Cryptocurrency naysayers would have breathed a sigh of relief this week. As Bitcoin (CCC:BTC-USD) retreated from its $58,000 high, the feeling of missing out was temporarily replaced by a smug sense of, “Thank God I didn’t buy at the top.” Even now, Bitcoin at $49,000 shows signs of weakening further.
But as hot-money investors sell out, the king of cryptocurrencies should rise again. That’s because for all the technical analysis and fundamental valuation that Wall Street puts out, only one thing matters in cryptocurrency investing: investor confidence. And as the U.S. government prepares to fire a $1.9 trillion cannon at the U.S. economy, investors will likely see risk-on assets heat up again, sending Bitcoin back up.
Though it’s long-term potential is far from written, Bitcoin looks primed to eventually recover as an intentional consequence of an outsized stimulus package.
Bitcoin Investing: A Game of Investor Sentiment
Most stock investors value companies by expectations of future profits. Bitcoin, however, has continuously confounded equity investors and cryptocurrency enthusiasts alike. Without a fixed production cost (mining fees are variable), how can this comparably awkward coin emerge with a $1 trillion valuation?
The answer draws parallels to commodity investing, a world I worked in over a decade ago. When valuation metrics are absent, speculative commodities tend to rely on investor sentiment and demand. That’s why assets like Bitcoin show an abnormal correlation to risk-on assets such as the stock market, rather than risk-off ones like bonds.
We saw this play out back in 2020, when the first $2 trillion stimulus helped pushed asset prices to new highs. As the new administration prepares to launch a second stimulus that even relatively centrist pundits are calling too big, the flood of new money will likely find its way into the stock market and cryptocurrencies as well.
Cryptocurrencies in a Slump
The momentum effect, however, also works in reverse. When commodity prices start falling due to dwindling investor confidence, punters will often place stop-loss orders above their entry price. That often causes an unintentional cascade of sell orders as prices fall.
Today, we see Bitcoin going through a similar pullback. Most new investors bought in during late-December through January, so their $35,000-$40,000 entry prices mean they’re still willing to sell for profit at current prices. Chartists often call this a “floor” while anthropomorphizing the market by saying, “it’s taking a breather.”
Bitcoin, however, has neither lungs nor linoleum surfacing. Instead, its price is dictated by where speculators start getting fearful of loss (i.e., where they have their mental or in-market stop-loss orders). And that’s something you and I can reasonably guess by following investor chatter — something that has turned decidedly bearish in recent days as new crypto investors get their first taste of losses.
Bitcoin to $80,000?
In the short-term, all this will keep Bitcoin prices unpredictable. When single tweets and minor stock market moves can see new crypto investors cashing out, investors should be skeptical of anyone who claims to know precisely what’s next.
That could change quickly if President Joe Biden’s stimulus package hits the markets soon. A study by Michael Green of Logica Funds found that, on average, aggregate market capitalizations rise $2.50 for every dollar an active investor puts into the market. For passive investors, the amount increases to over $17 (Only marginal trades count in asset pricing, so the last trade price dictates the entire value for the remaining stock). In other words, it’s likely the $1.9 trillion stimulus package will increase stock market capitalizations by multiples of that figure, even though much of the money will flow elsewhere.
Where Bitcoin will exactly land is anyone’s guess. But as investor bullishness returns, so too will Bitcoin prices.
Should You Invest?
Bitcoin and all cryptocurrencies remain a no-man’s land for traditional investors. With zero earnings potential, Bitcoin needs to rise in price for investors to reap the rewards. So for most people, that means limiting your exposure to this potentially ground-breaking investment.
Generally, I recommend no more than 5% of your portfolio directly to cryptocurrencies or options, and another 10%-20% to businesses that will benefit from Bitcoin’s rise. These limits protect your portfolio in the case where Bitcoin irreparably plummets and never regains investor confidence.
For most, that means investing in high-quality companies like PayPal (NASDAQ:PYPL) or Square (NYSE:SQ) that are on the cutting edge of global crypto payments. These are companies that will still succeed even if Bitcoin stumbles. Others with higher-risk tolerance might consider Argo Blockchain (OTCMKTS:ARBKF) or other top Bitcoin miners — these firms act more like cryptocurrency options because of their high operating leverage.
Either way, one thing is certain: people don’t seem ready to back down from cryptocurrencies quite yet. So, though Bitcoin might see some near-term weakness, its wider adoption by payments processors and merchants means its price will keep riding the liquidity elevator straight back up come March.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.