The price of Bitcoin has almost halved since November last year, reminding investors that this it is not a one-way ticket to riches. Institutional and professional investors had been dipping their toes into cryptocurrencies and there was an idea that cryptos could replace gold as a ‘safe’ alternative to fiat currencies. Does the recent weakness disrupt the ‘professionalisation’ of crypto assets?
Many investors will have watched the astonishing rise of Bitcoin with some envy. In spite of its recent volatility, it is still four times high than it was in September 2020. Investors that have stuck to conventional stock and bond portfolios may be wondering whether it is a route to wealth in spite of its Wild West reputation.
However, it is not FOMO that is driving cryptocurrency adoption in most cases. Blockchain data platform Chainalysis has created a Global Crypto Adoption Index. Its most recent report says: “At the end of Q2 2020, following a period of little growth, total global adoption stood at 2.5 based on our summed up country index scores. At the end of Q2 2021, that total score stands at 24, suggesting that global adoption has grown by over 2300% since Q3 2019 and over 881% in the last year.
“Our research suggests that reasons for this increased adoption differ around the world — in emerging markets, many turn to cryptocurrency to preserve their savings in the face of currency devaluation, send and receive remittances, and carry out business transactions, while adoption in North America, Western Europe, and Eastern Asia over the last year has been powered largely by institutional investment.”
This suggests that cryptocurrencies are increasingly becoming part of the financial market ecosystem. Certainly, they appear to show a stronger relationship with financial markets and macroeconomic events than ever before. The most recent bout of weakness is thought to be linked to the ‘risk off’ narrative that has emerged since the Federal Reserve accelerated its monetary tightening programme in late 2021. Liquidity is being withdrawn from financial markets and there is less appetite for speculative assets.
That said, cryptocurrency investors may be encouraged by the relatively moderate falls – this was an asset class where 80% drops were not unusual. This may reflect the growing involvement of longer-term investors in the asset class, rather than the day traders that characterised its early life. The question is whether those investors may now be deterred.
Regulators are yet to be convinced on the merits of Bitcoin. In the UK, there is still a ban on the sale of cryptocurrencies to retail investors, though many investors have found ways to circumvent the rules, buying them abroad or through related assets such as listed crypto platforms or ETFs. The FCA started a consultation in January to build a more pragmatic approach. Its consultation “seeks views on how the UK can ensure its regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers and stability.”
In the meantime, there have been a number of new launches for investors who don’t want to invest directly. The first Bitcoin futures ETF from ProShares launched in the US in October 2021. Two others followed from Valkyrie and VanEck. The ProShares offering raised $570 million of assets in its first day, demonstrating the mainstream appeal of cryptocurrencies.
Other companies have links to the growth of cryptocurrencies. Coinbase is the world’s largest crypto exchange. Chip companies such as Nvidia and Advanced Micro Devices, for example, make high performance graphics that help with crypto ‘mining’. Digital payments companies may also have crypto-related revenues, though it may be a relatively small part of their overall business.
The major challenge for cryptocurrencies will be persuading regulators to allow wider participation in cryptocurrency markets. Some, such as the UK, recognise that they need to find a way to manage growing interest in the asset class. Others, such as China, don’t like the idea of having a widely-used widely-used currency that is out of their control. Chinese regulators banned all virtual currency trading and speculation in 2021. India has also restricted use of the cryptocurrencies.
It will also be important for investors to watch the type of asset cryptocurrency becomes. There had been an idea that it would replace gold as a store of value during turbulent markets. However, the recent volatility suggests that Bitcoin, still the leading cryptocurrency, is seen as a risk asset and will correlate with buoyant market sentiment, selling off at times of stress. This will affect how cryptocurrencies are adopted and by whom.
The volatility of cryptocurrencies remains a problem if it wants to be taken seriously as an alternative currency. No-one wants to find that the asset buys them half what it did just a few days ago. If institutional and long-term investors take a greater interest, this volatility may ebb, but we’re not there yet and the recent price drops may prove a deterrent for the very investors it needs to attract.
