This essay was contributed by Marion Laboure, a macro strategist and economist at Deutsche Bank in London.
In just one year, Bitcoin prices have jumped from $4,900 to $60,000. This spectacular increase marked the big comeback of the king of cryptocurrencies in the public eye.
The concept of cryptocurrency emerged around 30 years ago when DigiCash created the world’s first virtual currency. The company went bankrupt in 1998, less than 10 years after its creation.
It was not until May 2010 that the first Bitcoin transaction was executed, with the purchase of two “Papa John” pizzas for 10,000 Bitcoins by programmer Laszlo Hanyecz; today, BTC10,000 is worth $600 million. Sign of their democratization, there are now more than 5,000 cryptocurrencies in the world. Bitcoin is, however, in a virtual monopoly position since its current capitalization is more than four times that of the second most traded cryptocurrency, Ethereum.
The value of Bitcoin will continue to rise and fall depending on what people think it is worth. This is sometimes called the “Tinkerbell Effect” — a recognized economic term stating that the more people believe in something, the likelier it is to happen based on Peter Pan’s assertion that Tinkerbell exists because children believe she exists.
Bitcoin’s resurgence in popularity is based on the recent entry of institutional investors and hedge funds. Bitcoin has even become a cash management tool for some companies. Several listed companies have started converting their cash flow into Bitcoins. For example, in August 2020, MicroStrategy, a business analytics company, converted $425 million worth of cash in its treasury to Bitcoin.
Such company leaders believe that Bitcoin, as the world’s most widely adopted cryptocurrency, is a dependable store of value and they continue to believe Bitcoin will provide the opportunity for better returns and preserve the value of our capital over time, compared to holding cash.
Several other companies have followed suit, boosting confidence in Bitcoin as a reserve and safe-haven asset. On February 8, 2021, Tesla said it had invested $1.5 billion in Bitcoin and that the company would also soon accept Bitcoin as a form of payment for its vehicles. In February 2021, in Switzerland, the Canton of Zug started accepting tax payments in Bitcoin.
Whether you take Warren Buffett’s advice of “Stay away from it. It’s a mirage”, or think like Jack Dorsey, co-founder and CEO of Twitter, that Bitcoin will become the single currency of the world, Bitcoin’s market cap of $1 trillion probably makes it too important to ignore. The big players who buy and sell Bitcoin have considerable market power. As long as asset managers and businesses continue to enter the market, Bitcoin prices will rise.
Bitcoin will remain volatile. Transactions are still very limited. A few companies already accept it, such as Microsoft, AT&T, Norwegian Air, PayPal and Subway. But we estimate that less than 30% of Bitcoin transactional activity is related to payment for goods and services, with the rest being widely used as financial investment.
As an investment asset, Bitcoin’s liquidity remains low. In 2020, 28 million bitcoins changed hands (150% of total bitcoins in circulation), compared to 40 billion Apple shares (270% of its total shares in circulation).
Due to its still limited “tradability”, Bitcoin is expected to remain ultra-volatile: a few large additional purchases or exits from the market will have a significant impact on the balance between supply and demand. The question now is whether the rise in valuations alone will be enough to make Bitcoin a real asset class, or if its illiquidity will remain an obstacle.
In the long term, and like Tesla, Bitcoin will need to turn its potential into concrete results.
Tesla is five years older than Bitcoin and has also sparked heated debate between those who see it as a passing fad and those who see it as the future of the car. Tesla’s current market cap is $665 billion, as of March 12, 2021: nearly five times the combined market cap of Ford and General Motors. This is remarkable since GM sold around eight times as many cars as Tesla in 2020, and Ford over five times as many. Tesla’s valuation is based on the belief that the company will be an absolute leader in the automotive market when this it will be dominated by electric cars.
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If we compare its value in circulation to that of major fiat currencies, Bitcoin would be mostly in the top five depending on the live exchange rates, but its liquidity is actually close to that of the Thai baht!
Yet, the average number of Bitcoins exchanged daily in USD is equivalent to only 0.05% of the yen and 0.06% of the GBP. The current valuation of Bitcoin is based on the belief that it will become a benchmark global currency and an important means of payment.
The next two or three years will be decisive for Bitcoin. Central banks and governments understand that digital currencies are the future of payments, which has been clearly acknowledged in markets such as Mainland China and India. Some governments are therefore expected to start regulating crypto assets by the end of this year or early next year. Other authorities are accelerating research on their own central-bank digital currencies (CBDCs) and launching pilot projects. Tinkerbell can do only so much; the future of Bitcoin is in their hands.