Are cryptocurrencies here to stay?

In case you didn’t notice, an important milestone was reached last month in the legitimisation of digital assets, including Bitcoin. On 14 April, digital asset exchange Coinbase direct listed on the Nasdaq, finishing its first trading day valued near $86 billion - putting it ahead of traditional exchanges like the Intercontinental Exchange and the Nasdaq.

Most investors have heard about Bitcoin, but the Coinbase listing is a recognition that it and other crypto assets have moved more into the mainstream and are no longer viewed as fringe assets. The size and profitability of Coinbase’s operation is enough to let you know that the growth of Bitcoin and digitisation of real-world assets has caught the attention of investors and CEOs alike.

Coinbase and Bitcoin: The background

Founded in 2012, Coinbase has grown into the largest U.S. digital asset exchange, boasting some 56 million users, a posted estimated first-quarter revenue of $1.8 billion and net income of approximately $800 million.1 The adoption and subsequent rise in value of Bitcoin has poured fuel on Coinbase’s growth and revenue.

In 2017, Bitcoin was all the rage with the retail investor. Popular culture and network news were filled with stories and mentions of the digital asset. As with all markets, however, the price of Bitcoin inevitably declined and celebrities and television shows lost interest. However, this didn’t mean those inside this ecosystem threw in the towel. In fact, the exact opposite happened, as the Bitcoin bear market proved to be an opportune time for the industry to build further, with the implementation of new code and the rollout of new products and new visions.

The bull market returns - with institutional investors in the mix

We now find ourselves in the midst of another Bitcoin bull market, with prices moving up to a recent high of about $65,000. This time around, the retail investors are still here, but now the professionals have shown up as well. The market is seeing more and more new institutional products that hold Bitcoin and other digital assets, and many hedge funds are now adding these digital assets to their investment mix. Some of these funds are taking outright long and short bets but others are focused on relative value strategies, i.e., extracting some spread by trading a pair of assets.

Beyond speculation, why are investors buying Bitcoin?

Aside from professional investment types trying to profit from the rise and fall of prices, why would anyone want to own Bitcoin?

Let’s take a step back first to better understand. Bitcoin was created in 2009 as a peer-to-peer electronic cash system, allowing for online payments to be sent directly between parties without the need of going through a financial institution. Bitcoin also solved the double-spend problem inherent in cryptocurrencies, wherein a digital dollar could be duplicated, allowing nefarious individuals to spend that dollar more than once (a problem that doesn’t exist with physical cash). Bitcoin solved this problem by using a peer-to-peer network which timestamps the transaction into its blockchain - the underlying technology behind digital currencies.2

Aside from its role as digital money, those that support Bitcoin believe it has also become a store of wealth or digital gold. Its scarcity (Bitcoin’s code limits its supply to 21 million), its mining process and its ability to move outside of the financial system give it similar characteristics to gold, but with less burden on storing and transportation, making it a preferable solution in the digital age.

Many market participants also view Bitcoin as an inflation hedge similar to other commodities, and this has not gone unnoticed by those with wealth, including corporations. Several firms, including MicroStrategy (NADQ:MSTR), Tesla (NADQ:TSLA) and Square (NYSE:SQ) have put Bitcoin on their balance sheet. These moves were driven by economic uncertainty and a desire for these corporations to diversify their mostly U.S. dollar-denominated balance sheets.

What are some of the arguments against Bitcoin?

Bitcoin’s detractors will point to several potential headwinds that they believe will spell trouble for the asset in the future. The first is increased regulation and oversight. While this is certainly possible, regulators in the U.S. (as an example) have been fairly restrained in their approach, likely as a function of their viewing Bitcoin as a commodity rather than a security. The fact that we now have Bitcoin ETFs (exchange-traded funds) in Canada, in addition to the Coinbase listing in the U.S., shows that onerous regulation may be become more difficult the more integrated Bitcoin becomes in the system. That said, the pseudo-anonymous nature of Bitcoin is not popular with governmental agencies around the world. 

Another potential challenge to Bitcoin, according to some, will come in the form of central bank digital currencies, or CBDCs. CBDCs are legal tender, but in a digital form representing fiat currency. Most central banks are actively working on CBDCs, with China likely being the furthest along, having already begun small pilot programs to test its system. In response to this, Bitcoin advocates emphasise that CBDCs are not a replacement for Bitcoin, pointing out that CBDCs are subject to rules and potential monitoring. This harkens back to Bitcoin’s founding ethos of being a peer-to-peer cash system without the need for a financial intermediary.

Critics of Bitcoin have suggested that its environmental impact outweighs any potential benefit of this burgeoning monetary system. A common complaint is that proof of work systems, like Bitcoin, are computationally intensive. Some studies have suggested that a single Bitcoin transaction uses as much energy as several hundred thousand Visa transactions and consumes more energy than a country like Norway.3 Additional critiques focus on miner centralisation in China, where coal is commonly used to produce electricity. Bitcoin proponents have pointed out that, according to a September 2020 Global Cryptoasset Benchmarking Study, 76% of miners use renewable energies as part of their asset mix while total renewable energy consumption sits at 39%.4

While ESG concerns are a topical issue for Bitcoin and other proof of work cryptocurrencies, it is likely that profit motives5, changing desires for cleaner energy and better technology will provide solutions to reduce its net carbon footprint. It should also be noted that Bitcoin’s mining schedule is finite with a 21-million cap on coins that can be created. Once mining to create new bitcoins is complete, the protocol will rely on transaction fees and less so on the computationally heavy mining process that we have today as new coins are minted and put into circulation.

The bottom line

It is true that the price behaviour of Bitcoin is still very volatile, and understanding that volatility may continue for quite some time regardless of the ultimate future of Bitcoin should be a critical part of any decision to invest. That said, we believe it’s safe to say that the era of digital money and digital assets is upon us and the significant future impact of blockchain technology is likely going to be profound across a myriad of industries. Amid this backdrop, we believe it would be wise for financial planners and individuals to educate themselves on the potential for this new technology.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.

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