“Bitcoin is dead,” proclaimed one prominent cryptocurrency investor in late 2018. The 18-year-old, Erik Finman, had become a BTC millionaire that year. But as Bitcoin (CCC:BTC-USD) prices plummeted 75%, even he couldn’t shake the feeling that the cryptocurrency’s story was over.
Today, the mood couldn’t be more different. Since its 2018 crash, Bitcoin prices have steadily climbed 1,600%. This week, it hit an all-time high of $63,729.50, tempting investors to add millions more into crypto funds. (Mr. Finman, fortunately, seems to have held onto his initial investment).
Core to Bitcoin’s success has been Coinbase (NASDAQ:COIN) and other crypto exchanges. These intermediaries essentially eliminate the high costs of transacting Bitcoin by matching orders off the blockchain. They also make it possible for those without coding experience to open wallets and buy currency from others.
The exchanges’ importance is hard to overstate; when Coinbase listed earlier this week, The Financial Times hailed it as a “coming-of-age” moment for cryptocurrency. (The New York Times took it a step further, calling it a “coming out party” despite cryptocurrency’s relative asexuality).
The bullishness, however, masks a growing problem: the same factors that helped Bitcoin succeed are now doing the same for its competitors. Though the world’s largest crypto might yet advance to $130,000, Coinbase’s listing means the case for smaller altcoins is growing faster yet.
Bitcoin Prices to $130,000? It’s Possible…
Cryptocurrencies have long confused traditional Wall Street analysts. Bitcoin doesn’t generate earnings, nor is it handy as a medium of exchange; its average blockchain confirmation time can range from 80 minutes to almost two days.
But Bitcoin has succeeded for one reason alone: people want in on its gains.
“Bitcoins are mainly used as a speculative investment,” wrote researchers in the Journal of International Financial Markets, Institutions and Money. “And not as an alternative currency and medium of exchange.”
That kernel of truth has driven crypto exchanges like Coinbase to multi-billion-dollar valuations. Today, COIN stock is worth more than the latest private-market values of TD Ameritrade, E-Trade and Robinhood combined. Its $1.8 billion Q1 revenues and 40% to 45% profit margins put it as both one of the fastest-growing and most profitable firms in America on a percentage basis.
Bitcoin, too, has benefited from Coinbase’s success. As key exchanges beefed up their security, high-profile crypto thefts have become increasingly rare. Today, regular investors have pushed the coin to a staggering $1.1 trillion market cap – easily eclipsing the Japanese yen by size as the world’s third-largest currency. JP Morgan now has a $130,000 BTC target price, a 100% upside from today’s levels.
… But Lessons from Coinbase Say Beware
Venture capital investors, however, will immediately sense a problem. Bitcoin rising to $130,000 is much like Coinbase reaching a $150 billion market cap. It’s possible, but gets increasingly hard to achieve as its addressable market saturates.
To reach JP Morgan’s expectations, Bitcoin would have to surpass the U.S. dollar in size. Ark Invest’s $470,000 price will make Bitcoin worth more than all the gold ever mined.
Occasionally, prices do rise beyond their potential market value. During Japan’s real estate peak in the early ’90s, Japanese banks started lending to companies based on how much real estate the borrowers held, rather than the strength of their underlying business. At peak mania, the value of Tokyo’s Imperial Palace alone was theoretically worth more than the state of California.
But these bubbles usually burst in a phenomenal display of fireworks and “I told you so” tongue-wagging. In a world where economic substitutions exist, competitors will always pose a challenge to slower-moving incumbents.
Competition Heats Up for Bitcoin
Coinbase highlights these issues perfectly. The exchange started almost a decade ago by offering Bitcoin only, smoothing over the coin’s technological deficiencies with a user-friendly interface and efficient trading mechanisms. Users no longer had to code their wallets or struggle to find sellers on the Dark Web. Even Bitcoin’s high fees (which today can reach $23 per transaction) were reduced to pennies thanks to order batching.
But Coinbase’s support cuts both ways. In 2016, the exchange added support for Ethereum (CCC:ETH-USD), a competing coin that now dominates NFTs. By the end of the decade, Coinbase would add 50 more altcoins to its list of tradable assets.
Today, investors have a bewildering choice of cryptocurrency investments. Small coins like TRON (CCC:TRX-USD) and EOS (CCC:EOS-USD)now see daily volumes that rival Bitcoin’s 2019 figures. Meme coins like Dogecoin (CCC:DOGE-USD), which aren’t tradable yet on Coinbase, now have so much support on competing exchanges investors have managed to make it the world’s fifth-largest coin this week.
In other words, the exact mechanisms that forgave Bitcoin’s technological deficiencies are now doing the same for its competition.
A Fig Leaf of Safety
Institutional investors haven’t gotten the memo. With every jump in Bitcoin price, much of Wall Street has remained bullish for more gains. Investment bank Morgan Stanley now offers BTC funds for its wealth management clients, while prominent investors have called for even higher prices.
Yet, it’s easy to confuse “big” with “low-risk.” Bitcoin still theoretically has zero intrinsic value, so a decline in short-term volatility means nothing about its underlying systemic risks.
Meanwhile, newer coins like Cardano (CCC:ADA-USD) and Polkadot (CCC:DOT1-USD) now offer energy-efficient “proof-of-stake” (PoS) protocols that reduce energy usage by more than 99%. And thanks to help from cryptocurrency exchanges, smaller entities like Dogecoin are becoming viable alternatives. Bitcoin may survive a crypto crash better than its peers, but its lower upside is eating away at its once one-sided upward bet.
How High Can Bitcoin Go? A Lesson from the Market
In 1910, Standard Oil was the most valuable company in America. Adjusted for inflation, it would have been worth $1 trillion today. Yet, the firm’s spinoffs – a collection of Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and others – no longer dominate Wall Street as John Rockefeller’s firm once did.
Many historians might credit the oil giant’s breakup in 1911 as its turning point. The resulting 34 companies were intentionally designed to compete. But in truth, investors know it was Standard Oil’s rapid rise that laid the groundwork for its decline decades later.
By its breakup, the energy giant had grown so large that had it kept up with the 10% annual returns of the U.S. stock market, the stock would be worth $500 trillion today. That’s five times more than all U.S. stocks and real estate combined. Such a valuation is impossible. No asset can grow larger than the market it services.
Today, Bitcoin falls into that same bucket. It’s the dominant player by size – over half of all cryptocurrency is still Bitcoin. But as altcoins continue to gain traction on Coinbase and other crypto exchanges, Bitcoin will find it increasingly challenging to maintain its breakneck growth.
So, whenever you’re looking to buy cryptocurrency next, remember that it’s altcoins – not Bitcoin – that can offer the 10x, 20x or 50x returns investors so desire. Perhaps Bitcoin Erik Finman was right after all about Bitcoin being dead – he was just a little early on its call.
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.