Investment Insight | Bitcoin - here to stay
Cryptocurrency markets have expanded dramatically in the thirteen years since an anonymous author published the Bitcoin white paper. While all cryptocurrencies share common features (primarily, they are distributed networks secured via cryptography) the structure of the individual assets and their intended real-world use cases have become more diverse.
The two largest coins, Bitcoin and Ethereum, still account for a large majority of market capitalisation. According to CoinMarketCap.com, there are nearly 6,000 cryptocurrencies in the marketplace today with a total market capitalisation of $2.0 trillion. For comparison, the total market value of bonds covered by the Bloomberg-Barclays US Corporate High Yield Index is $1.67 trillion, while the market cap of the S&P 500 is approximately $39 trillion. Bitcoin currently accounts for 44% of the total cryptocurrency market, while Ethereum accounts for about 20%. Given its dominant position, the remainder of this article will focus on Bitcoin.
Fixed Supply
Bitcoin is one of the only verifiably scarce, fixed supply assets in the world. Bitcoin’s underlying code controls how much new Bitcoin is created and limits the maximum amount of Bitcoin that will ever exist to 21 million. Bitcoin has a price-inelastic supply, meaning that a change in price cannot change its supply issuance. Said differently, an increase in the value of Bitcoin does not affect its supply and does not affect Bitcoin’s issuance schedule. As of today, just over 18 million of that total supply has been issued as block rewards to the miners processing transactions on Bitcoin’s network.
Approximately every four years, the supply of Bitcoin issued as mining rewards gets cut in half until eventually no more supply will be issued. The next Bitcoin supply reduction is set to occur in 2024, when the supply issuance will be reduced from 6.25 Bitcoin per block to 3.125 Bitcoin per block. This ‘block reward’ for miners will continue to be cut on a fixed schedule until it approaches zero around 2140.
Modern Portfolio Theory in the Digital Age
Modern portfolio theory (MPT) is the standard analysis used by professional investors to model scenarios of optimal portfolio allocations to traditional assets such as shares, bonds, property and commodities. Academic research suggests that, if we expand the assets to incorporate Bitcoin into this analysis, there are diversification benefits and owning Bitcoin improves long-term portfolio efficiency. This is despite Bitcoin being a volatile asset.
It is worth noting that given Bitcoin’s relatively recent creation, we only have a short performance history so its contribution may change over time. As Bitcoin becomes a more mainstream asset, its correlation with traditional cyclical assets (shares, bonds and commodities etc) appears to be increasing.
While Bitcoin has diversification benefits for a portfolio, this does not mean that it is a reliable hedge during times of acute market stress such as March 2020. Over shorter time periods, Bitcoin has tended to do well when share markets have performed well and this suggests that it should not be used as an asset to mitigate short-term market draw downs. Bitcoin is, however, uniquely positioned along with gold to protect portfolios against a simultaneous loss of faith in a country’s currency and its payments system. This is because it exists outside the traditional payments system.
Still early days
Bitcoin may seem like it has quickly exploded onto the scene, and awareness has grown rapidly over its 13 years since inception. However, these are early days and Bitcoin still has tremendous room to expand compared to other global markets. Bitcoin’s current market cap stands at $900 billion. That is still far smaller than individual companies like Apple ($2.4 trillion) or Amazon ($1.67 trillion). Further still, when compared to the size of the gold market ($114 trillion) or the US stock market ($47 trillion) Bitcoin has tremendous upside growth potential.
Institutional adoption
Growth in Bitcoin is likely to come from increasing institutional participation. A recent survey conducted by Fidelity Digital Assets found that seven in ten institutional investors expect to buy or invest in cryptoassets in the near future. More than half of the 1,100 respondents surveyed revealed that they already own such investments.
The shift in attitudes by traditional asset managers is also evidenced by the recent allocation made by the world’s largest asset manager, Blackrock, to cryptocurrencies in two of its actively managed funds, ‘Global Allocation’ and ‘Strategic Opportunities’.
Other examples of note are well-known investors including George Soros and Paul Tudor Jones, hedge funds such as Point72, Millennium Management, Brevan Howard, and Matrix Capital Management, and the 169-year-old insurance company MassMutual which has purchased $100 million of Bitcoin for its general fund (a 0.04% weight).
Even fiscally conservative Germany has just passed a law, effective 1 August 2021, that allows Spezialfonds to invest up to 20% of their asset in Bitcoin.
Where to from here?
In many respects Bitcoin in 2021 is not dissimilar to the internet in the early 2000s. In the case of the internet, most people suspected that it was a significant development that had the potential to change our daily lives – we just didn’t know how that would happen. Cryptoassets are here to stay and will become an increasingly important factor in our daily lives over the years ahead.
The two largest coins, Bitcoin and Ethereum, still account for a large majority of market capitalisation. According to CoinMarketCap.com, there are nearly 6,000 cryptocurrencies in the marketplace today with a total market capitalisation of $2.0 trillion. For comparison, the total market value of bonds covered by the Bloomberg-Barclays US Corporate High Yield Index is $1.67 trillion, while the market cap of the S&P 500 is approximately $39 trillion. Bitcoin currently accounts for 44% of the total cryptocurrency market, while Ethereum accounts for about 20%. Given its dominant position, the remainder of this article will focus on Bitcoin.
Fixed Supply
Bitcoin is one of the only verifiably scarce, fixed supply assets in the world. Bitcoin’s underlying code controls how much new Bitcoin is created and limits the maximum amount of Bitcoin that will ever exist to 21 million. Bitcoin has a price-inelastic supply, meaning that a change in price cannot change its supply issuance. Said differently, an increase in the value of Bitcoin does not affect its supply and does not affect Bitcoin’s issuance schedule. As of today, just over 18 million of that total supply has been issued as block rewards to the miners processing transactions on Bitcoin’s network.
Approximately every four years, the supply of Bitcoin issued as mining rewards gets cut in half until eventually no more supply will be issued. The next Bitcoin supply reduction is set to occur in 2024, when the supply issuance will be reduced from 6.25 Bitcoin per block to 3.125 Bitcoin per block. This ‘block reward’ for miners will continue to be cut on a fixed schedule until it approaches zero around 2140.
Modern Portfolio Theory in the Digital Age
Modern portfolio theory (MPT) is the standard analysis used by professional investors to model scenarios of optimal portfolio allocations to traditional assets such as shares, bonds, property and commodities. Academic research suggests that, if we expand the assets to incorporate Bitcoin into this analysis, there are diversification benefits and owning Bitcoin improves long-term portfolio efficiency. This is despite Bitcoin being a volatile asset.
It is worth noting that given Bitcoin’s relatively recent creation, we only have a short performance history so its contribution may change over time. As Bitcoin becomes a more mainstream asset, its correlation with traditional cyclical assets (shares, bonds and commodities etc) appears to be increasing.
While Bitcoin has diversification benefits for a portfolio, this does not mean that it is a reliable hedge during times of acute market stress such as March 2020. Over shorter time periods, Bitcoin has tended to do well when share markets have performed well and this suggests that it should not be used as an asset to mitigate short-term market draw downs. Bitcoin is, however, uniquely positioned along with gold to protect portfolios against a simultaneous loss of faith in a country’s currency and its payments system. This is because it exists outside the traditional payments system.
Still early days
Bitcoin may seem like it has quickly exploded onto the scene, and awareness has grown rapidly over its 13 years since inception. However, these are early days and Bitcoin still has tremendous room to expand compared to other global markets. Bitcoin’s current market cap stands at $900 billion. That is still far smaller than individual companies like Apple ($2.4 trillion) or Amazon ($1.67 trillion). Further still, when compared to the size of the gold market ($114 trillion) or the US stock market ($47 trillion) Bitcoin has tremendous upside growth potential.
Institutional adoption
Growth in Bitcoin is likely to come from increasing institutional participation. A recent survey conducted by Fidelity Digital Assets found that seven in ten institutional investors expect to buy or invest in cryptoassets in the near future. More than half of the 1,100 respondents surveyed revealed that they already own such investments.
The shift in attitudes by traditional asset managers is also evidenced by the recent allocation made by the world’s largest asset manager, Blackrock, to cryptocurrencies in two of its actively managed funds, ‘Global Allocation’ and ‘Strategic Opportunities’.
Other examples of note are well-known investors including George Soros and Paul Tudor Jones, hedge funds such as Point72, Millennium Management, Brevan Howard, and Matrix Capital Management, and the 169-year-old insurance company MassMutual which has purchased $100 million of Bitcoin for its general fund (a 0.04% weight).
Even fiscally conservative Germany has just passed a law, effective 1 August 2021, that allows Spezialfonds to invest up to 20% of their asset in Bitcoin.
Where to from here?
In many respects Bitcoin in 2021 is not dissimilar to the internet in the early 2000s. In the case of the internet, most people suspected that it was a significant development that had the potential to change our daily lives – we just didn’t know how that would happen. Cryptoassets are here to stay and will become an increasingly important factor in our daily lives over the years ahead.
Source: www.blockchain.com.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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Mark Brooks is Portfolio Manager for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. Mark's comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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