While bitcoin’s stunning 700% rise over the past year has some grasping for centuries-old historical precedents, such as the South Sea Company or “Tulipmania,” you actually don’t need to go that far back.
Indeed, just a few years ago, in 2017, the price of bitcoin spiked to nearly $20,000 in December of that year after starting the year below $1,000. One year later, however, and the price had tumbled to around $3,000, about 75% below its peak.
Could that be what’s in store for bitcoin now as it surged to a peak of more than $61,000 in mid-March, from around $7,000 a year ago (it currently sits at around $56,000)?
The extreme volatility and uncertain intrinsic value are precisely why seasoned investors like Berkshire Hathaway’s vice chairman Charlie Munger, have derided bitcoin in the past as essentially pure speculation.
"To me, it's just dementia,” Munger said in his typically acerbic fashion at Berkshire’s 2018 annual meeting.
While others are not so keen to dismiss the investment opportunity outright, there remain some corollaries that beg caution if bitcoin’s breakout continues towards unsustainable heights.
On this point, Ulrik Lykke, CEO of Crypto-focused hedge fund ARK36, said that history should teach investors not to be overly greedy, alluding to Joseph Kennedy’s famous anecdote about how he knew it was time to get out of the market in 1929 when shoeshine boys were giving him stock tips.
“If the market goes completely parabolic and the price hits $100,000 to $300,000 per coin, a big downturn similar to the one we saw in 2018 will probably follow,” he said. “The lesson here is to know to take profit when the price gets so big that a sale can change your life radically. In other words, if absolutely everyone, including your grandmother, is optimistic about bitcoin then it is probably a good time to sell some of it.”
What’s Different This Time
However, there are numerous aspects of the current bull market that mark significant differentiations from late 2017 and therefore need not be regarded with such suspicion.
Perhaps most prominent is the much higher level of buy-in from institutional investors. While retail investors overwhelmingly led the bull market in 2017, institutions have outpaced retail purchases over the course of the past two quarters, per JP Morgan research.
"[There is] little doubt that the institutional flow impulse into bitcoin is what distinguishes 2020 from 2017," the firm said in a note earlier this year.
The institutional support has also helped push bitcoin’s market cap above $1 trillion, more than 400% higher than its previous zenith in 2017. While a largely retail base may have left the 2017 bull run on shaky footing, institutional endorsement is seen by many as a firm foundation that can prevent such a drastic draw-down as was observed in 2017 into 2018.
“Institutional acceptance of cryptocurrencies was very low in 2017, but clearly is rising now both in the world of derivatives as well as exchange-traded funds,” noted Bob Fitzsimmons, the executive vice president of fixed income, commodities and stock lending at Wedbush Securities. “The number of firms accepting and clearing cryptocurrencies has risen beyond the ‘establish the beachhead’ phase and has entered the ‘virtuous network’ phase wherein liquidity begets liquidity.”
He added that a tightening U.S. monetary policy in 2017 and 2018 contrasts sharply with present policy, adding differentiation between the present and past bull runs. Instead of 2017, Fitzsimmons likened cryptocurrencies’ current trajectory to an accelerated timeline of the dot-com bubble and recovery.
“Cryptocurrencies’ market history bears a resemblance to internet stocks history: The first phase of the dot-com bubble saw the swift rise and swifter fall of new entrants,” Fitzsimmons explained. “The consolidation of the industry after 2002 and the emergence of large-scale firms benefiting from network efficiencies created a market dominated by highly profitable and completely accepted firms whose dominance far exceeds that envisioned during the late 1990s bubble.”
As such, he regards the crash in late 2017 as akin to the dot-com crash. The current move is more in line with the era following the crash wherein the industry consolidated and fomented the growth of a powerful tech sector undergirded by some of the largest companies in the world.
ESG Adds a New Wrinkle
Yet, many forward-looking investors are also concerned about the future of the planet. In this respect, bitcoin -- and cryptocurrency mining generally -- fall afoul of best principles, a fact only amplified since the 2017 top.
According to the bitcoin Energy Consumption Index, bitcoin’s carbon footprint is 25% greater than that of the Czech Republic and annually consumes about the same amount of electricity as the Philippines. The sustained lofty price allows for high levels of energy usage to be justified, exacerbating the issue.
Per a London School of Economics survey, 96% of firms polled expected to increase the prioritization of environmental, social and governance (ESG) issues in 2021, cementing the secular trend of ESG investing. Overall, this puts the megatrend of cryptocurrencies at loggerheads with the other great investment paradigm shift of our time in ESG.
In this case, the differentiation from 2017 is in terms of added scrutiny, which could threaten the aforementioned institutional support of cryptocurrencies and curtail the bull run in a similar fashion, albeit by different means.
Caution From China
Intertwined with the scrutiny surrounding environmental issues as a common thread is the sizable amount of bitcoin mining conducted in China.
Shortly before bitcoin’s tumble to close 2017, Chinese regulators moved to crack down on cryptocurrencies by banning initial coin offerings (ICOs), and further moved to end preferential policies for bitcoin mining companies in terms of electricity prices, taxes, and more in Jan. 2018.
However, crackdowns did not ultimately kill China’s bitcoin industry. According to Statista, 65% of bitcoin mining was still done in China in 2020. While there were major crackdowns on ICOs and the exchange of yuan for cryptocurrencies, Chinese bitcoin enthusiasts were able to skirt regulations by utilizing USDT, a dollar-linked stablecoin offered by Tether.
At present, the Chinese state is seeking to further undercut bitcoin by establishing its own cryptocurrency, the digital yuan, and banning all other cryptocurrencies from being mined or circulated by Chinese nationals. This includes the stablecoins such as the USDT offered by Tether.
“Most bitcoin trading occurs, not against fiat USD, but USDT,” JP Morgan analyst Joshua Younger warned in a recent note. “Were any issues to arise that could affect the willingness or ability of both domestic [Chinese] and foreign investors to use USDT, the most likely result would be a severe liquidity shock to the broader cryptocurrency market which could be amplified by its disproportionate impact on HFT-style market makers which dominate the flow.”
2017 showed that China’s crackdowns might not be immediately effective and can be skirted by savvy netizens as shown by USDT’s usage and bitcoin’s bull run outlasting initial sanctions. But successive regulations in 2018, as documented by the Library of Congress, appeared to shore up many loopholes and further damage bitcoin demand as the price per coin plummeted.
Therefore, wariness about China’s ability to crack down further, especially on mining and stablecoins, is certainly warranted considering its recent actions in cancelling major IPOs, reining in digital payments and other firmer financial regulations.
In this sense, some learning from history with an appropriate adjustment to present realities is likely a smart move for bitcoin investors.