More than likely you have heard about the gravity-defying rise in the price of a bitcoin.
Bitcoin is a decentralized cryptocurrency which is theoretically untraceable —did that help? Ok, let’s get a little techie before discussing investment opportunities and concerns.
For starters, what is a cryptocurrency? It is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions, to control the creation of additional units, and to verify the transfer of assets. Bitcoin, created in 2009, was the first cryptocurrency, but since then other cryptocurrencies such as Ethereum, Litecoin, Dash and Ripple have been created.
Blockchain technology is the backbone for bitcoin’s existence. It’s a digital ledger of economic transactions that can be programmed to record not just financial transactions, but virtually everything of value. Information held on blockchain exists as a shared – and continually reconciled – database. The blockchain database is not stored in any single location, meaning the records it keeps are public and easily verifiable. Hosted by millions of computers simultaneously, its data is accessible to anyone on the internet.
Have any interest in knowing how bitcoin miners verify the transactions added to the public ledger? For purposes of this article let’s assume no (sorry techies) and focus on bitcoin as an investment—though miners really do exist and they earn real bitcoin fractions for their additive computing power. Who knew.
To date, no one. That should be your first concern. Bitcoins are purchased via online exchanges. Did I mention in 2014 the then largest bitcoin exchange collapsed? …and the individuals affected are still trying to obtain the funds they lost.
Every time the price of bitcoin spikes so does public interest. However, without an adequate supply of bitcoins to meet any increase in demand, we simply get further price increases. Bitcoin supply is limited by design; about 17 million bitcoins have been created to date with an ultimate cap of 21 million. Bitcoin’s design and a lack of regulatory oversight clearly help contribute to its price volatility.
There are many different buyers; true believers, we suspect some that are looking to wash “dirty” money, others include citizens of countries that are experiencing political turmoil, and of course we have the classic risk-taking group who believe they will be lucky enough to exit this potential “musical chair game” of speculating while a comfortable seat exists.
In our opinion, its value stems from only a belief (or leap of faith) that it is a store of value. Without a physical/industrial application, an appeal like a precious or semi-precious metal or the implicit guarantee of a government entity, its intrinsic value is quite simply whatever someone is willing to pay for it. Could this be our modern-day version of the Dutch Tulip mania in the 1630’s? If you’re not familiar with that time frame or bubble, it’s a fun Google search.
The price of one bitcoin was below $9,000 in mid-November of this year, and less than two weeks later is approaching $15,000 for the first time. Meanwhile as a comparison, gold is trading around $1,200 an ounce. While its true gold also requires a miner, and has little industrial value, it does not have a predetermined supply limit, it can be used for jewelry and, in the past, has sometimes provided a hedge against inflation. Try filling a cavity with a bitcoin.
Well, is the parabolic move up in price-roughly 1000% year- to-date-sustainable? Generally, these types of price spikes are not. Can you “short” bitcoin today—place a bet the value declines? No, not yet. But the CBOE (Chicago Board Options Exchange) recently announced Bitcoin Futures will trade under the ticker symbol “XBT” with a launch date to be announced shortly. XBT futures will be a way for participants to buy and sell bitcoin futures in a highly-regulated marketplace nearly 24 hours a day, five days a week. Keep in mind that while bitcoin remains unregulated, the trading in its future contracts will be.
What is astonishing to some is the current price per bitcoin multiplied by coins minted exceeds $200 billion total as of this writing. That value is greater than the individual market capitalization of each of the following well-known, publicly traded stocks; Philp Morris, PepsiCo, Disney McDonalds, Home Depot, Verizon, Citigroup and Toyota. Even if we were to temporarily ignore that most of these stocks pay a healthy dividend, one would expect the uses and acceptance of Bitcoin must increase rather quickly for relative valuation comparisons such as these to be sustainable. And perhaps that will happen—and perhaps not.
The 22.7% one day decline on October 19th, 1987 was largely attributed to “program trading” used by institutions to protect themselves from significant market weakness. As prices declined that day, institutional trading programs sold securities which prompted further institutional selling. Since then, reforms and circuit breakers have been instituted to temper steep declines. What is worrisome, however, is that while the purpose of futures contracts is to effectively increase liquidity, the use of these derivative contracts by those looking to hedge profits or profit from a falling bitcoin price may adversely increase volatility under certain scenarios.
There is an open-ended, publicly traded, unregistered, grantor trust, symbol GBTC that allows for participation in the direction of bitcoin. However, as per Bloomberg, the price of the fund has averaged a 48% premium for the past 52 weeks to its underlying investment. The Wall Street Journal recently reported the current premium was approaching 70%. While this is obviously a very fluid number, any premium paid above a net asset value represents an additional risk to investing. If still intrigued, please remember to put your seatbelt on before purchasing. The ride may get a little bumpier.
Should the price double or decline by 50% we would neither be surprised or care. We believe it is also important to view prospects for blockchain technology independently of bitcoin valuations. It is our opinion blockchain technology has tremendous application in multiple industries including banking and finance. If interested in digging deeper and charting “orphaned blocks”, “hash rate distributions” and “mempool size growth” click here. If interested in a simpler takeaway, please remember investing and speculating may produce very different results over time. Best of luck.
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