A Reality Check for Bitcoin Investors?
By Alfie Davies, MSc Banking and Finance Student at King's College London
*Disclaimer – Opinions presented in this article are not intended as investment advice.
The Bitcoin Story
Bitcoin was launched in 2008 by an anonymous individual or group of people, whose identity was only revealed under the pseudonym of Satoshi Nakamoto. This mysterious character, which also devised the first blockchain database, merged its two inventions to create the first blockchain based cryptocurrency the world had ever seen. Whilst this generated an air of excitement about the years to come, few could have predicted the extent of the journey it would have undertaken over its first 12 years of existence. Its first official transaction occurred in May 2010, when Florida investor Laszlo Hanyecz spent 10,000BTC on two pizzas , at a current value of more than £350 million . This milestone preceded its first real price increase from $0.0008 to $0.08 for a single coin .
Why is Bitcoin Attractive?
This new tech-based currency presented a number of attractive features, particularly by way of its decentralised nature. Indeed, being spread across distributed networks using blockchain technology, it can be subjected to no external manipulation by governments or central banks. In recent years, Bitcoin has become attractive to retail investors due to their increasing regulation and due diligence (KYC checks), giving a greater sense of confidence to less experienced investors .
What have the last few years looked like for Bitcoin?
The immense volatility of this cryptocurrency has fuelled a rampant bullish run over the past 5 years. A boom between January 2017 ($921 per coin) and December 2017 ($13,062)  produced enormous returns for mid-stage Bitcoin investors, consequently drawing substantial attention from wider audiences. However, many believed that the crash over the next 12 months (down to $3689) would burst the bubble to end to the wildly speculative run, and that it had corrected itself.
Hitting its lowest price in 11 months in March 2020 ($4944), another wave of excitement and speculative investment triggered a meteoric rise, which was partially facilitated by the troubled and volatile nature of markets throughout the COVID-19 pandemic . It reached its all-time high of $40,797 on January 4th 2021, reflecting a price increase of 725% in just under 10 months. It subsequently soared past the market cap of Facebook, the 5th largest US corporation by this metric .
Bitcoin surged in price between January 2020 and January 2021, returns charted alongside S&P500 index returns. Source: Forbes.com
Why Did Bitcoin Surge Again at the end of 2020?
Investors flocked to Bitcoin after the announcements of multi trillion-dollar stimulus packages in the US to shake off the recession the pandemic has triggered, as many see bitcoin as a legitimate hedge option against inflation . A Citibank report leaked last week hailed bitcoin as ‘The New Gold’, describing it as ‘an asset with limited supply. It is digital. It moves across borders easily and ownership is opaque’ , presenting it as a modern-day store of value. Bitcoin has in fact been outperforming gold as a hedge against G7 banks’ balance sheet expansion  which has prompted much excitement, especially from institutional investors . Investors such as Paul Tudor Jones have publicly praised the value of Bitcoin .
The news of institutional investment in Bitcoin also excited retail investors, confirming it as a possibly viable option. US online payments company PayPal have facilitated individual investment in Bitcoin, announcing in October 2020 that their 346 million worldwide users would have the opportunity to directly invest in cryptocurrency through their site , prompting a new wave of investment.
What Happened This Week?
The value of bitcoin tumbled up to 26% between Friday 8th and Monday 11th January, wiping out approximately $185 billion in value  – more than the market cap of 90% of the companies in the S&P500. Some have stated that this may no longer be a viable alternative, but the principal reason this may have happened is the use of leverage in trading . Traders buying Bitcoin with leverage will have their positions wiped out with small market blips, which results in their position being sold to the market. This creates a massive selling pressure that effectively snowballs into a selling frenzy, wiping out further value from its price.
The weekend of 8th-11th January saw significant value knocked off Bitcoin’s price. Source: BBA.Bloomberg.net
This market collapse coincided with an announcement on Saturday by HSBC, the worlds’ 6th largest bank, that they would be blocking cryptocurrency-based transactions for account holders . This presents a number of challenges particularly for investors in seeing their profits converted liquid cash, and an article by The Times suggests that a number of leading banks may follow suit . Whilst there are solutions, such as using crypto banking cards , this solidifies the hard stance the UK has taken towards retail cryptocurrency investment in recent years, following a decision by the FCA to ban crypto related derivative products in October 2020 .
The FCA released a chilling statement on Monday (11th January), aimed to particularly warn retail investors about the dangers associated with crypto investment, announcing that they should ‘be prepared to lose all [their] money’ . The regulator directly attributed this to both crypto volatility and difficulties in reliably valuing crypto assets. Furthermore, they supported HSBC’s stance on the lack of guarantee that assets can be converted into accessible cash, owing to the dependency on supply and demand at any one point in time.
The Future of Bitcoin?
Whilst the recent plunge in Bitcoin’s value has caused alarm for both retail and institutional investors, there is a general feeling that Bitcoin could in-fact still be a store of long-term value. Analysts at JP Morgan have forecasted that it could reach as high as $146k . Although Tom Lee, the Fundstrat analyst who successfully predicted Bitcoin’s rise to $40k, has warned that a 50% drop could follow, he forecasts that it could yet carry returns in excess of 300% for 2021. He was quoted as saying ‘I don’t think its straight up with a ruler, it is going to be pretty jagged but at the end of the year, Bitcoin is much higher’  if recovers suitably from this crash.
Risk and expected return follow a positive correlation, and the historic volatility drives the risk element of this relationship. The risk that investors have opted to take has, in recent times returned astronomical profits, however they must be prepared to run this risk in the hope of sufficient reward. Speculative bubbles are always likely to experience dips in confidence and price, so should investors be panicking and selling off their assets to minimise their losses? It doesn’t seem that way yet, as many thought the crash in 2017 would bring the end of the ‘cryptocurrency dream’. Instead, it was just the beginning of a far more promising journey.
Retail investors should use this as a reality check, rather than a cue to panic. Less experienced investors do not have access to the same analytical tools as their institutional counterparts and are also more likely to be subjected to behavioural biases in investment. They must be wary of the dangers of overconfidence bias – the tendency to hold a misleading assessment of our own knowledge and skill, which can be particularly dangerous in capital markets . This market drop should also serve as a reminder of the dangers of herding behaviour, the phenomenon that investors tend to ‘follow the crowd’ and opt to make trading decisions based on others’ decisions . Herding behaviour is often at the forefront of the collapse of bubbles and therefore investors must be aware that this could, if observed on a wide scale, cause Bitcoin and other cryptocurrencies to snowball into much darker crashes.
What do you think? Let us know in the comment section below!
Interested in writing for us? Click on the 'Write For Us' button at the top of the page!