As Bitcoin (CCC:BTC-USD) prices collapsed this week, crypto investors have been left looking much like a deer in headlights. ETF flows for most of the six popular blockchain ETFs have largely remained stagnant even as crypto prices plummeted.
The indecision highlights a worrying truth: Bitcoin investors are shifting from an aggressive profit-seeking crowd to one that’s increasingly fearful of missing out. In March, the Grayscale Bitcoin Trust (OTCMKTS:GBTC) – a proxy for institutional investor interest – saw its NAV premium flip from positive to negative.
In their place, conservative investors have stepped in. On Wednesday, Wells Fargo (NYSE:WFC) joined other wealth management teams in announcing plans to open crypto trading to high-net-worth clients. (Apparently, it’s better to let your customers lose money than losing it yourself). Meanwhile, forward-looking investors moved onto more technologically advanced cryptocurrencies like Ethereum (CCC:ETH-USD), Cardano (CCC:ADA-USD) and Internet Computer (CCC:ICP-USD). Central banks have also announced plans to launch digital currencies of their own.
That makes a BTC recovery ever more unlikely. As Bitcoin’s age starts to show, its future has never looked wobblier.
Bitcoin Prices: Fallacy of the $60,000 Price Target
Bitcoin’s 30% slide this week highlighted a fact that experienced investors have long known: Bitcoin has no fundamental value. Talks about $60,000, $600,000 or $6 million price targets ring hollow because cryptocurrency is only worth how much your next-door neighbor is willing to pay. (Lucky are those living next to a Goldman Sachs office).
The lack of a serious price target has long benefited Bitcoin holders. Influential investors like ARK Innovation’s Cathie Wood have long proclaimed $500,000 price targets without providing any deep rationale. Squint hard enough, and any value seems possible.
The benefits, however, cuts both ways. Since 2020, Bitcoin prices have become more like a leveraged bet on investor confidence than on cryptocurrency adoption. According to data from Thompson Reuters, the cryptocurrency now has a 25% correlation with the S&P 500 and a 34% correlation with Tesla (NASDAQ:TSLA). The stock market’s 4% wobble last week sent crypto prices crashing a third.
Ordinarily, investors might want to buy the dip. The stronger-than-expected post-Covid recovery led banks to revise stock projection upward. Bitcoin would presumably win too.
But this time might be different. As experienced crypto investors have also long known, Bitcoin’s community is astonishingly status-quo. As other competitors continue to rise, Bitcoin will find itself falling ever further behind.
The Bitcoin Protocol: Miner League
Stakeholder-led cryptocurrencies like Ethereum have motored ahead. In November, the world’s No. 2 crypto joined Cardano and other “third-generation” coins in launching an energy-efficient proof-of-stake protocol. Rather than have miners waste energy on pointlessly complex calculations, PoS systems run on a system of approved validators. Energy savings can top 99.7% or more, and crypto watchers expect Ethereum to fully transition its blockchain to the PoS protocol by the end of the year.
These improvements are possible because cryptocurrencies like Ethereum rely on a stakeholder-based voting system rather than a mining-based one. With enough support from the Ethereum Foundation and community, beneficial proposals can proceed without miner support. Centralized cryptocurrencies have found it even easier to push changes. Ripple controls 60% of all XRP, making amendments virtually effortless to pass.
Bitcoin, on the other hand remains relatively stodgy because of a historical quirk in its development: BTC miners hold an outsized vote in protocol changes.
Though miners only account for 10% of supply, the Bitcoin protocol doesn’t work on a democratic voting system. Instead, all proposed changes run through a similar process – miners must reach a consensus for any proposal to pass. While the system can prevent fraud and security issues, it also makes the cryptocurrency demonstrably hard to change.
The Bitcoin community put this theory to test in 2017 when they launched a bid to increase the cryptocurrency’s block size limit. Only when 95% of miners accepted the change did the software upgrade pass. That makes a switch to an energy-efficient PoS system virtually impossible without a hard fork. No miner will willingly vote for a more energy-efficient system when it would render their billion-dollar investments in ASIC machinery worthless overnight. It’s a prisoner’s dilemma where stakeholders acting in self-interest poisons the cryptocurrency for both themselves and everyone else.
Already, former Bitcoin champions like Tesla CEO Elon Musk have walked back support for the energy-burning cryptocurrency. More backlash could be on the way.
Rearranging Deck Chairs on the U.S.S. Bitcoin
That hasn’t stopped Bitcoin fans from giving up hope. In April, Niklas Nikolajsen, the founder of Swiss crypto broker Bitcoin Suisse, predicted that Bitcoin would eventually move to the energy-efficient PoS protocol.
“I’m sure, once the technology is proven, that Bitcoin will adapt to it as well,” the entrepreneur noted in a German TV interview.
In truth, Bitcoin’s technology has fallen so far behind that it might not matter. Today, the cryptocurrency can still only act as a medium of exchange, not a payment processor or commercial bank. It’s the banknotes of the cryptocurrency ecosystem rather than the pipes or pumps.
As time moves on, this weakness could become Bitcoin price’s death knell. In its current state, the crypto’s limited functionality makes it vulnerable to competition from central bank-sponsored digital currencies. China’s e-Yuan project has already threatened Bitcoin’s viability in the People’s Republic. A digital dollar could eventually do the same in the U.S., threatening the entire value of Bitcoin’s $1 trillion market capitalization.
Combating this involves using blockchain technologies for more than transactions alone. Projects like Ethereum have already moved into NFTs, creating electronic deeds for artwork and collectibles. Others like Celsius (CCC:CEL-USD) allow users to borrow and lend money much like a commercial bank. The latest addition to the industry – Internet Computer – promises to use decentralized networks for cloud computing and website hosting.
Bitcoin, however, has fallen short. Its current projects focus on minor improvements to wallets and bug fixing rather than the sweeping changes it needs to keep up.
There’s a good reason why early moving crypto investors have abandoned Bitcoin’s stodgy technology. You should, too, while you still can.
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.