Is it time to consider Bitcoin as a part of your portfolio?

The cryptocurrency exchange, Coinbase, made stock market history on Wednesday, 14 April by becoming the first company specialising in cryptocurrencies to launch an initial public offering.

This move by Coinbase raises the question, is there value in Bitcoin and, if there is, should you consider including it in your investment portfolio? For answers here, we need to understand where the perceived value comes from. Does Bitcoin derive value from its transactional uses? In other words, does Bitcoin have value because one can purchase goods and services? Or is it simply a store of value, similar to gold?

Transactional value argument – There are a lot of online articles that argue that Bitcoin should be regarded as the currency of the future.

The BTC network (on which Bitcoin is mined) can process 4.6 transactions per second, a rate equating to 276 transactions per minute. While this may sound like a lot, if one compares this to the volumes handled by a large payment processor such as Visa, the story looks somewhat different.

Visa can process approximately 1 700 transactions per second. To put this into perspective, it will take the BTC Network six minutes to achieve what Visa can do in a second. This takes only the transactions of individuals into account – and we haven’t even considered other complexities such as borrowing and mortgages, or even something as simple as paying your taxes. So, there is still a long way to go for Bitcoin to be regarded as the currency of the future. With limited value in terms of transactional ability, should it be regarded as a store of value?

Store of value argument – A report by Chainalysis found that nearly 18.6 million Bitcoin had been mined as of June 2020. However, 20% of this existing Bitcoin supply has not moved from its current set of addresses for five years or longer and these are referred to as “lost Bitcoin”. This leaves 13.5 million Bitcoin available to buy or sell. Only 3.5 million are being actively traded, which means the price of Bitcoin is driven by just 19% of the total Bitcoin in issue. Chainalysis also came to further conclusions regarding the trading activity:

• “Retail traders who deposit less than $10 000 worth of bitcoin on exchanges at a time, account for 96% of all inflows to exchanges per week.

On the other hand, professional traders represent 4% of active traders – or approximately 39,000 transfers weekly. However, they control market liquidity, accounting for 85% of all the US dollar value of bitcoin sent to exchanges.”

Another possible reason for the recent price movement could be optimism bias, which is defined by behaviouraleconomics.com as the phenomenon where:

 “People tend to overestimate the probability of positive events and underestimate the probability of negative events happening to them in the future.” (Sharot, 2011)

Richard Thaler, a Nobel prize-winning economist, argues that when stocks go up, people will continue to buy them because they go up. If one looks at the Bitcoin price and then searches for Google trends on Bitcoin, the graphs turn out to look very similar:

Google Trends (Google’s interest gauge over time):

Source: Google Trends

Notice the spike in interest in the above graph in Mid-December of 2017. When you look at the price movement for the same period, you can see that the price peaked in mid-December of 2017. Three years later, we see a similar occurrence – there is a pickup in interest on the Google trends graph in late 2020. This pickup, yet again, corresponds to the price movement, with the price of Bitcoin having started to make significant gains in October 2020. This shows that people are becoming increasingly interested as the price goes up, which begs the question, why are we more interested in something when it becomes more expensive?

Source: I-Graph

When returns are high, and regulation is low, the probability of fraud increases substantially. In 2019 alone, cybercriminals were able to siphon $4.26 billion away from cryptocurrency users and exchanges, according to a new report by Cipher Trace. In South Africa, Mirror Trading International (MTI) perpetrated the world’s biggest crypto scam of 2020, roping in $588 million worth of Bitcoin, according to Chainalysis.

In terms of its being a store of value, Bitcoin lacks certain fundamental principles that are usually in place to protect investors, namely liquidity and, more importantly, regulation. The lack of these two principles can lead to fraud and market manipulation.

In conclusion, Bitcoin, along with the technology behind it, is here to stay and it has already changed how we think of transactions. Many institutions, such as JP Morgan, Citi, Wells Fargo, and US Bancorp, are already using blockchain technology – nonetheless, their use thereof does not vindicate Bitcoin of its risky or speculative status. Without proper regulation and sufficient liquidity, the cryptocurrency cannot be considered a suitable destination for retirement savings. It will remain a speculative investment that must be treated with caution.

PRETORIA EAST | Lynnwood Bridge Office Park, Kaaimans Building, 4th Floor, Lynnwood Manor | Postnet Suite 96, Private Bag X025, Lynnwood Rige 0040 Tel: 0861 774 000 | Fax: 012 349 5300 | pretoriaoos@psg.co.za 

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter.
PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.