CWG Insight Series: Understanding Bitcoin

%POST_TITLE% Thumbnail

Bitcoin is at it again. The most polarizing asset in the world is making waves as it has gone on a tear, gaining about 450% since October. As such, the debate has grown louder between the enriched enthusiasts and steadfast naysayers. One group of experts predicts it will be the best performing asset of the next decade; the other group will tell you that it could meet its demise in the same timeframe. 

All the while, the recent performance has seduced millions of individual investors to take the plunge without even having a basic understanding of what it is, or the risks. My goal for this letter is to explain these critical points in a practical manner. The following paragraphs can serve as a good starting point for you; while YouTube and Google both offer attractive rabbit holes of expertise on the matter. 

What is Bitcoin?

The full answer to this question is complex and unfortunately would require several more pages of explanation. A more basic answer is that it is a cryptocurrency. Which means it is a digital asset on a peer-to-peer network that is not controlled by any person or government. These distinctions give Bitcoin characteristics unlike any asset or technology the world has ever seen:

-    Limited supply: There will only ever be 21 million bitcoins in circulation. This creates scarcity and is the main driver of value for Bitcoin’s market price

-    Decentralized: Allows online payments to be sent directly from one party to another without going through a financial institution. This trait can theoretically eliminate government control of money

-    Immutable: Impossible to forge or falsify. Possibly the most secure way to transact in the world 

-    Global & Fast: Anyone with an internet connection is able to conduct transactions instantly with other users 

-    Transparent: Every transaction is recorded on the blockchain ledger and available for viewing to anyone

-    Pseudonymous ownership: Accounts and transactions are not connected to a real-world identity

Given these characteristics, Bitcoin has the potential to disrupt many global industries. 

Bitcoin as an Investment

Investors are able to purchase, hold and trade Bitcoin on apps. The runup in price could very well be a bubble and potential investors need to be cautious. 

Some investors have treated Bitcoin as a speculative play. Others as a new asset class, using it for a “store of value” relative to the US dollar and gold. These Bitcoin bulls will point to the market pricing impact of its limited supply and greater usage adoption in the form of several increasing metrics:

-    Number of transactions

-    Market participants

-    Computing power

-    Exchange traded volumes

-    Number of institutions and corporations

-    Number of retail investors

Bitcoin critics argue that it should not be viewed as a store of value due to its extreme volatility and it is an “unproductive asset”. This means that it does not have any actual value by itself and could go to zero. The bears will also point to historical examples such as the dotcom bubble when adoption of unproductive assets (nonprofitable tech companies) was increasing across the board. 

Bitcoin Has High Risk

There are several risk factors to consider when it comes to investing in Bitcoin.

-    Volatility: The first time I heard of Bitcoin was in 2011 after it had gone through a massive price boom and bust. Over a nine-month period it went from about $1 to $30 and back down to $2. This pattern of boom-bust has occurred several times in the last decade. Most recently in 2017/2018 after the price had climbed from about $1,000 to $19,000 then dropped down to $4,000. During that timeframe Bitcoin became somewhat mainstream and speculation was rampant.

-    Unpredictable: The variables of what makes it go up or down are endless. Thus, making a decision of when to buy or sell is trivial, and not worth your time.

-    Worst-case-scenarios are possible: There are several scenarios that could result in Bitcoin being obsolete. This includes being replaced by a better cryptocurrency, replaced by a government issued cryptocurrency, or governments attempting to ban Bitcoin due to illegal activities.

-    Speed: Because it is decentralized it trades 24/7/365. Any of the above scenarios playing out would result in an unthinkably fast decline in price. Years of gains could be wiped out in hours/days. 

Final Thoughts

My current opinion on Bitcoin focuses on three components that have enabled its dizzying climb since 2017: technology, scarcity and human nature. 

Bitcoin and the blockchain technology it uses are truly amazing feats. This technology has created a token that anyone in the world, at any time, can trade with another individual; all on a platform that is secure, transparent and free from 3rd party control. In short, cryptocurrency is the perfect trading token.  

Unlike any other currency or commodity, Bitcoin’s supply is limited/fixed; more of it cannot be created. This is unlike a government printing more currency or an oil producer creating more gasoline. This scarcity is attractive to investors for its potential to hold value.  

The fastest growing systems, platforms and ideas tend to be those that are powered by the emotions that dominate our human nature. The scarcity of Bitcoin triggers greed and the fear (of missing out) accelerates the animal spirits. This type of scenario is not new and is similar to herd mentality. But never has it been able to play out on such a grand/global scale due to Bitcoin’s technology, where so many in the world are vying for the same scarce resource on a level playing field. 

When looking at Bitcoin’s price growth in this light, we as investors need to be cognizant of the risks. History has shown us many times before (especially in times of extreme growth like Bitcoin) that rising prices do not mean something is working, or that it is successful. 

With all this in consideration, we feel that an investment in Bitcoin currently is a pure speculation play. Your wealth would be better served tied to a specific goal in a more strategically built portfolio, giving you the best chance at success.

If you have questions feel free to contact me. Have a wonderful Spring!

Steve Lindgren - Chief Investment Officer