Bitcoin: Game-Changer or Investor Fad?

Dec 18, 2017

Bitcoin has come a long way over the past ten years, from an obscure thought experiment to a legitimate currency accepted by banks and retailers worldwide. Over the past year, the currency’s tremendous rise in value has sparked interest among both short-term speculators and long-term investors that believe it has more room to grow. The big question now is whether Bitcoin will become a fad and fade over time or if it is just starting to realise its full potential.

In this post – we take a look at Bitcoin from a high-level. For a deeper-dive please consult the newly released Bitcoin Asset Highlight – we authored it as ‘required reading’ for anyone new to or curious about bitcoin and cryptoassets.

Where is Bitcoin Gaining Traction? 

Since Bitcoin was launched in 2009 it (among other cryptocurrencies and crypto assets) has gained traction as an alternative to 1) fiat currencies and 2) traditional assets and investments. In the case of the former – one of the most relevant, recent examples is found in Venezuela – where the annual inflation rate is expected to hit 1,600 percent this year. Citizens have turned to bitcoin as an alternative to the rapidly inflating Venezuelan Bolivar.

In the case of the latter, look no further than the rapid growth of user accounts at venues such as Coinbase (one of the largest bitcoin exchanges) who, by the end of November, was adding 300,000 user accounts per week and boasts more accounts than the likes of Charles Schwab.

The price of bitcoin has risen more than 20x from $972 at the beginning of 2017 to over $19,500 as of December 16, 2017. With a $300+ billion market capitalization (network value), the cryptocurrency has become a top-performing asset and increasingly attractive asset class for would-be investors. This has drawn the attention of both short-term speculators and long-term investors who believe cryptocurrencies are the future.

Bitcoin may have been the first cryptocurrency to gain traction, but many others have been launched in recent years. Ethereum is the largest bitcoin competitor (see: Ethereum Asset Highlight), while over 1000 other cryptocurrencies have been launched since then. The market has become so large that many governments have taken action to regulate cryptocurrencies and prevent individuals from being defrauded by scam artists leveraging their growing popularity.

Should You Invest in Bitcoin?

Bitcoin has been growing in popularity as an investment vehicle, which isn’t surprising given its spectacular gains throughout 2017. According to Google Trends, the term ‘invest in bitcoin’ has been trending up since the beginning of the year and is currently at an all time high level of interest. Many institutional investors have also been showing increased interest in bitcoin as an investment vehicle.

Bitcoin has several benefits that may be appealing to investors:

Low Correlation – Bitcoin is entirely uncorrelated with traditional financial assets, which makes it valuable for diversification. See the figure below (bitcoin asset highlight available at the bottom of this page for more depth.).

 

High Volatility – Bitcoin’s volatility is relatively high compared to other, ‘traditional’ assets, which could make it an effective tool for diversification in a larger portfolio. While volatility involves greater risk, these risks are mitigated in diversified portfolios. See the figure below (bitcoin asset highlight available at the bottom of this page for more depth.).

 

High Liquidity – Bitcoin may not be as liquid as Treasuries or S&P 500 index funds, but it has the highest liquidity level, by far, of any cryptocurrency. As a result, investors interested in holding a cryptocurrency may prefer bitcoin since it’s easier to buy and sell large amounts without the risk of moving the market (price).

Institutional Demand – Bitcoin has the longest track record of any cryptocurrency, arguably a part of what has made it appealing to institutional investors. Since supply has a known limit and the number of bitcoins produced daily declines at a known rate over time, higher demand could translate to higher prices for the currency as it’s adopted by both consumers and investors.

But, there are also several drawbacks that are important to consider:

Mean Reversion Risk – Bitcoin prices have moved sharply higher over the past year, which could mean that a pullback is imminent under the mean reversion theory. This theory suggests that prices and returns eventually move back toward the mean or average over time as supply and demand even out.

Limited Intrinsic Value – Bitcoin is like gold in the sense that it doesn’t generate cash income over time (unlike stocks and bonds). This means that it has negative real returns in the absence of asset appreciation and prices tend to be driven by supply and demand more than intrinsic value. That said, it is also similar to gold in the sense that it requires a significant outlay of resources (electricity in this case) to create or “mine” a bitcoin. Thus there is an initial input of “value” to create a single bitcoin.

Satoshi Nakamoto – The true identity of Bitcoin’s legendary creator (or creators), Satoshi Nakamoto, is unkown. Additionally, Satoshi has been absent from the market since its early days, but holds an estimated one million bitcoins. If Satoshi does in fact control these bitcoins and decides to sell, it is very likely to have an adverse effect on bitcoin prices.

Investors should carefully weigh these benefits and drawbacks before adding bitcoin to their portfolios. In addition, it’s a good idea to ensure that bitcoin is only one part of a diversified portfolio, which can help mitigate some of the volatility and other risk factors associated with the cryptocurrency, as well as maximize the benefits.

How to Invest In Bitcoin

There are two different ways to invest (directly or indirectly) in bitcoin and each approach has benefits and drawbacks that are important to consider.

The traditional way to invest in bitcoin is to simply buy them outright. Before buying Bitcoin, you must sign up for a bitcoin wallet through a service like Coinbase. You can then use traditional payment methods – such as a credit card or bank transfer (ACH) – to purchase bitcoins on an exchange. The bitcoins can then be transferred to your wallet for safekeeping. Many providers also let you purchase other cryptocurrencies on the same platform.

The second, and often simpler option is to invest in bitcoin exchange traded products, differnt versions of which are available in both Europe and the U.S. These are exchange-traded products that enable investors to purchase a stake in bitcoin’s performance without direclty buying the cryptocurrency.

Traditional investors may be best off purchasing exchange traded bitcoin products versus the currency for the same reasons that gold funds are typically better options than owning and securing gold bullion. You don’t have to worry about the mechanics of buying and selling or securely storing the cryptocurrency. Additionally, exchange traded vehicles such are often eligible for retirement and other investment accounts, giving them different tax treatment than a direct investment. That said, these conveniences come with a cost – as exchange traded products often carry a management fee.

The Bottom Line

Bitcoin has soared in popularity over the past couple of years and is being embraced by mainstream financial institutions from traditional banks to the worlds biggest futures provider, the CME group. Investors interested in bitcoin should carefully consider the benefits and risks of the cryptocurrency, as well as decide how they would like to invest. Many long-term investors prefer exchange-traded investment vehicles that fit neatly alongside other investments via their normal brokerage account/portfolio.

care for more depth? read the bitcoin asset highlight:  

care for more depth? read the bitcoin asset highlight:  

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