It seems these days that you can’t turn on CNBC or read the Wall Street Journal without seeing Bitcoin (BTC) in one of the headlines. The usual headline reads, “Bitcoin Surges” or, “Bitcoin Plummets.” These articles tend to get a lot of interest and make for a great story, one that does not seem likely to end any time soon. But that begs the questions, what really is Bitcoin and why all the excitement?
Bitcoin, a digital currency without the need for a central bank, was created in 2009 by the mysterious pseudonym Satoshi Nakamoto1. There are no physical coins associated with Bitcoin but rather balances kept on a public ledger that everyone has transparent access to. Bitcoins are not backed by any bank or government; in other words, they are the antithesis of a fiat currency (e.g. the U.S. dollar, the Euro, or the Japanese yen). The supply of Bitcoin is limited to just twenty-one million Bitcoins with the last Bitcoin to be released in the year 2140. As of February 2021, there are about 18,624,350 Bitcoins in circulation, or 89% of the total supply.
The most plausible use case for Bitcoin is for payment.
Bitcoin can be transferred from person to person for payment much easier and more efficiently than a wire transfer (in which money is sent from bank to bank). A typical wire transfer fee from a bank is roughly $302, but a wire transfer for $500,000,000 is much more expensive. Typical transfer fees for wires over $10,000 can be 1%3 of the total wire. If you transfer money via the Bitcoin network, the fee is minimal. In 2019, there was a transfer of $450,000,000 worth of Bitcoin from an unknow wallet to another unknown wallet and the fee for the transfer was only $4404.
To create a Bitcoin, you must “mine” it with a computer.
Bitcoin mining involves using computing power to solve complex problems on the Bitcoin network. Whoever solves the problem first is awarded a block. That block contains a certain number of Bitcoin. The current amount of Bitcoin per block is 6.25 Bitcoins, but that number is halved, roughly every 4 years. In the media you will hear talks about the “halvening” as an inflexion point; the reduction in the amount of Bitcoin mined by 50% is what it is referring to.
The price of Bitcoin recently rose above $50,000 USD/Bitcoin. You may be wondering how something that isn’t tangible, is not controlled by a central government, and can’t really be used to broadly purchase goods has any value.
The value of Bitcoin is derived from a few sources. The most obvious is supply and demand. Its limited supply (21,000,000 Bitcoin) creates a demand issue. The more that companies and people adopt Bitcoin, the more the price will be driven up due to the limited supply. From a BTC investment “language” perspective, you will hear both bullish proponents cite the “stock to flow” valuation model to justify and/or project the price of Bitcoin; “stock to flow” is another way of saying supply and demand. From a portfolio perspective, many investors are correctly asking the question: Does Bitcoin belong in my portfolio? For the bullish proponents of the digital currency, the answer is yes, while prominent bears, like gold enthusiast Peter Schiff, say the asset is nothing more than a bubble because “a financial asset is in a bubble when its price has no relationship to its underlying present value or a reasonable expectation of its future value, and investor conviction in price appreciation is high and fear of loss is low. At $50k bitcoin is the biggest bubble of them all.5” Prior to making the previous statement, Mr. Schiff said “a temporary move up to $100k is possible, a permanent move down to zero is inevitable.6”
Like most things in life, and investing, the answer is more nuanced than a simple black or white explanation/answer.
Using one of the most liquid and easy to access vehicles for Bitcoin as a proxy for BTC, the Grayscale Bitcoin Trust7, Bitcoin has some interesting diversification properties that in a vacuum may be attractive from a portfolio construction and asset allocation point of view. However, like the old adage says, there is no such thing as a free lunch, and with Bitcoin, those valuable diversification properties and tantalizing returns comes with a hefty amount of volatility (as measured by standard deviation). This was never more evident than the 15% correction that occurred on February 23rd after comments from Elon Musk8 in which he suggested the crypto currency was overvalued at the $1 trillion market capitalization. Mr. Musk’s comments came alongside Treasury Secretary Janet Yellen opining that Bitcoin was “extremely inefficient.”9 The chart below shows the YTD chart on Bitcoin with several wide swings just in the last 44 days.
