Key Observations
Recent returns, greater accessibility and broader backing of Bitcoin have led to broader adoption by investors, custodians and developers. While recent returns, low correlations and significant network growth are promising, significant risks from other cryptocurrencies, regulators and geographic concentration must be assessed carefully. Investors should consider the suitability of Bitcoin in the context of their specific situation and portfolio.
Introduction
In 2017, investors around the world were captivated by the rise of Bitcoin, a digital currency decentralized from government intervention. At the time, Bitcoin was largely relegated as an asset for day traders. Fast forward to today, and interest from other investing parties has grown, predicating many questions. This research paper seeks to address Bitcoin’s merits and risks as an institutional-quality investment. For an introduction to Bitcoin and cryptocurrency, we encourage you to revisit our research paper published in 2018: Cryptocurrency Q&A.
Overview
Some investors see the role of Bitcoin and other cryptocurrencies as a store of value to protect against rising inflation and to mitigate the risk of currency debasement amid the substantial increases in global money supplies. Its unique technology and momentum-driven characteristics add a speculative growth element but have provided a historically low correlation to other assets. Some of these characteristics may also be captured in other assets, though in a very different way. Real assets like real estate or commodities may also provide a hedge against inflation, while allocations to private equity or technology stocks can capture similar growth and momentum characteristics. While these assets have similar top line objectives, they likely achieve those objectives in different ways. Gold often serves as a store of value, retaining its monetary worth. It proved to be a haven asset in periods of market stress and inflation. Bitcoin has been compared to gold due to its perceived role as an inflation-hedging asset, sometimes referred to as “digital gold,” since both assets are divisible, free from intervention by any single government, verifiable, portable and transferable.
The recent run-up and subsequent crash in Bitcoin prices happened before, most notably in 2017. However, a proliferation in the type of investment solutions separates this cycle from earlier ones. Solutions like crypto mining, wallets, exchange-traded futures contracts and crypto-specific exchanges existed for many years, but newer options include institutional-grade custody solutions from firms such as Fidelity and BNY Mellon. There have also been cryptocurrency ETFs launched in Canada. If interest in cryptocurrencies continue to rise, it is likely the marketplace for institutional-grade solutions will evolve with it. With such evolution, there may be an opportunity for the quality and cost of solutions for investment to become more appealing.
From a regulatory standpoint, there are important considerations around investing in cryptocurrencies. At the time of this writing, the IRS recognizes crypto-asset investments as property and therefore they are taxed with traditional short- and long-term capital gains based on the holding period. Crypto futures contracts, however, are treated as futures and taxed as ordinary income. In late 2020, the Office of the Comptroller of the Currency (OCC) permitted all national banks to participate in cryptocurrency networks to process transactions and provide custody solutions. Investors considering crypto assets should consult with a tax professional around details and impacts on after-tax returns.
Bull Case
Bitcoin’s price behavior continues to follow a boom-and-bust cycle, with each cycle reaching new peaks. Each cycle featured a similar dialogue about Bitcoins merits and shortcomings.
Prior to 2021, Bitcoin reached a peak in 2010, 2013 and 2017, rising suddenly and then losing nearly two-thirds of its value in the subsequent year. This pattern played out soon after a Bitcoin ‘halving event,’ which has occurred about every four years when the reward for mining a Bitcoin block is halved: from 50 to 25 in 2012; 25 to 12.5 in 2016; and from 12.5 to 6.25 in 2020. While this level of volatility is concerning, Bitcoin supporters have pointed to this algorithmic predictability in the Bitcoin supply as a positive compared to the irregular and highly expansionary growth in money supply of fiat currencies, especially in recent years. Supporters argue the predicted supply growth provides transparency and that, paired with the growth in the number of participants in the Bitcoin network, a limited supply will continue to exert upward pressure on Bitcoin’s price. The Stock-to-Flow model is often pointed to as capturing this longer-term trend, with short-term deviations around the trendline but a broadly accurate movement over a longer horizon.
The argument around increased network participation is based on the usefulness of Bitcoin, and cryptocurrencies more broadly, as a transparent, globally accessible, rapid and efficient payments networks. This contrasts with the slow-moving bank networks that exist today, which are often restricted to individual countries. The belief is that as more developers build decentralized apps (DApps) on the Bitcoin network, its network value will increase and draw in more participants and more developers, a self-perpetuating cycle. These network effects are reminiscent of the rise of telephones or the internet. Recent developments, such as acceptance of Bitcoin by payments processors like PayPal or vendors such as Whole Foods, highlight the growth in Bitcoin’s payments network and its wider acceptance.1
1Forbes. “Retailers are accepting crypto. Should loyalty programs be next?” https://www.forbes.com/sites/bryanpearson/2021/05/24/retailers-are-accepting-crypto-should-loyalty-programs-be-next/?sh=53b4cd4f1368
The information contained herein is confidential and the dissemination or distribution to any other person without the prior approval of Fiducient Advisors is strictly prohibited. Information has been obtained from sources believed to be reliable, though not independently verified. Any forecasts are hypothetical and represent future expectations and not actual return volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. The opinions and analysis expressed herein are based on Fiducient Advisor research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is risk of loss.
