regulation.They must make sure that there is investor protection and “the SEC must ensure that the crypto markets are free of fraud and manipulation”.
According to Techcentral.co.za, South Africa’s home-bred Mirror Trading International (MTI) was the world’s biggest crypto scam of 2020, roping in more than R8bn worth of Bitcoin across 470 000 transactions.
The fraud probably left a bad taste in the mouths hose who lost vast sums of money and scared off many prospective investors.Counterparty risk analysis is crucial, and it is best to stick to the reputable and well-known crypto exchanges.Looking back over the past 10 years, it is evident that Bitcoin provided the best returns among all asset classes, but it also had the highest downside risk – the risk of losing money.Two questions come to mind.
Is there any merit to include Bitcoin and some other cryptocurrencies in a well-diversified equity portfolio and, if so, what percentage of one’s growth assets should be held in crypto currencies? My analysis indicates that if 1 percent exposure to Bitcoin is added to a well-diversified portfolio consisting of developed market equities using the MSCI World Index in US dollars as proxy and rebalanced in December every year, the return per unit of volatility increases by 15 percent while the price volatility increases to 23 percent from 14 percent.So, yes, Bitcoin could add value to a well-diversified equity portfolio.Investors who are more willing to accept higher volatilities and invest 2 percent of their equity portfolio could expect an increase of about 5 percent return per unit of volatility a year but will experience a volatility of about 35 percent in their equity portfolio.I was always sceptical about cryptocurrencies, but I too had a change of heart.Well, to be honest, the Bitcoin market is coming into its own and the fundamentals are changing.I still take a very cautious stance, though.It was the same with the development of the derivatives market in South African.Investments were and remain a huge learning curve.
Ryk de Klerk is an independent analyst.
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