Understanding Bitcoin – Its a Bubble or an Asset for Investment

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Bitcoin has been the best performing asset class of 2020 with a return of 238%. Since 12th March 2020, Bitcoin has given a return of 373%. The movement of Bitcoin in 2020 can be seen as under:

Bitcoin Movement 2020

Source – Coindesk

As price of bitcoin continues to go up, more and more people are talking about the same. There are a lot of unanswered questions around Bitcoin and through this post I have tried to answer them. 

1 ) What has been the historical performance of Bitcoin?

Bitcoin historical movement

*Source : 99bitcoins.com

In 2010, the price of 1 Bitcoin was 5 Cents or USD 0.05. Today, each bitcoin is trading at USD 23,600. This is a phenomenal growth and no other investment has given similar return.

In the last 10 years, Bitcoin has given an annualized return of ~207% per annum. For reference, during same period, Nasdaq in USD has given annualized return of ~20% per annum and Emerging Markets Equity in USD has given an annualized return of ~3% per annum. 

2) How Volatile or risky is Bitcoin?

Following chart shows major corrections in Bitcoin from all time highs

Bitcoin major corrections

Source : CharlieBilello

The above chart shows that in 2010 and 2011, the value of Bitcoin fell by ~94%. In 2018 and 2015, the value of Bitcoin fell by ~85%. In 2010, the value of Bitcoin fell by 72% in just 4 days. 

The above chart clearly shows that Bitcoin is not for a faint hearted person. Bitcoin is highly volatile and short term losses can be significant and very fast. 

The good news which above chart also gives is that the recovery is quick and it always touches new high. If an investor is able to handle the volatility then Bitcoin rewards him/ her with a new high and better returns.

3) What is Bitcoin and its price movement is dependent on what factors?

Bitcoin is a virtual and decentralised currency that can be traded or used over the internet. Bitcoin is not backed by any country or central authority. Its an open source network whose power and functions are distributed to the users in internet. 

The value of Bitcoin is purely derived on the basis of demand and supply. The supply of Bitcoin is limited and already known. A total of 21 Million Bitcoins will be produced by the year 2140. Presently, approx 18.57 Million Bitcoins are in supply. 

The supply of Bitcoin since 2009 can be seen as under:

Supply of Bitcoin

Source : blockchain.com

Demand of Bitcoin is dependent on number of people using or investing in Bitcoin. As the usage and acceptance of Bitcoin goes up, the demand goes up and eventually bitcoin price moves up.

The following log price graph shows movement of Bitcoin price against number of people using Bitcoin:

Bitcoin demand

*Source : Katusa Research

There’re approximately 100 million people using bitcoin now. 

Since supply of Bitcoin is limited and known, its more about demand and future usage of Bitcoin. Investors are betting that in long term, usage will be higher and so price of Bitcoin will be also higher. 

4) Bitcoin is a Commodity or Currency?

Technically, Bitcoin is both Commodity and currency. It functions as both a medium of exchange and a commodity with a finite supply. 

However, in current scenario, as far as use case is concerned then its more popular as a commodity like a digital version of Gold. 

Presently, its not being used popularly as medium of exchange because of huge volatility in price and longer time taken to do transactions through Bitcoin. But in few years, hopefully, both volatility and transaction time will get reduced and it will become more acceptable as medium of exchange. 

The below chart shows median time taken for reach Bitcoin transaction which is currently at ~15 minutes

time to process bitcoin transaction

*Source: Katusa Research

5) Why did Bitcoin price go up in 2020?

Bitcoin has seen a fantastic growth in 2020. The growth is not driven by mass retail investors or speculation.

Following chart shows Google search trends for Bitcoin and movement of Bitcoin Price.

bitcoin google trend

Source – Coindesk

Back in 2018 and 2019, a lot of people were searching about Bitcoin. The Google Search surge is in line with the Bitcoin rally. But 2020 rally has not been accompanied with Google searches by mass retail investors.

The primary reasons for the rally of 2020 are as under:

a) Fiscal Stimulus by US Fed in March 2020 – Huge Fiscal Stimulus by US Fed led to increase in printing of US Dollars and increase in global liquidity. To protect against the purchasing power of cash, investors moved money into assets like Gold, Equity and Bitcoin. 

Graph showing US Fed’s Balance sheet expansion for stimulus:

Bitcoin US fiscal stimulus

*Source – FRED

b) Participation of Institutional players – Paypal recently announced that their customers will be able to use Bitcoin to transact with their 26 million merchants around the world. Square has recently invested 1% of their total assets in Bitcoin. Another US company MicroStrategy has invested USD 250 Million in Bitcoin as well. 

Bitcoin institutional players

Source : Dr. Wealth

6) Whats the legal status of Bitcoin in India?

In early 2018, India’s central bank, the Reserve Bank of India (RBI) announced a ban on the sale or purchase of cryptocurrency by entities regulated by RBI.

In 2019, a petition had been filed by Internet and Mobile Association of India with the Supreme Court of India challenging the legality of cryptocurrencies.

In March 2020, the Supreme Court of India passed the verdict, revoking the RBI ban on cryptocurrency trade.

So, currently, its legal in India to trade and invest in Bitcoin. However, a new law by Government of India to ban Cryptocurrency cannot be ruled out in future.

7) What are the risks involved when investing in Bitcoin?

Some important risks of Bitcoin are as under:

a) The biggest risk is that all the Governments will be against Bitcoin. Since Bitcoin reduces the power of Countries to print money at their own will, no Government would like Bitcoin to be popular. So most probably Governments are going to ban or try reducing the public usage of Bitcoin. 

b) Bitcoin can be used for money laundering and terrorist financing due to the anonymous nature of cryptocurrencies.

c) Bitcoin is highly volatile and investors should be comfortable to see a loss of 95% in a very short period of time. 

d) Bitcoin is prone to hacking and scams. Its not easy investing and storing the bitcoin. Since its digitally stored, its always exposed to digital frauds.

8) What should be the portfolio strategy for Bitcoin? Does it makes sense to invest?

If investor is comfortable with the above mentioned risks then he/ she can consider investing in the Bitcoin.

Only that money should be invested in Bitcoin, which investor is comfortable to lose completely and which he/ she can forget for 10-20 years.

From an Asset Allocation perspective, an allocation of upto 0.5%-1% of total investible surplus can be considered in Bitcoin.

The advantage of having Bitcoin in portfolio is that it can deliver asymmetric returns for overall portfolio. In 10-20 years, Bitcoin will either become Zero or can become 10 to 100 times. For an investor who is investing 0.5%- 1% of his/ her wealth, the loss will not be significant if value becomes zero but if the value goes up by 10 to 100 times then return contribution in portfolio can be huge and very meaningful.

However, in case you decide to take the plunge in Bitcoin then it will be ideal to build exposure gradually in phases since there has been a huge rally recently. This will help in reducing the market timing risk. 

The most important recommendation for investors considering to invest in Bitcoin is that they should spend good amount of time reading about Bitcoin and understanding the fine points in detail. Knowledge and conviction of Bitcoin will help them in handling the volatility well and take right decisions.

Happy Investing!


Also Read on FinMedium:  Market Outlook and Key Financial Developments

Dr. Mukesh Jindal CFA, CFP, CAIA. Ph.D.

Alpha Research

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