Bitcoin, the most prominent crypto asset, surged past $34,000 for the first time over the weekend, on the day of the Bitcoin network’s 12-year anniversary. This built on an incredible December in which it grew more than 50% and flew past its previous all-time high of $19,793. This is an astounding gain considering Bitcoin dropped below $4,000 in March 2020, around the time Covid-19 began to impact Western countries. Bitcoin now ranks as the 17th most valuable global currency, recently overtaking the Saudi Riyal to sit just behind the Mexican peso.
Cryptocurrencies? Crypto assets?
Crypto assets is a broad term that covers all assets stored on distributed ledgers, this includes cryptocurrencies like Bitcoin as well as non-currency assets such as security tokens and utility tokens (to be discussed in another blog post). A distributed ledger is simply put a list of digital transactions that occur between different parties, with each party having its own copy of the list. The ledger is not stored by one central entity (e.g. a bank). A cryptocurrency is designed to work as an exchange medium, with coin ownership records stored on the ledger. Cryptography – the encryption of data, is then used to create additional coins and verify the transfer coin ownership on the ledger.
Cryptocurrencies specifically use ‘public key cryptography’. A user on the ledger has a public key and private key, both encrypted random assortments of numbers and letters. The public key can be given to other users, who can send assets to the address. However, only the private key can be used to remove assets from the address. Consider a public mailbox, anyone can place mail into the box, yet only the mailman has the key to unblock the mailbox, cryptocurrency cryptography works similarly. 1
What caused Bitcoin’s 2020 surge?
I don’t think there is any coincidence that Bitcoin has grown during a global pandemic that is wreaking economic turmoil. The $900 billion stimulus package agreed by the US government in mid-December has coincided with the bull run as of late. It could be argued US investors see Bitcoin as a haven for their dollars, despite the dollar being relatively stable during the pandemic.
PayPal, one of the largest digital payment platforms, secured the first conditional cryptocurrency license from the New York State Department of Financial Services in October 20202, allowing it to provide cryptocurrency holding services for its users. Bitcoin’s price had been slowly rising in the months prior to the announcement, but in the week post-announcement it saw a 13% price increase. It could be argued that PayPal bringing the cryptocurrency into the public eye has been a major factor in the current bull run, with its adoption inspiring confidence in investors. The US firm also plans to increase the services it offers around cryptocurrencies in 2021, allowing users to shop with them. Increased accessibility of cryptocurrencies by consumers could further bolster demand.
Institutions have long been put off cryptocurrencies by potentially volatile returns and lack of regulation. However, Institutional investors’ interest in Bitcoin and other cryptocurrencies grew significantly in 2020. In December alone, SkyBridge Capital Investment invested $182 million in Bitcoin, while Massachusetts Mutual Life Insurance Co invested $100 million. Additionally, Guggenheim Funds Trust could place up to 10% of its $5 billion macro fund into Grayscale’s Bitcoin Trust – the first SEC-reporting digital currency investment vehicle. Meanwhile, Fidelity reported in a survey of nearly 800 institutional investors that 36% owned crypto assets.3
One key factor that could be driving Institutional interest in Bitcoin is its ever-increasing scarcity. A prominent model in the Bitcoin community – stock-to-flow – provides insight into this.
Bitcoin’s stock-to-flow
Firstly, to touch on the Bitcoin technology, there will only ever be 21 million bitcoins created. Approximately 18.5 million coins are already in circulation, leaving 2.5 million left to be acquired. New bitcoins are produced by “miners” who use computing power to acquire them. Approximately every four years, the rate at which Bitcoin can be mined halves, with the most recent halving occurring in May 2020. It won’t be until 2140 before all bitcoins have been mined.
The Bitcoin stock-to-flow model, created by an anonymous Dutch Institutional investor, calculates a ratio based on the existing supply of an asset compared with how much is entering circulation each year. Take gold, for example. The World Gold Council estimates around 190,000 tons of gold have so far been mined, with an additional 3,000 tons being mined each year4. This gives gold an approximate stock-to-flow figure of 63.3, i.e. it would take more than 63 years of gold production to mine the current gold stock. Following last year’s halving, Bitcoin’s stock-to-flow is approximately 50 – which is higher than silver and closing in on gold. Should Institutional investors other than the creator of the model view Bitcoin as a store of value like gold and silver, it could be argued that Bitcoin should retain and increase in value over the long term due to its scarcity. Critics are, however, fast to point out that the model is based on a strict correlation between price and scarcity, which is not always the case for assets.
Cryptocurrency & UK financial institutions
Over 1.9 million adults in the UK are estimated to hold cryptocurrencies. However, its noted that 50% of these hold less than £260 worth, with 80% of cryptocurrency wealth being held by less than 1% of the UK population5 – likely the early adopters. The FCA recognises cryptocurrencies, and all existing cryptocurrency businesses in the UK are supervised for anti-money laundering and counter terrorist financing6. Until October 2020, consumers were offered no regulatory protection. However, the FCA has now banned the sale of crypto derivatives to retail consumers in the UK, citing extreme volatility across cryptocurrency price movements and inadequate understanding of crypto assets by retail consumers as determining factors, amongst others.7
Regardless, the sale of cryptocurrencies to professional investors is still permitted, and UK-based investment managers are paying attention to Bitcoin. Ruffer Investment Company Limited added $750 million (£550 million) of Bitcoin to its portfolio in December 2020.
In my opinion, we could see many more UK investment firms diversifying into Bitcoin in 2021. An asset once seen as an internet fad is now too prominent in society to ignore. However, attempts to leverage cryptocurrency in the UK have previously led to failure. Prime Factor Capital, the first crypto-focused hedge fund to be given a license by the FCA, struggled to attract investors and closed last summer, despite successfully delivering returns of up to 4% a month.8 Perhaps it was a case of bad timing for Prime Factor Capital, which may have flourished were it still operating in today’s bull market.
Conclusion
Only time will tell what stance other UK investment managers take on crypto assets in 2021. The FCA ban on the sale of crypto derivatives to retail clients may have deterred some managers. However, the opportunity to sell to professional investors may just be at forefront of some managers thinking. The price movement of Bitcoin will prove to be fascinating over the next few months, the coins having achieved a new recent all-time high place it firmly in the public eye to start off the year. As it grabs the attention of more global financial institutions, UK investors licking their wounds from Brexit, with optimism of a post-Covid 19 UK on the horizon, may just hedge their bets on Bitcoin.
“Buy not on optimism, but on arithmetic.”
― Benjamin Graham, The Intelligent Investor
References.
- How cryptography is used in cryptocurrency. World Crypto Index. https://www.worldcryptoindex.com/how-cryptography-is-used-cryptocurrency/
- PayPal Launches New Service Enabling Users to Buy, Hold and Sell Cryptocurrency. Paypal. https://newsroom.paypal-corp.com/2020-10-21-PayPal-Launches-New-Service-Enabling-Users-to-Buy-Hold-and-Sell-Cryptocurrency
- Growing institutional interest in buying Bitcoin and other cryptocurrencies. BTC Assessors.https://btcassessors.com/blog/growing-institutional-interest-in-buying-bitcoin-and-other-cryptocurrencies/
- Bitcoin and the Stock to Flow Model. Binance. https://academy.binance.com/en/articles/bitcoin-and-the-stock-to-flow-model
- https://www.fca.org.uk/publications/research/research-note-cryptoasset-consumer-research
- Research Note: Cryptoasset consumer research. FCA. https://www.institutionalassetmanager.co.uk/2020/12/22/293819/fca-authorised-wallet-provider-moneybrain-welcomes-regulators-crypto-update-end
- FCA bans the sale of crypto-derivatives to retail consumers. FCA. https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers
- UK’s first regulated crypto hedge fund set to close down after failing to attract investors. FN London. https://www.fnlondon.com/articles/uks-first-regulated-crypto-hedge-fund-set-to-close-down-after-failing-to-attract-investors-20200722