A friend recently asked if he should buy bitcoin. It hit the USD 42,000 level only a week ago having traded at 10,000 back in October, and last weekend, volatility in bitcoin spiked and it dropped 20% in a couple of days. These moves have drawn a lot of attention and many are now asking whether it is time ‘to buy?’, not just in the US but also in Europe.
Bitcoin was intended to serve as a means of facilitating the transfer of money in a decentralized way (beyond the influence of governments and central banks) – and that in time it would spread as a means of retail payment. In a world where trust in institutions has been challenged since the global financial crisis, bitcoin has appealed to some as an alternative system of exchange (indeed part of the coding of bitcoin contains a reference to the global financial crisis).
Bitcoin is far away from meeting these objectives, and in my view is a ‘tulip’, a speculative, trading asset. It also seems to me that many people are increasingly happy with bitcoin being assigned this role, and much of the interest and eco-system that is developing around it underpins the role of bitcoin as a speculative asset rather than as a bona fide currency.
In particular, more banks and payment systems – notably PayPal – are allowing bitcoin onto their platforms, either in the sense that it can be used to buy other assets or that it can be traded. It is likely that in coming months regulators will permit cryptocurrency ETF’s to be launched, and other products such as derivatives will spring up around this.
At the same time, many of the highly dubious coin issues of recent years have been shut down by regulators, principally in the USA, though bitcoin remains a favourite means of transacting in the underworld.
More hedge funds that specialize in crypto currencies are on the rise, and crypto exchanges are readily attracting investment funding (Baakt the digital marketplace has recently announced a plan to go public through a special acquisition vehicle).
If the role of bitcoin (and crypto-currencies) as a trading asset eco-system is growing, its place as a currency or means of exchange is being curtailed – indeed the price moves of the past three months would make it very difficult to operate as a reliable means of payment (in addition the verifiability of payments may be harder to complete than some think according to the Bank for International Settlements).
Moreover, the entry points to the crypto currency world are under attack – either in the case of exchanges being hacked or closed down by governments (nearly 80 crypto exchanges ceased to exist through 2020), or in governments looking to identify and tax those putting capital into or taking it out of crypo currencies.
In particular central banks, many of whom are close to launching their own digital currencies (conceptually at least) have an interest in the failure of cryptocurrencies to catch on. Notably Christine Lagarde this week called for bitcoin and its associated ‘funny business’ to be more closely regulated.
As such, this points to crypto currencies being ushered into the corner of eclectic trading assets – though less of an experience than horse racing, with none of the aesthetic bonus of art and not quite the fun of collecting wine.
It’s also worth pointing out that from the point of view of ESG investing (Environmental, Social and Governance) which is arguably another ‘mania’, bitcoin is a ‘sinner’ in that the mining or manufacturing of bitcoin consumes an enormous an amount of electricity, not to mention its negative social and governance aspects.
To draw these strands together in a way that is relevant for investors – what is happening is that as the economic and social utility of bitcoin is falling (i.e. its use as a ‘money’), then its intrinsic value is eroded, and the greater the portion of its price that is made up by speculative activity.
So, if bitcoin is fast becoming a trading asset, should one buy it now? My sense is that many of the people who trade bitcoin also trade S&P futures and assets at the more speculative end of the equity market. A manifestation of this that crypto currencies are highly correlated, making diversification difficult.
In this respect bitcoin is at the very risky end of market risk appetite and increasingly equity market investors use it as one of a number of steers for the direction of equities. In this context, for most investors, it is best to wait for a drop in risk appetite – and for a degree of panic to return to markets, or for liquidity conditions tightened. The last time we saw depressed risk appetite was in late September, when bitcoin traded below the 10,000 level.
As it stands, risk appetite is very high and due a reversal in coming weeks, so now is not the time to jump into bitcoin.