In this article, we’ll take a closer look at Bitcoin from an investor’s point of view. We hope you gain a deeper understanding of what Bitcoin is like as an asset.
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If 2020 was the year of Covid-19, then 2021 is surely the year of cryptocurrency, judging by how rapidly Bitcoin and its ilk are breaking into the mainstream.
Today, Bitcoin is no longer a niche asset purely for tech geeks, but increasingly an essential part of any professional investor’s portfolio, whether they be individuals or institutions.
Despite its growing popularity, Bitcoin remains a bit of a mystery to many investors. Since it is so unlike any traditional currency or asset class, we struggle to understand Bitcoin’s peculiarities — from its esoteric mechanics, to its unique challenges.
Bitcoin: a brief history
You might already be familiar with Bitcoin, but its origin story is worth repeating.
The brainchild of a pseudonymous Satoshi Nakamoto, Bitcoin was born in 2009, making it the world’s oldest cryptocurrency — a whole six years older than the next most popular crypto, Ether.
It is a form of digital currency that does away with any central bank, government or institution. Instead, transactions are validated in a decentralized manner by Bitcoin miners around the world. New supply is released only when miners successfully complete their work.
The fact that Bitcoin has been around is important.
First, it has clearly benefited from first-mover advantage. At US$600b to US$700b, it is the largest cryptocurrency by market capitalisation, and has scale and network benefits in terms of infrastructure and services.
Bitcoin’s age also bodes well for its staying power. It has prevailed through market ups and downs for over a decade, and looks poised to do well in the future, (Bitcoin fans often invoke the “Lindy effect” theory, which states that the longer a technology has been around, the greater its chances of survival).
Why do people buy Bitcoin?
Bitcoin’s earliest adopters were — no surprises here — the young and digitally-savvy. According to a 2021 Morgan Stanley report, 27% of US millennials own cryptocurrency, compared to only 3% of baby boomers.
For younger investors, the decentralised, transparent nature of cryptocurrency actually makes Bitcoin more trustworthy than traditional monetary systems, where decisions are seemingly made in ivory towers.
Having grown up with digital wallets, online brokerages and electronically-available financial products, younger investors are also more comfortable with virtual assets like Bitcoin.
Of course, many buyers have been seduced by the possibility of quick, dramatic gains thanks to Bitcoin’s notorious volatility (more on that later).
But alongside the speculators are sophisticated investors and young idealists who buy and hold Bitcoin and other cryptocurrencies. This growing pool is keen on crypto’s long-term value as an up-and-coming technology and financial product.
Many expect cryptocurrencies to take off in a big way as the world starts adopting them, not just for payments, but also to solve deeper issues like: corruption, unreliable governance, and the greed of financial institutions, among others.
Why are institutions interested in Bitcoin?
Since the second half of 2020, Bitcoin’s public image has been shifting rapidly, and is increasingly seen by institutional investors as a coveted asset class.
So far, numerous global investment banks (such as Morgan Stanley, Goldman Sachs and JP Morgan) as well as businesses, traditional (such as Mass Mutual) and otherwise (such as Tesla, Microsoft, PayPal and Square) are now actively holding, transacting or providing Bitcoin related services.
Why all this institutional approval? One major reason is that Bitcoin is increasingly seen as a viable asset to protect against inflation.
As central banks around the world are printing money to keep the economy afloat amidst Covid-19, many fear that fiat currency will become devalued. Putting money into Bitcoin protects it from this inflationary environment.
Notice that this strategy wouldn’t work if it were easy to mint new Bitcoin. It’s not. Bitcoin’s supply is scarce, with a hard cap of 21 million. It also takes tremendous resources to mine any new Bitcoin, prompting miners to make the switch to utilising renewable energy sources to operate.
These features preserve Bitcoin’s value in a way that’s similar to a scarce commodity like gold. That explains why it is sometimes thought of as “digital gold” and thus a “store of value”.
Why is Bitcoin so volatile?
Theoretically, Bitcoin has a lot of appealing features. But in practice, putting your money in Bitcoin is not for everybody, not least because of its volatility.
A 2021 DBS report pegs Bitcoin’s daily volatility at 3.9%, which far exceeds that of (already volatile) instruments like crude oil, silver and emerging markets currencies.
This is somewhat expected since Bitcoin is a new institutional asset class. There are inconsistent regulatory approaches globally for crypto, and nothing close to consensus on what constitutes value in this market. Thus, demand for Bitcoin is largely fuelled by sentiment from news, publicity or even rumours.
At the same time, Bitcoin’s supply is highly inelastic. So, prices can soar or nosedive whenever there is a sudden surge or drop in demand — which in turn can be spurred by anything from a news headline to Elon Musk’s Twitter feed.
However, it’s worth noting that Bitcoin’s liquidity has increased significantly in tandem with a reduction in volatility over the last decade.
As institutional adoption increases, we can expect Bitcoin’s volatility to significantly reduce, while its price increases given the fixed Bitcoin supply.
How would regulations affect Bitcoin?
Apart from volatility and being prone to market manipulation, another key risk associated with Bitcoin is regulation.
Cryptocurrencies are still in their infancy and have yet to be regulated under a robust framework. Nonetheless, governments are taking action: China has banned crypto trading, while the US has made trading profits in cryptocurrencies taxable.
Regulation is not necessarily a bad thing for Bitcoin. It could clarify a number of “grey” areas and increase certainty, which could allow institutions to invest with more confidence. This is likely to result in more stable (and potentially significantly higher) prices.
A lot hinges on why governments wish to regulate crypto. If a government bans it due to a perceived threat to its monetary sovereignty, that would be bad news for anyone holding a significant amount of Bitcoin.
On the other hand, if a government merely seeks to clean up the cryptocurrency market by cracking down on illegal uses — money laundering, terrorism financing and tax evasion — that could benefit long-term investors by bringing Bitcoin into the overall regulatory system.
It’s hard to say how exactly Bitcoin will be affected, but recent regulatory announcements suggest that the trend is to include Bitcoin in the regulatory regime rather than to eliminate it. These include Basel Committee on Banking Supervision recognising Bitcoin as an asset that banks can hold, and El Savador recognising Bitcoin as legal tender.
How should we approach Bitcoin as an investment?
Above, we have covered in broad strokes Bitcoin’s potential as well as pitfalls. Now, let us summarise and reframe things from the lens of the would-be investor.
To start with, Bitcoin is worth considering as an asset class because it is the oldest and largest cryptocurrency by market cap.
One of Bitcoin’s most attractive features is its limited supply, which stands in stark contrast against (easily-printed) fiat currency.
This scarcity makes Bitcoin unsuitable as actual currency, since owners are likely to hoard their coins. But it does make Bitcoin an attractive store of value, rather like gold.
Finally, Bitcoin does not correlate with other asset classes, such as stocks and bonds, which makes it ideal for portfolio diversification.
That said, investors should be conscious of the risks around Bitcoin, especially security (given it is digital money, there is the risk of hacking or theft), the ever changing regulatory regime and also volatility.
When is a good time to invest in Bitcoin?
Because of its brief history, it is extremely challenging to time the Bitcoin market. Unlike other asset classes with well-established cycles, crypto is simply too young and volatile to fit into any existing pattern or theory.
If Bitcoin is seen as a “store of value”, then similar to gold, there are a number of tools that professional investors can use to predict its price (such as technical charts) rather than traditional methods to predict its value (such as discounted cash flows).
But we do know that Bitcoin’s price has fallen significantly since its peak in early 2021, resulting in interest around “buying the dip”.
At its height in February 2021, Bitcoin’s market cap surpassed the US$1 trillion mark, so, for a time, it was part of the trillion-dollar club alongside tech giants like Google, Apple and Amazon. BTC’s price hit a record high of over US$63,000 shortly after.
The Bitcoin fever broke in May 2021, prompted by Tesla CEO Elon Musk’s anti-BTC stance as well as the Chinese government’s crypto ban. Bitcoin’s market capitalisation has since fallen to about US$600 billion.
But while its price has nearly halved since its peak, it is still roughly up 18% year to date, more than any other mainstream asset class. Those keen on Bitcoin’s long-term potential are likely to find its current price attractive, given it is at an early phase of increasing institutional adoption.
How much of your portfolio should be invested in Bitcoin?
Bitcoin may have plenty of potential as “digital gold”, but it is still young, volatile, and subject to both short- and long-term risks.
Unlike established investments like stocks and bonds, holding cryptocurrency does not promise any future cash flow. Instead, its role is to diversify one’s portfolio and protect against inflation risks.
To that end, experts generally agree that Bitcoin, as well any other cryptocurrency, should constitute at least a small part of a professional investor’s total investment portfolio.
Some recommend limiting Bitcoin holdings to 3% of your portfolio. Others who are more bullish on Bitcoin, like hedge fund manager Paul Tudor Jones, believe 5% is the perfect percentage (watch video).
What are the best ways to invest in Bitcoin?
Thanks to crypto’s burgeoning popularity, there are plenty of options for investing in Bitcoin, including derivatives. However, the most direct methods are:
Buying Bitcoin directly through a crypto exchange
Investing in a Bitcoin fund managed by a regulated fund manager
Investing through a crypto exchange is probably the most straightforward method. It has an extremely low barrier to entry, with some exchanges allowing you to buy just US$50 of BTC.
This method serves small-time investors looking to “play” on the cryptocurrency market well enough. However, there are many, many risks associated with crypto exchanges, especially if you are investing a significant sum.
An institutional-grade Bitcoin fund managed by a regulated fund manager, on the other hand, has a higher barrier to entry, but it is more appropriate for professional investors, whether individuals or institutions.
Additionally, institutional Bitcoin funds are often able to obtain the best price by connecting to many different exchanges and market makers, and also provide better liquidity to transact in and out of Bitcoin due to its rigorous approach to regulatory compliance.
A regulated fund manager also provides investors comfort that their investment complies with institutional-grade governance standards they are already familiar with when it comes to other traditional asset classes.
What are the risks of buying Bitcoin through an exchange?
Buying Bitcoin directly is as easy as setting up an account with one of the hundreds of cryptocurrency exchanges on the internet.
But the bulk of these entities are unregulated, meaning investors have little protection. The crypto “wild west” abounds with scams and Ponzi schemes, such as Torque, which absconded with investors’ money in April 2021.
Even the more legitimate platforms can get shut down overnight. This is what happened to BTCChina, one of China’s oldest crypto exchanges, which wound up abruptly when the government banned crypto trading.
And that’s on top of existing security risks, such as crypto exchanges being hacked, password phishing, even schemes to uncover investors’ offline crypto wallet passwords.
The unregulated nature of cryptocurrency exchanges can cause friction in the deposit and withdrawal process. For instance, certain transactions may be deemed high-risk and therefore blocked by your bank, making it difficult to transact smoothly.
For security, obtaining the best pricing and liquidity as well as convenience, professional investors who wish to invest in a significant amount of Bitcoin should consider an institutional-grade investment product such as a Bitcoin fund managed by a regulated fund manager instead.
Conclusion: Understanding Bitcoin is key to investing successfully
Bitcoin remains a divisive asset in popular imagination. Many embrace it uncritically, while others fear and avoid it. However, the sophisticated Bitcoin investor adopts a more studied approach, choosing to understand the asset’s potential as well as risks.
We hope this article has shed light on the Bitcoin phenomenon and added nuance to your understanding of it — all while equipping you with the right information to make successful investment decisions.
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