The Rise of Bitcoin
A year after COVID-19 caused the world economy to turn on its head with massive panic-induced selloffs, some sectors have fared better than others. This is especially true of rare metals like silver and platinum.
However, not many assets have recovered better than Bitcoin. Riding a wave of strong institutional demand, the digital currency has rallied over 1000% since the March crash. Record low interest rates, an increasing supply of USD, and endorsements from big names like Tesla and Deutsche Bank are making a strong case for Bitcoin’s legitimacy as a reserve currency.
Earlier this year, Tesla made headlines when it announced an investment of $1.5 billion into Bitcoin. A month later, Elon Musk declared via tweet that customers can now purchase Tesla vehicles using Bitcoin. Portfolio managers around the world were left scratching their heads even further when Tesla also announced that it would not be converting its Bitcoin revenue into dollars. What does this mean for Bitcoin? It means real world adoption from big companies is happening. As it stands today, Tesla is “on a trajectory to make more from its Bitcoin investments than profits from selling its EV (electric vehicle) cars in all of 2020,” (Kharpal 2021). Even though most firms still think the largest cryptocurrency in the world is too risky to hold on their balance sheet, Tesla’s leap of faith will have a positive impact on the currency by onboarding more institutional investors (Locke 2021).
These new institutional investors will have an easier time entering the world of crypto now that banks offer crypto exposure to their accredited clients. In mid-March, Morgan Stanley announced its “move to allow its top-level clients access to Bitcoin funds” (Manning 2021). This came weeks after JP Morgan and Goldman Sachs announced Crypto exposure services of their own (Manning 2021). The now trillion-dollar asset has quite possibly become “too big to ignore,” according to research published by Deutsche Bank (Deutsche Bank Research, Laboure, and Reid 2020). Through this virtuous cycle of adoption and accessibility, Bitcoin has the potential to soar to new heights.
For many investors, the fear of a market bubble is too great to justify investing in Bitcoin at $50,000. Historically, Bitcoin operates in market cycles that end in giant speculative bubbles. However, to understand why this time may be different, one needs to understand why there is such a high demand for Bitcoin in the first place. The reason Tesla and others are looking to Bitcoin is because of the unprecedented money response to the COVID-recession from the United States and other countries. An increase in money supply is bullish for Bitcoin because “many are looking to Bitcoin as an inflationary hedge or a protection against inflation” (Huang 2020). Without delving too deeply into technical jargon, Bitcoin’s code hard-caps the supply at 21 million. With 19 million Bitcoin in circulation currently, there are still 2 million Bitcoin left to be “printed.” Newly minted Bitcoin is distributed to Bitcoin miners first, and these miners sell Bitcoin on the open market. Every 4 years, however, Bitcoin rewards for miners are cut in half. All else equal, this should reduce the supply of Bitcoin available in exchanges over time. This factor strengthens the argument that Bitcoin is a reserve asset superior to traditional government issued currencies because dollars are subject to inflation, while Bitcoin is coded to be a deflationary instrument.
The best way to understand Bitcoin’s appeal is to compare it to gold. Gold is a store of value due to its scarcity and consensus value. In the same way that people don’t use gold in day-to-day transactions, Bitcoin isn’t optimized for regular purchases. Transaction speeds are too slow and fees are too high for most transactions. However, most Bitcoin holders don’t use Bitcoin as a method of payment. Deutsche Bank estimates that “less than 30% of transactional activity in bitcoins is related to payment for goods and services, with the rest largely used as a financial investment,” (Deutsche Bank Research, Laboure, and Reid 2020). As more investors buy into the idea of Bitcoin as a reserve asset, it will continue to gain dominance because of the Tinkerbell effect, which explains that things exist because enough people believe in them.
Admittedly, the Tinkerbell effect is a highly speculative argument towards Bitcoin adoption; however, Bitcoin’s emerging ecosystem is rapidly becoming more appealing for investors. For instance, through Decentralized Finance, also known as DeFi, Bitcoin holders can participate in frictionless lending and borrowing using their Bitcoin as collateral. Lenders earn higher interest rates than are otherwise possible in traditional savings accounts. At the same time, borrowers can collateralize their Bitcoin and have access to a loan almost instantly without the hassle involved with borrowing from a bank. In the same way that the internet introduced a frictionless way of accessing data and information, Bitcoin and DeFi are providing a frictionless alternative to traditional finance. Moreover, the current low interest rate environment has investors looking for yield, and Bitcoin is a solution.
While Bitcoin has established itself as the go-to hedge for a weak dollar, gold has underperformed this past year. Bitcoin and rare metals like silver and platinum have grown substantially because they are finite and associated with disruptive technologies. Bitcoin is at the heart of blockchain innovations, solar panels need silver, and EV batteries use platinum. If the past year is any indication, forward looking investors aren’t enthusiastic about gold’s appeal in the long term. The argument can be made that any asset as volatile as Bitcoin cannot be considered a reserve asset. However, this argument ignores that Bitcoin is still in its infancy, and there are bound to be large swings as the market determines its value.
A more fitting argument against Bitcoin is that it’s too disruptive to exist. As an autonomous currency, Bitcoin deleverages all nation-states around the world. It’s no secret that currencies are hegemonic tools that inherently lead to conflict. Bitcoin is a legitimate decentralized network for transferring value without the invasive, omnipotent presence of power dynamics. People are capable of buying assets to make a statement—just look at Gamestop’s absurd rise over the past year. Moreover, when authorities intervene (like Robinhood cancelling buy orders) it only adds fuel to the fire. Due to its decentralized nature, people can buy Bitcoin to keep their governments in check. This is happening today as people buy Bitcoin to hedge against their government’s monetary policies, albeit this is much more passive. Will governments view Bitcoin as a threat and therefore outlaw it? The implications of such a move are daunting, but history has proven time and time again that it’s better to be on the side of the people. Bitcoin is the people’s asset, and that is why it will ultimately succeed.
Sources
Deutsche Bank Research, Marion Laboure, and Jim Reid. 2020. “The Future of Payments - Part III. Digital Currencies: the Ultimate Hard Power Tool.” Deutsche Bank Research. https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000504589/The_Future_of_Payments_-_Part_III__Digital_Currenc.pdf.
Godbole, Omkar. 2021. “Bitcoin Rises Despite Dollar Strength as Elon Musk Adds BTC Payment Option.” Yahoo! Finance. https://finance.yahoo.com/news/bitcoin-rises-despite-dollar-strength-093148576.html.
Huang, Roger. 2020. “Bitcoin vs. Inflation.” Forbes. https://www.forbes.com/sites/rogerhuang/2020/05/18/bitcoin-vs-inflation/?sh=72528c231c07.
Kharpal, Arjun. 2021. “Tesla has made about $1 billion in profit on its bitcoin investment, analyst estimates.” CNBC. https://www.cnbc.com/2021/02/22/tesla-has-made-1-billion-profit-on-its-bitcoin-investment-analyst.html.
Locke, Taylor. 2021. “Thinking of buying bitcoin? What experts say about big crypto concerns: ‘You have to be mentally prepared.’” CNBC. https://www.cnbc.com/2021/01/09/what-experts-say-about-cryptocurrency-bitcoin-concerns.html.
Manning, Landon. 2021. “With Bitcoin On The Rise, Morgan Stanley Joins Institutional Adopters.” Nasdaq. https://www.nasdaq.com/articles/with-bitcoin-on-the-rise-morgan-stanley-joins-institutional-adopters-2021-03-22.