The latest gyrations in cryptocurrency are making it harder for wealth managers and advisors to ignore. The high volatility continues to be a cause for caution.
The news that electric car maker Tesla has bought $1.5 billion of bitcoin and the fact that its CEO Elon Musk is a fan, has pushed the digital currency to new heights. As of the time of writing today in London, bitcoin fetched $46,550 per coin (source: Coindesk). That compares with more than $40,000 on January 10. The coins had sagged to just under $30,000 in late January before rallying sharply. A year ago, bitcoin fetched just over $10,000.
As more and more professional and institutional investors get into the act, it’s becoming more difficult for skeptics and regulators to dismiss this as a fad. Bitcoin has been propelled by a desire for “apolitical money” that isn’t at the mercy of governments and money-printing central banks, as well as by a desire for privacy and interest in the possibilities of tech.
Wealth management number crunchers are finding it harder to ignore. Even if clients aren’t keen on bitcoin, the chances are that their adult children might be. And some of the figures look compelling at first glance. EFG, the Swiss private bank, pointed out in a recent note how bitcoin outperformed the wider equity market in 2020. “A portfolio invested entirely in the S&P 500 (in USD, net dividends reinvested) would have generated compound annual returns of 14.5 per cent in the five years to end 2020. A portfolio consisting of 10 per cent invested in bitcoin and 90 per cent in the S&P 500 would have generated compound annual returns of 26.8 per cent.”
"One of the main arguments in favor of cryptocurrencies is the potential for high returns. For example, in the five years to December 31, 2020, the S&P 500 index of large-cap US equities has compounded at an annualized growth rate of 14.5 per cent (in USD, net dividends reinvested); over the same time period the price of bitcoin in USD has compounded at an annualized growth rate of 131.5 per cent," EFG said.
Using bitcoin in a portfolio approach requires discipline, as pointed out in these pages recently by Nickel Digital Asset Management. The firm said that having a small allocation to bitcoin – such as 1 per cent – has a positive effect in a portfolio. Its analysis found that between December 31, 2012 and December 31, 2020, a portfolio of 60 per cent equities, 40 per cent Treasuries would have delivered a 124 per cent total return with a standard deviation of 10.0 per cent. Adding 1 per cent of bitcoin to that portfolio would have improved the return to 146 per cent, with a slight decline in realized volatility, benefiting from bitcoin’s qualities as an uncorrelated asset.
Developments continue. A number of payment platforms such as BitPay, Square and PayPal now accept payments in bitcoin and other cryptocurrencies.
“The digitization of markets is also - in part - behind the spectacular rise of bitcoin. We wrote about bitcoin in 2018 - even then it was becoming easier to buy and spend. More recently, PayPal has started to accept transactions in bitcoin and more and more retailers are accepting it,” Mohammad Kamal Syed, head of asset management at Coutts, said in a note. “But that gradual expansion of bitcoin’s presence as a medium of exchange doesn’t explain its rise in value. At the time of our last article, bitcoin had been on a high of around £15,000 ($20,718). At the start of 2020, bitcoin peaked at around £30,000, a rise of around 100 per cent.”
Should you have invested then? Maybe, but you would have to be prepared for eye-watering levels of volatility. Mohammad warns: “Within 12 months of the £15,000 high, the value of bitcoin fell to around £3,000, a loss of 80 per cent.”
“A decade of low rates has meant there is a great deal of money available for investors and, arguably, the availability of investments hasn’t kept pace,” Mohammad said. “This makes alternative assets like bitcoin attractive, especially when bond returns are so low.”
The past 12 months of bitcoin:
The Tesla effect
“Tesla investing in and accepting bitcoin is a great show of confidence in the future of crypto. It will also be a welcome move for many of its modern customers that do already hold cryptocurrency and may choose to purchase their next car with a brand aligning with their investment interests,” Yang Li, chief growth officer at UK-regulated digital currency service Ziglu, said.
“Equally this a shrewd move for Tesla. As Tesla is opening up sales in new markets and establishing manufacturing in new countries, the borderless nature of bitcoin may allow it to optimize its finances and cash flow. Furthermore, as world governments continue to aggressively stimulate the economy during this current pandemic there will be inevitably high levels of inflation. Investing into bitcoin will allow Tesla to protect its current holdings from inflation and even potentially experience a windfall if the price of bitcoin continues to increase, as it has done historically.”
Jason Cozens, founder and CEO of Glint, the gold-based payments system, said: "This is yet another wake-up call for the banking industry; an ever-growing number of consumers are making it absolutely clear that the current financial system does not work for them. The accessibility and potential returns available, as well as the longer-term boost to their purchasing power, outstrips traditional banking savings accounts which are bogged down by miniscule interest rates which causes savings to actually lose real value."
EFG argues that limited supply is a major force behind the price shift.
"A particular feature of bitcoin is that there is a maximum of 21 million coins that can be created or 'mined'. At the moment around 18.5 million bitcoins have been mined, leaving less than three million still to come into existence. A related feature is that the rate of production of bitcoins slows over time via a process known as halving – every so often according to pre-determined conditions the number of bitcoins paid for mining a block halves. Whereas in 2009 each block mined was worth 50 bitcoins, the value is now 6.25 bitcoins per block following the latest halving in May 2020. Additionally, it is thought that around 20 per cent of existing bitcoin supply has been lost or is inaccessible as a result of lost or forgotten passwords. The scarcity of bitcoin adds to its appeal for some investors – if demand for bitcoin increases further and supply is capped that would potentially drive the price higher. More generally, this supply-cap is a feature of many cryptocurrencies," it said.