12/29/20: Bitcoin (BTC) is on a winning streak. The best-known cryptocurrency, enjoying its longest winning streak since mid-2019, touched over $28,000 on December 26. The recent moves are attributable to institutional inflows, including hedge-fund managers Paul Tudor Jones and Stanley Druckenmiller, insurance giant Massachusetts Mutual Life Insurance and other companies like Square and MicroStrategy, according to The Wall Street Journal.
Designed as a digital alternative to cash, cryptocurrencies like bitcoin operate beyond the reach of government regulators and banks. Electronic accounts, or “wallets,” run on blockchain software, which is in essence a distributed ledger that links a network of independent computers. Blockchains, which uniquely identify each bitcoin transaction, contain all previous bitcoin transactions in their chain to ensure consistency.
The cryptocurrency’s growing popularity begs the question, what’s motivating bitcoin buyers? We’ve identified four factors that could explain the phenomenon:
- Bitcoin serves as a non-tracible store of value. Bitcoin holders enjoy the benefit of anonymity, which is why it’s a preferred payment method for cyber criminals. But gold is also an untraceable store of value, and has served this purpose for thousands of years. From that perspective, one might expect bitcoin and gold to move in tandem. Yet the value of one bitcoin has expanded more than 13 times that of an ounce of gold over the last five years. Proponents could argue that bitcoin’s increased price reflects its growing acceptance as a store of value. However, bitcoin has outpaced gold by nearly three times since March alone.
2. Bitcoin offers its holders the ability to transfer their wealth internationally outside of state supervision – a particularly useful feature for inhabitants of countries with unstable political regimes. Bitcoin can be sent to family members in other countries or used to prepare for the eventuality of fleeing an oppressive regime. Recall that it was the ability to carry their wealth discretely across hostile borders that originally motivated Hasidic Jews to become experts in the diamond business. In a similar vein, bitcoin could serve as an interesting and unique hedge against global political instability. While the correlation between political risk and bitcoin is relatively low, both are rising. Time will tell whether or not their relationship is causal or casual.
3. Bitcoin serves as a potential hedge against runaway inflation fueled by currency devaluation. This is probably the most popular factor investors point to for holding cryptocurrencies. Investors seek a stable store of value that would be impervious to widespread currency devaluation owing to a crisis or to excessive currency creation. Bitcoin’s price instability undercuts that argument, however. Investors hoping for an alternative currency in bitcoin should, at this point, consider it akin to taking a rodeo bull out on a horseback riding trail. Perhaps bitcoin’s volatility will settle down as it matures.
4. Bitcoin is a speculative play. Speculation probably explains why bitcoin’s value can’t be fully explained by the other three factors. Investors buying bitcoin today are likely speculating that the electronic currency’s value will continue to rise as it becomes more widely used.
In our view, if bitcoin were to become more popular for the first three reasons, then it would be worth taking a position in the currency. However, if bitcoin’s price rises on further speculation, then it’s a bubble in the making.