By Nick Ziarek CFP®, CFA
Should you "invest" in Bitcoin? The popularity of cryptocurrencies, and in particular Bitcoin, center around people’s varying beliefs in its role in the global landscape both today and in the future. Bitcoin can be viewed as a store of value, a decentralized replacement to fiat (paper) currency, or a long-term alternative investment.
Functionally, the underlying digital ledger technology called blockchain can serve a wide range of purposes. Some of these purposes include settlement of financial transactions, supply chain management, medical record storage, and even online voting. We’ve already seen many global companies making use of blockchain technology in their operations including Wal-Mart, Pfizer, Unilever and IBM.
Bitcoin benefited from being the first blockchain-based cryptocurrency, introduced in January 2009 by the online pseudonym Satoshi Nakamoto. The inventor’s true identity remains a mystery.
The coins are created through a process called mining, in which highly sophisticated computers solve complex puzzles and algorithms to be awarded a block of coins. There can only be 21 million bitcoins ever created, and the rate at which the coins are created is halved roughly every 4 years. 18.6 million coins have been mined to date.
When bitcoin was first introduced, miners were awarded 50 coins - worth $2.5 million today, but less than $1 back in 2009. By 2012 the award was cut in half to 25 coins; today a block consists of only 6.25 coins – worth roughly $316,000. At the rate of decline in coins awarded, it will take until 2140 before all the coins are mined.
Bitcoin’s Role as an Investment
A common argument is that bitcoin is an asset that provides a store of value. Much like gold has long been considered a store of value and hedge to inflationary periods, bitcoin is believed to retain its purchasing power due to its scarcity.
Another argument is the decentralized nature of the currency. No government entity can issue more bitcoins to stimulate their economy or deflate the value of their future debt obligations. Consider that at a time of central banks across the globe dispensing unprecedented levels of monetary stimulus, the rate at which bitcoins are rewarded was halved in May 2020, where the supply will increase by less than 2% this year.
Within investment portfolios, alternative assets play a primary role of portfolio diversification, return enhancement, and income generation. While bitcoin does not pay a dividend, its limited nature has led to uncorrelated returns compared to stocks and bonds, along with return enhancement from wider retail acceptance and evolving reasons to invest in the coins. Just recently Tesla announced they would invest $1.5 billion into the currency and begin accepting bitcoin for payment of their vehicles.
Criticisms of Bitcoin
Probably the loudest criticism of bitcoin is its historical volatility. Over the past year alone, bitcoin appreciated or declined by more than 5% in a single day 56 times, compared to the S&P 500 which had only 9 similar occurrences. Consider bitcoin recently hit an all-time high of $57,469, when only a year ago it was trading for less than one-tenth of that, at $5,600. Or that in December 2017 it reached a then all-time high of $19,345 before falling more than 80%. It would take until December 2020 before fully recovering.
It’s hard to imagine any currency or long-established asset being accepted as a good long-term store of value with volatility that high. Imagine going to the car dealership with bitcoin and not knowing if you’ll be leaving with one car, two cars or half a car on any given day. In 2017, the Venezuelan bolivar plummeted in value by more than 70% increasing the price of staples such as rice from 8,000 bolivars to more than 17,000 bolivars. For bitcoin to be a mainstream currency, its price needs to be more stable.
Other consistent complaints include bitcoin’s history of being used as currency on the dark web for illicit activities; it is wasteful due to the significant amount of energy consumed by supercomputers and computer farms used to mine bitcoin today; and unlike the US Dollar which is backed by the full faith and credit of the US Government, there is nothing backing bitcoin. Should investor sentiment ever shift away, the coins can and would collapse in value.
How to invest in Bitcoin
Bitcoin cannot be directly purchased in traditional brokerage accounts like a joint account, IRA or 401k partially due to the exchanges on which the coins trade. One of the largest and most recognizable exchanges is Coinbase where one can buy/sell/exchange dozens of different cryptocurrencies 24 hours a day for a fee.
Alternatively, you can buy exposure to bitcoin through an IRA-friendly publicly traded trust called Grayscale Bitcoin Trust. The trust trades similar to an ETF (exchange traded fund) but is considered a closed-end fund meaning it can – and does – trade at a large premium to the net asset value (NAV) of the fund itself. In the past few weeks Canada has approved the launch of two exchange traded funds that track bitcoin itself and it is expected that the US will follow suit before year-end in approving ETF products.
In addition, a handful of publicly traded companies have become a proxy for bitcoin as they invest their cash reserves in the coins themselves. These companies include Tesla, Square and most notably a small cap company by the name of MicroStrategy. In December 2020 MicroStrategy issued $650 million in debt to specifically purchase additional bitcoin. Today the company holds more than $3.5 billion in bitcoin. Just a year ago the company itself was worth only $1 billion.
Should you invest in Bitcoin?
Well, that’s the million-dollar question. There are strong arguments for the potential long-term value and role of cryptocurrency, while the volatility and nascent nature of these digital assets provides a reason for caution. Exploring new markets and technologies is exciting; and the appeal of being on the front-end of a generational shift could be powerful enough to have many investors dip a toe in the waters.
As with any investment, there is always risk and return. Go into it knowing you may lose the full value, but may also experience growth if the market for and acceptance of cryptocurrencies further develops.