Divided opinion: A representation of the virtual currency Bitcoin is seen in this illustration. Some economists argue that Bitcoin fails as a hedge against inflation, as its price behaviour is more correlated with the equity market than anything else. — Reuters THE year 2020 is turning out to be one hell of a ride for investors as we have seen the volatility in equity markets, turning from a bull market to a bear market in a matter of days, and within another short space of time, returning to the bull phase, as easy monetary policies across the world sent markets soaring. If every index point on the Dow Jones is translated into a measurement of height, the Dow has now surpassed the Mount Everest while other asset classes too saw significant rallies, be it in the commodity space, the bond market and even selected currencies. However, one “asset” beat them all – the cryptocurrencies, and in particular, Bitcoin. Starting the year at US$7,250, Bitcoin rallied to a high of US$10,368 by mid-February but the price tumbled to under US$5,000 a month later on the global sell-off of markets due to the fear of the unknown and its impact to markets then – Covid-19. With the US Federal Reserve and the rest of the world starting to provide massive liquidity via quantitative easing (QE) programmes to markets, not only did it impact the equity markets but it also had a spillover effect on other asset classes, including cryptocurrencies. Even gold and silver found new best friends as prices soared to multi-year highs. Bitcoin hit the US$10,000 mark again by early June and hovered between US$9,000 and US$12,000 per coin between June and up to the third week of October. Thereafter, prices just went berserk as Bitcoin gained as much as 66% in six weeks to hit a high of US$19,768 on Dec 1 before retracing back to US$18,220 per coin at the time of writing. Bitcoin is up 155% year-to-date while other cryptos like Ethereum have leapfrogged 330% while Ripple has almost doubled. Why Bitcoin? Any economist with a brain will tell you that Bitcoin doesn’t make sense, as it has no intrinsic value, is not a currency and neither is it a scalable means of payment. It is also highly volatile and hence it cannot be a store of value. Of course, it is also neither backed by any asset nor a legal tender. It is also seen as highly speculative and manipulative. Some economists will also argue that Bitcoin fails as a hedge against inflation, as its price behaviour is more correlated with the equity market than anything else. The speculative element of Bitcoin is also driven by the sheer increase in the size of stablecoins, in particular Tether. Tether, which is pegged to the US dollar on the basis of one coin per US dollar, has seen the number of coins issued rising by almost five-fold from just 4.14 billion coins to 19.75 billion, with the additional supply seen as being the main catalyst for the super charged rally in Bitcoin. Crypto-mania fans, traders, speculators and those who live in the virtual world will tend to disagree with all of the above arguments as the reason for the very existence of the alternative “medium of exchange” is mainly due to the failure of the government issued currency system, which today, has deviated from its original backing of gold. Most currencies today, including the ringgit, are what is referred to as fiat currencies and the value derived from these fiat currencies are mainly driven by confidence the currencies bring to the users, be it to purchase an asset or investment, as a store value, as a medium of exchange and so forth. In some cases, due to the past crises that the world has experienced, central banks have become money printing machines as they assumed the role of economic driver in the form of providing stimulus packages, a back-stop for markets from severe corrections and providers of capital to protect employment and even to provide wage subsidies. To do this, central banks can carry out two distinct but perhaps rather similar expected outcomes. Central banks can either carry out a QE programme or deploy “helicopter money”, a term that is defined under the modern monetary theory (MMT). While QE allows a central bank to create money via the purchase of debt securities issued by the government, MMT is effectively printing money to directly fund public expenditure or tax cuts. Under MMT, the central bank prints money for the government with no expectation of it being paid back. The only fear of the MMT approach is the impact on inflation. Being done without basis or indiscriminately would result in significant deterioration of confidence in the currency, which in turn could lead to rating downgrades and higher borrowing costs. Of course, as we have seen in the examples of some African nations, not every country in the world has the ability to print money. If a government or central bank is borrowing money in its own fiat currency, meaning a currency backed by nothing but the government’s good word, only then it can assume the “printing” of any amount necessary to cover its debts. For now, that is only seen possible for the reserve currency of the world, the US dollar. The world has a staggering debt problem. So, going back to the argument of cryptocurrencies and fiat money – how different are they in the form of asset backing? In actual fact, we can now argue that currencies too have lost their meaning, as we have a huge burden of debt that has been created by various economic turmoils of the past, the present and perhaps in the future as well. Statistics from the Institute of International Finance (IIF) show that as at the end of the third quarter (Q3) of 2020, global debt topped US$272 trillion and is expected to continue to climb to reach US$277 trillion by end-2020, translating to a massive 365% of the debt-to-GDP ratio. Global debt will rise by an estimated US$20 trillion in 2020 alone. With so much of debt that has been created by the financial system, the government and the central banks, sometimes one wonders who are the investors holding these debts. For the proponents of cryptos and in particular Bitcoin, the argument for them is precisely the argument against fiat currencies, which of course includes the notion that Bitcoin is also a store of value or wealth. In addition, due to the massive money creation capability of central banks, that for Bitcoin is not that simple, as the creation of new coins is only based on the mining capability of crypto-miners to solve the complex mathematical question. In addition, Bitcoin’s limited issuance of new coins, driven by the “halving” effect, which reduces the number of coins issued every time a mathematical equation is solved, as well as its lifetime limit of 21 million coins, makes Bitcoin almost a limited supply product. With about 18.567 million issued to-date, Bitcoin has only some 2.433 million coins worth about US$44.33bil to go in terms of future supply. Just like an asset, Bitcoin’s price is not only determined by the demand and supply of the coins itself but its ability to project itself as some sort of a payment system based on the technological platform that its build-upon. Bitcoin today is held and accepted by its users, which includes both individuals and institutions and both online and offline. Its payment system is popular globally and we are already seeing increasing acceptance among central banks even. Today, we have Bitcoin Futures traded in the CME Group’s derivative exchange and going into 2021, S&P Dow Jones will be introducing Cryptocurrency Indexes – a recognition that Bitcoins and other cryptos are here to stay. After all, the crypto space today has a total market capitalisation of in excess of a half a trillion dollars and with value traded on a daily basis in excess of US$100bil a day. Bitcoin itself accounts for more than 60% of the total market capitalisation of all cryptocurrencies and 20% of value traded on a daily basis. To be an asset, an instrument needs to have a fundamental value. It must be able to function as a stored value, convertible to cash or cash equivalent and has a observable market price. With more and more merchants and banks recognising Bitcoin, it can be said to have passed the test to be deemed as an asset. Although it does not provide a return in the form of an income like a dividend, its characteristics are similar to gold, as the latter too is not an income-generating asset and yields zero return. Investors who buy gold or Bitcoin have only one thing on their mind – capital gains.With that, should investors have an asset allocation to have Bitcoin or other cryptocurrencies as a part of the alternative asset allocation? Perhaps it is time. Bitcoin anyone?Pankaj C Kumar is a long-time investment analyst. Views expressed here are his own.
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