Bitcoin is an attention grabber. It has gained 271%, more or less, so far for 2020. That’s a whopper of a number. And no wonder that it’s getting the attention of everyone from newly minted super-speculative traders to old market veteran guys like me.
And that price gain includes the minor plunge in February-March of a mere 46.11% which, in perspective, may just be argued as a bad series of trading days for the cyber coin supporters.
Bitcoin is the leader among cyber coins that come into existence via solved algorithms on computers, as opposed to digital coins that represent actual assets.
I was involved with digital coins back in the 1990s when one of my old banks, Mark Twain Bank (now part of U.S. Bank (NYSE:USB)) contracted with David Chaum to utilize his encryption methodology. We utilized our multi-currency systems and products to offer ecash that was denominated in any currency of the customer’s choice that was effectively held in trust at the bank.
Ecash could then be used for truly anonymous transactions over the beginnings of the internet and the world wide web. And each coin was unique, like is the case for a U.S. dollar bill or a Swiss franc – they used an encryption system that is similar to blind key mechanisms that are now commonplace for things such as email accounts.
Bitcoin and other cyber coins are units that, after creation based on solved algorithms, are tracked using blockchain accounting that is effectively a distributed and shared ledger.
To buy bitcoin, investors need a digital wallet that is offered by a variety of online companies, including Coinbase. And then various exchanges offer the ability to buy and sell these cryptocurrencies, including Coinbase.
Trading Bitcoin Alternatives
Bitcoin, like for other cyber coins or cryptocurrencies, is not yet an approved, regulated security by the U.S. Securities & Exchange Commission (SEC), so broadly there are no pure investment securities on U.S. stock exchanges that represent bitcoins. But there are some major exceptions
First is via futures contracts. The U.S. Commodities Futures Trading Commission (CFTC) has allowed the CME Group (NASDAQ:CME) to offer and trade bitcoin futures contracts. The contracts are based on the CME CF Bitcoin Reference Rate (BRR) that tracks the global spot market for bitcoin. Each contract is for five bitcoins, so that each represents a sizable sum.
The next contract is for March 2021 under the core symbol of BTC with H for March and 1 for 2021 for the effective trading symbol of BTCH1. And as you can see in the graph of that contract above, the open interest (active contracts) has been climbing with the price of the future contract, particularly through December of this year.
Then I come to the grayer part of the market exchange-traded funds, or ETFs. There is the Grayscale Bitcoin Trust (OTCMKTS:GBTC) that’s organized by Grayscale Investments. This ETF is set up for accredited investors (meaning those with investable assets in excess of $1 million or other criteria) but there is limited policing on this restriction. The ETF supposedly holds assets both real and synthetic that track the market rate for bitcoin. But be warned as the premium over the implied asset value can be widely higher than the current level of 17%.
Then there is the Bitwise 10 Crypto Index Fund (OTCMKTS:BITW) organized by Bitwise Investments. This ETF synthetically represents cyber coins, including bitcoin, that Bitwise deems to be in the top 10 of coins by market capitalization, trading volume and other proprietary characteristics that are made up inside its own Bitwise 10 Large Cap Crypto Index (BITX).
This ETF has some major challenges, including premiums over the implied synthetic value of assets that currently is at 233.32%. And the other implied coins in the ETF have other challenges, including for XRP from Ripple Labs. XRP is now considered an unregistered security by the SEC and is charging Ripple and its executives with breaking U.S. securities laws.
XRP will soon be a coin with fewer to no exchanges or wallets, as Coinbase will be dropping it Jan. 19 on the SEC charges.
Then outside the U.S. is BTCetc Bitcoin ETP. ETP stands for exchange-traded product, which is the German equivalent of the U.S. ETF. BTCetc is represented as a fully fungible ETP with bitcoin. That might be the good news, along with German regulation overseeing what’s going on under the hood and in trading. But for U.S. investors, it is a challenge outside of those that are well-heeled with a global trading account such as with Interactive Brokers (NASDAQ:IBKR).
There are other alternatives to Bitcoin for ETFs in the U.S. that include ETFs that track companies and their stocks that are part of blockchain development and usage. These include First Trust Indxx Innovative Transaction & Process ETF (NASDAQ:LEGR) and Capital Link NextGen Protocol ETF (NYSEARCA:KOIN).
Both of these ETFs synthetically have allocations to technology and other companies that are either part of blockchain technology or utilize it in their operations.
While not directly participating in bitcoin or other coins, both ETFs have impressive returns so far this year with LEGR returning 18% and KOIN returning 31%.
Bitcoin, Buy or Sell
Bitcoin’s attraction comes from three primary attributes. First, it is a store of value that’s supposed to be untraceable. Second, it is supposed to be able to be transferred across legal jurisdictions, again with supposed untraceable conditions. Third, as a non-currency-based security it can be a hedge against local currency challenges.
As a store of value, bitcoin has its own valuation proposition. It is worth what the market will bid and offer it. There is no intrinsic value, nor any industrial or other use for it. So, it is like gold in a way, outside of gold’s industrial and jewelry demand. And like gold, it can be valued based on opportunity costs for cash interest which, for U.S. dollars, is very low to nil given interest rates. And for U.S. investors, the dollar has been under control at lower levels, as measured by the Bloomberg U.S. Dollar Index.
But also, as for for gold, it competes with U.S. stocks and bonds for investor cash. So, with the buoyant U.S. stock and bond markets this year, gold has run out of heavy investor demand. Yet for bitcoin, it has continued to gain — particularly very recently.
But it is far from untraceable as a store of value. Unlike gold that can be physically delivered and held, bitcoin is held in wallets. And wallet companies require identification and registration. And blockchain by its definition has a full history of ledger transactions embedded in each bitcoin, making for tracing a doable venture by regulators.
As for transferability, bitcoin can move from market to market or from nation to nation just like gold or other securities or assets including currency in cash. That’s a good thing – but again, the traceability of blockchain as well as registered wallets takes out the anonymous transfer attribute.
And for a currency alternative, bitcoin is another store of value. And as the U.S. dollar moves lower bitcoin can rise in value in U.S. dollar terms. But again, there are plenty of alternatives to currency, including for the U.S. dollar — gold, other commodities or even stocks, bonds or other securities.
Bitcoin Going Up to Go Up
One of the biggest reasons that I believe is behind bitcoin’s performance from October through to now is that it is attracting more investors and traders. That reads as inane of course.
But like for the S&P 500 Index and its tech-heavy stock weighting — and more so for the S&P Information Technology Index and its go-go tech stocks — traders and investors are buying bitcoin because of expectations for further appreciation. Buy now as its going up makes for a reason — particularly for momentum investors or traders.
But U.S. stocks are being bought at high valuations that are based on expectations for higher sales and earnings gains in 2021. These may well have challenges to come to fruition and may or will change, but there are fundamental arguments behind valuations for member stocks of the S&P 500 and S&P Information Technology Indexes.
Unless there are fundamental arguments for a dramatic downturn in the U.S. dollar or a dramatic downturn in U.S. stock and bond markets, bitcoin doesn’t have an immediate compelling reason to buy and buy higher right now.
And if the U.S. stock and bond markets do take a big drop, such as what happened in February through March of this year, bitcoin will likely drop as well. Everyone wanted or needed actual cash, and that sent the U.S. dollar soaring for that same time period. Remember that 46.11% drop in bitcoin for that dark time this past February-March when the U.S. dollar soared by nearly double-digits as measured by the Bloomberg U.S. Dollar Index.
But for now, individual investors are onboard and increasingly institutional investors including fund managers are indeed on board with bitcoin. Buyer beware as you count gains on any given day. Just keep an eye on it and have your digital wallet at the ready to sell if or when the market turns again.
About Neil George:
On the date of publication, Neil George did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
As the editor of Profitable Investing, Neil George helps long-term investors achieve their growth & income goals with less risk. With 30+ years of experience in the financial markets, Neil recommends undiscovered and underappreciated companies that offer subscribers double-digit yields now and triple-digit returns over time.