Is Tesla overvalued? Is Gold cheap? Do Oil majors offer a bright or dim future? Differing opinions are an important part of market function. That said, no other asset caused the controversy or divergence of opinion as cryptocurrencies. Whether you are a “Bull”, “Bear” or still somewhere in the middle, below I look at the latest news and insights in cryptocurrency trading.
Fantastic foresight from Milton Friedman
“The internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing, but that will soon be developed, is a reliable e-cash: a method whereby on the internet you can transfer funds from A to B without A knowing B or B knowing A—the way in which I can take a $20 bill and hand it over to you, and there’s no record of where it came from.”
Source: Milton Friedman, 1999 - https://www.coindesk.com/economist-milton-friedman-predicted-bitcoin
What are Cryptos?
A cryptocurrency is a digital token or asset which uses a peer-to-peer network to operate. The basic idea is that everyone has a copy of the ledger, and this distributed ledger maintains all the checks and balances either for transactions or as proof of ownership. All cryptocurrencies have this basic premise but there are variations on how they validate transactions. Bitcoin, like many other cryptocurrencies, is privately operated and is separate from central banks, governments, and other more traditional currency issuers. Some find this appealing given their distrust of these institutions; particularly in today’s environment where central banks have been increasing the supply of fiat currencies via their QE programs.
Bitcoin is by far the most successful cryptocurrency given it has been in existence since 2009 and has a market cap of $640bn at a price of $34,000 per coin. This dwarfs the next biggest Ethereum which has a market cap of $233bn.
Is it a Commodity, a Currency or even a Stock?
Some have compared bitcoin and cryptocurrencies more generally to commodities given that the key driving force of price is down to supply and demand. The fixed amount of bitcoin can be compared to the limited quantity of gold on planet earth and the SEC doesn’t regulate bitcoin like they would equity markets?
Given the size of the crypto market, it is becoming difficult for institutional investors to ignore this as an asset class, with the market capitalisation of bitcoin briefly exceeding $1tn earlier in the year before falling back. I think it is likely that bitcoin could still benefit from the network effect, but it remains unlikely that it will becomes an important means of payment in the future given its ultra-volatile nature.
Gold and bitcoin are often compared but neither can be fairly valued, since they are both inherently speculative assets reliant on someone selling it to someone else for more than they paid for it. Having said that, Gold has three distinct advantages presently over bitcoin. 1) Gold is physical and is used in jewellery and industrial uses (even though this is only a small proportion). 2) Gold has been around for thousands of years and was originally used in coins giving it a long-term track record. 3) Gold is heavily owned by central banks. The only advantage bitcoin has over gold is its ability to be easily transferred and stored.
Mining cost could arguably provide a valuation basis for both gold and bitcoin. But just like mining commodities, Bitcoin owners and users have their own environmental concerns. Miners in the case of crypto use cryptographic code to process large amounts of data to solve complicated mathematical problems, which in turn add blocks to the blockchain. The electricity usage is significant and comparable to both Ukraine and Sweden. This energy usage also increases as the market valuation increases, although some have argued that capital in this sector could flow into green energy technological innovation which could be used outside the crypto space.
Source: University of Cambridge Bitcoin Electricity Consumption index. Deutsche Bank. Note: National energy use in TW/h.
Not a Currency
Although the crypto market is large and significantly bigger than Sterling bank notes in circulation (approx. £80bn), it remains small and relatively illiquid as a currency. When compared to M2 money supply, the size of the Bitcoin market cap is small having peaked at $1tn compared with Sterling M2 value of around $4tn. In terms of a direct comparator, the Russian M2 money supply is about equal to that of the market capitalisation of bitcoin.
Crypto now has over 100m users or investors according to sources, although it’s difficult to know how accurate this is. With environmental concerns leading to a more bearish sentiment on bitcoin in the last month, should USD bears be worried?
The answer is a resounding no. When crypto has large moves of over 5% in either direction, there seems to be little to no spill over on to FX markets. The asset classes seem to be unrelated. The ultra-volatile nature of crypto also makes it unsuitable for many merchants given the high swings. At one bitcoin conference aimed at promoting the benefits of crypto, they stopped accepting the coin, partly down to high transaction fees and slow payments. This goes to show the difficulties in practical use as a currency. Other companies have had similar problems particularly as their fixed costs and liabilities are in traditional currencies. Accepting payment in something as volatile as crypto just doesn’t make sense.
I’m a firm believer that bitcoin and crypto do not fit into any of the above categories and should instead be seen as an emerging asset class. This has not stopped companies jumping in on the action. Both PayPal and Square have adopted the ability for users to use crypto. PayPal saw strong early adoption of its crypto initiative, with an early waiting list larger than anticipated.
What Can Explain the Rise and Price Action of Crypto?
In my view the rise of cryptocurrencies over the last year has as much to do with central banks as it does any other exogenous variable, due to the perceived loss of central bank independence and the loose monetary policy in the last 12 months.
Most of the price action this year has been through institutional investors adopting the asset alongside retail investors on platforms. We have seen Ruffer, along with some famous hedge fund managers, namely Paul Tudor Jones and Stanley Druckenmiller, all declare positions in Bitcoin. The official reason being to seek hedges against inflation and monetary disorder or possibly just FOMO.
PayPal and Square clients have been buying approximately 70% of the new Bitcoin supply entering the market each day. This, combined with institutional adoption, has led to the sizeable surge in prices.
Although policy makers might attempt to ban or curtail the use of crypto, it is going to be extremely difficult to gain control of this decentralised asset. The best hope for regulators, in my view, is to create a regulatory framework and provide some oversight to new ICO (Initial coin offering) launches as is the case with IPOs. In parallel with regulation, central banks are looking to introduce their own digital currencies. This does however legitimise the space as an emerging asset class. I am uncertain as to where this emerging asset will take investors, but I am sure for those involved, or watching on the side lines, that the outcomes either of mass adoption, regulatory clash, or even demise will remain exciting over the coming years!