Bitcoin bull?

The furore surrounding Bitcoin in recent years has caught the attention of even the most hardened of crypto sceptics in financial markets. Rarely in recorded history has an asset returned 600% in 6 months. Bitcoin’s phenomenal rise can be largely attributed to a wave of new tech savvy retail investors who poured their discretionary incomes into crypto markets during  lockdowns. Bitcoin's price soared from $10,000 to $63,000 in a very short space of time.
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Large institutional investors followed. Then came Tesla’s CEO, Ellon Musk who announced on Twitter in March of this year that Tesla would accept Bitcoin as payment. Retracting the statement a month later, however, citing environmental concerns, Musk earned $101 million from his Bitcoin trade while simultaneously wiping $500 billion (60%) off the market cap. Millions of small investors got caught on the downside. 

Bitcoin's bubble burst again in May, this time from an announcement by China that it was clamping down on Bitcoin mining. Much to the delight of its critics, Bitcoin’s price plummeted another 50%. Remarkably, however, it rebounded within 2 days recovering its losses. At the time of writing, Bitcoin's current price is roughly where it was 6 months ago in January 2021 at $28,000. This still represents a 300% return over the last 12 months despite all the recent doom and gloom and volatility.  Apple's share price, in contrast, grew by 'just' 50% over the same period.

Like it or not, cryptocurrencies could be here to stay. Bitcoin is as much about ideology as it is a genuine alternative to traditional money. Nonetheless the world of finance is undergoing huge change as consumer payments move increasingly online. Bitcoin supporters believe these trends will only strengthen the demand for crypto in years to come.

According to the International Monetary Fund (IMF), 80% of global transactions in 2020 were cashless and carried out using debit cards and digital wallets. Banks around the world are now looking to innovate and compete with the growth of online payment providers such as Binance, Coinbase, Revolut, and We-Pay, who eat into their market share and offer crypto services.

Central Banks in the US, China, and Europe are also developing their own central bank digital currencies, or CBDC’s. Are governments now starting to view Bitcoin as a potential threat to fiat currencies? 

Not a Currency

Unfortunately,  no matter which way you twist and turn it, Bitcoin’s volatility makes it is highly unlikely that countries will ever adopt it as a currency or allow it as a medium of exchange. Although El Salvador recently announced it would accept Bitcoin as a second currency alongside the US dollar, this is probably a short-term strategy to encourage extra spending into the economy after extended lockdowns.

That's all well and good while the Bitcoin/Dollar exchange rate is high but less so when Bitcoin falls further in value. Shopkeepers either refuse to accept Bitcoin or charge a much higher Bitcoin price for a loaf of bread. This greatly reduces the incentive for people to use Bitcoin over dollars and so defeats the purpose of having it as a currency.

Tesla

Would Bitcoin become less volatile if Tesla, Amazon or Apple started to accept it as payment? There’s a good chance it would cause even more volatility. As soon as the announcement is made (as it was by Ellon Musk), investors rush into Bitcoin and its price soars. Investors who timed it well can now buy a Tesla car, an iPhone or a book from Amazon cheaper than before relative to dollars. But what about investors who don’t need a car, iPhones or a book? Would they be willing to hold their valuable Bitcoin or sell while the going is good? The likelihood is that they would sell, causing the price of Bitcoin to fall again.

Not A Store of Value
Inflation is a hot topic in financial markets in recent months as economies finally re-open. Due to supply chain issues, extra consumer demand, and enormous government spending, many economists are predicting consumer prices to soar as high as 10% or even 20% this year and beyond. Bitcoin's limited supply, unlike fiat currencies, protects it against long term debasement and inflation. Or so the story goes.

These inflation concerns were played out recently in the bond markets where investors, fearful that inflation would spark a reaction by the central banks to increase interest rates and drive down the value of their bonds, sold out of their assets. This should have been the perfect storm for Bitcoin. Many Bitcoin supporters believed that as investors fled the bond market they would rush into Bitcoin as a supposed store of value, hedging against inflation. However, Crypto’s were the hardest hit asset in the market falling as much as 60% in March and another 50% in May when China announced its clamp down. The truth is, when the going gets tough very few investors trust Bitcoin.

Non-productive asset
Cryptos like Bitcoin are non-productive assets meaning they do not produce goods, services or products and thus have no underlying value.  Their use-case or ‘utility’ as economists sometimes refer to it, is very low.

In contrast, if Apple launch a new product, its share price usually increases. Large public companies also pay dividends from profits earned on sales. This also increases their share price. By owning crypto, however, investors earn no dividend and their values cannot be linked to any value-producing product. As soon as crypto prices rise, investors are tempted to sell. This is not true of value stocks such as Apple or Coca-Cola who pay dividends to investors for holding their assets longterm.

The economic value of crypto’s are therefore derived largely from speculation. Prices move as crypto assets are off-loaded from investor to investor, each hoping that the price they buy is lower than price they sell. It’s ‘hot potato’ economics and unfortunately someone is always left holding the can. It’s a perfect example of ‘the greater fool’ theory at play. Everyone can’t win at the same time and for every winner there has to be a loser. Parallels of course can be made with most assets. If property prices crash, however, at least the homeowner can still make use of his home. If a government bond falls in value, it means the yield is rising.

Why the crypto craze?

The vast majority of crypto investors are below the age of 35. The millennial and Generation X generation have inherited a world of stagnating wages and low economic growth. Globalisation and the free movement of capital and labour has brought intense competition for jobs and accommodation in urban areas and city centres. As house prices soar, the price of abundant labour (wages) has been falling over the past 40 years when adjusted for inflation.

According to a report by the OECD, worker share of GDP from 1980 to the late 2000’s dropped 0.3% per annum in the advanced G20 economies. In other words, a worker in 2000 was 6% less well-off than in 1980. The assumption that wealth follows a linear trend upwards in time is no longer true. Generations are now getting poorer.

The steepest part of the decline occurred in the US between 2000 to 2016 where workers share of national income fell from 63.3% to 56.7%. These statistics show how wealth has been steadily distributed away from labour towards capital. In 2020 during the height of the pandemic, unemployment peaked at 20% in many advanced economies (including Ireland) while the stock market grew by 15% on the previous year.

Technological progress, automation, robots, and the outsourcing of manufacturing jobs to cheaper countries such as China exacerbates these deflationary trends in worker’s wages. So too does the dwindling influence of trade unions. Standards of living fall and economies stutter. Central Banks print money and interest rates turn negative. Households borrow to obtain higher living standards, government’s run larger deficits and global debt increases dragging down GDP, and so the cycle repeats.

For the vast majority of millennials, wealth accumulation and growth through saving is no longer an option due to declining real wages and the low interest rate environment of the last decade. In comparison, their parents, the baby boomer generation, could have expected to earn 10-15% interest on savings during the swinging 60’s and 70s. Holding deposits in a savings account today, however, represents a loss to capital when factoring in 0% interest and inflation. For the first time in history, parents are now wealthier than their adult children.

Future Finance

The hunt for yield among younger generations continues therefore, weaponised by Bitcoin and decentalised finance (DeFi). Online Blockchain exchanges such as Binance, Coinbase, E-Toro, Houbi Global, and Kraken have gained huge momentum and marketshare in recent years. Crypto’s market cap in June 2020 was $200 billion. 12 months later, the crypto industry is now valued at $1 trillion and online exchanges are eager to profit from its growth.

One such exchange, Gemini, with offices in the US, Canada, and the UK, offers high yielding crypto deposit accounts for their customers, acting much like a traditional bank.
The main difference, however, is that banks invest customer deposits in productive projects such as business loans and mortgages. Gemini invest crypto deposits in other crypto assets. These assets are its leverage.

If all goes well the house earn their spread and depositors earn yield. But what happens when the cryptos go to zero, or 50% as they regularly do? The house folds, depositors get burned, and there is no central bank to bail out the house. Possibly fair game. Free market economics. Winners and losers. Risk / reward. But it’s a fool’s paradise and a race against time as eventually even the winners themselves become losers. Gresham's law. Bad money chasing out good until there’s nothing left for anyone. Perpetual boom and bust cycles.

If these exchanges are the future of crypto it’s hard to get excited. But not everyone dislikes casinos. Where money can be made, investment usually follows. New and improved blockchains, Stablecoins, NFT’s, tokens, decentralised apps (D’apps) and smart contracts are continuously being unveiled. Ethereum layer 2, Web 3, Filecoin and all manner of advanced algorithms purposely designed to enhance cryptography and user experience are just the tip of the iceberg. 

Economists have always scribed that 'technological progress' is one of the key ingredients of economic growth. From the naked flame to the lightbulb,  the horse and cart to the automobile, the typewriter to the word processor, and the revolutionary effects of the internet, technology has always been the great disruptor.  

The current system of low growth, interest rates and perpetual debt badly needs an overhaul of some sort. DefI may offer solutions but also many questions. As its universe expands it may even be shut down. Financial markets are volatile enough.

Until then, network effects, mass adoption, and the accessibility of crypto markets to all incomes big and small will continuously replenish the field if horses fall or quit the race. Crypto could become the unstoppable trade that some analysts are calling 'the exponential age'. 

Virtual markets could replace stock exchanges, smart contracts could replace brokers, and banks may cease to exist. 'Tokenomics' could be the new driver of growth that includes investors from all economic backgrounds. A future where the trading of celebrity coins,  personalised memes, deeds, tweets, and every gimmick in between becomes commonplace. An over-commoditised playground in sci-fi, DeFi, and BlockFi where fiction meets finance and fortunes can be made. 

​Speculative mania sugar-coated by the brilliance of technology, which very few will understand.

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