What has happened?
Bitcoin ups and downs have taken on a new dimension over the past few months, as a string of institutional investors revealed direct investments in the cryptocurrency, while others publicly admitted to mulling analogous projects. Renewed buzz around bitcoin culminated in February, with the cryptocurrency’s market capitalization passing the USD 1 trillion mark for the first time.
The rise started in the summer of 2020, as various small and mid-sized financial services providers started disclosing investments worth hundreds of millions of US dollars in bitcoins. But the most spectacular announcement came in early February in the form of Tesla’s USD 1.5 billion investment in bitcoins, as it indicated plans to start accepting payments in the cryptocurrency.
Within days, several large companies, including payments processors, hedge funds, asset managers and pension funds, followed suit, indicating cryptocurrency-related projects, or at least a keen interest in this type of asset. Yet the frenzy turned out to be short-lived as prices quickly started to nosedive. By the end of February, bitcoin’s market cap was back closer to USD 850 billion.
Why is it important?
Putting aside the sustainability challenge – the computing power required to mine bitcoins draws on huge quantities of electricity – the recent excitement around the cryptocurrency places the spotlight on the rising interest in digital assets, including privately-issued ‘stablecoins’, central bank digital currencies (CBDCs), and so-called ‘decentralized finance’ (DeFi) projects.
Whether it is a store of value, an alternative payment system, or a hedge against inflation and tail risk in financial markets, the number of use cases considered for bitcoins and the like is on the rise. US regulators have so far resisted the approval of any cryptocurrency-based instruments, but other countries such as Switzerland and Canada have already taken the plunge.
Meanwhile, a growing number of countries around the world appear to be mulling the issuance of CBDCs. China seems by far the most advanced in this area. Its authorities have launched the e-yuan and are now conducting a series of trials across the country, to test the new technology before potential widespread adoption.
What does it mean for investors?
Digital currencies are increasingly seen as a way to address long-standing issues associated with traditional currencies and payments systems. For one, they may help improve competition within payments systems, something dearly needed for companies and individuals to make fast and cheap cross-border payments. They may also help track and prevent illicit transactions.
Moreover, a growing number of ‘DeFi’ initiatives aim to challenge existing traditional financial services providers – such as lenders, insurance companies, or exchanges – in a decentralized way, by leveraging the same blockchain technology used to mine bitcoins. Although the disruption potential of such assets should not be ignored, we believe it is also too early to rush headlong.
The average monthly volatility of bitcoins was more than twice that of the S&P 500 Index last year, while annual trading volumes on exchanges doubled between 2019 and 2020, to USD 12 trillion, according to Morgan Stanley. Also, risk of political involvement is rising. Meanwhile, CBDCs and ‘DeFi’ initiatives essentially remain on ‘project’ or ‘prototype’ status.
So, while the advent of digital assets is one of the developments we follow closely as part of our FinTech and New World Financials equity strategies – in particular, we monitor upcoming listings of companies operating in this area – we remain cautious for now. We limit our investments to firms that provide digital currency-related services, like exchange trading, settlement and custody.