With bitcoin trading about $US23,300 ($30,000) in mid-December, 30 per cent above its December 2017 peak and more than four times higher than its low in March this year, different dynamics are at play compared to late 2017, when the bitcoin bubble inflated dramatically, before violently popping at the start of 2018.
Google search data show inquiries about bitcoin are up a bit in recent months but are still tiny compared to the broad-based mania in the back-half of calendar 2017. This is not a rally being driven by retail speculators. Rather, demand appears driven by investors and many of them are being attracted to bitcoin as a hedge against inflation, as central banks debase the value of fiat currencies during quantitative easing.
Closer to home, DBS Bank in Singapore said this month it would open a bitcoin exchange and provide custodial services for investors. While Australian institutions remain on the sidelines, local bitcoin exchanges – now regulated by AUSTRAC – are reporting rising levels of interest from self-managed super funds and family offices, albeit off a very low base.
There’s a better understanding now around bitcoin’s scarcity. The total number of bitcoins – which are issued as rewards to “miners” who validate the ledger using computer grunt-power, the digital equivalent of extracting gold from the earth – will be capped at 21 million. The amount of bitcoin awarded to miners is cut in half every four years, as it was in May, helping to propel the dramatic price spike in the final months of 2020.
While bitcoin’s capitalisation is much smaller than gold – the total value of bitcoin is around $US350 billion, compared to $US10 trillion for the world’s gold – more investors are thinking of bitcoin as a new digital commodity: a safe-haven asset, which can’t be debased by central banks printing money, devaluing cash.
As the response to COVID-19 triggered another round of extensive QE, a meme, “Money printer go brrr”, circulated widely in the bitcoin community; believers in technology appear more trusting in mathematics and computer code than economic policy makers grappling with ways to stir inflation.
Some of the interest is also being driven by the explosion in 2020 of decentralised finance (DeFi), where blockchain technology such as Ethereum is creating new transactional infrastructure, improving on bitcoin by allowing “smart contracts” to automate business processes.
The infrastructure around bitcoin has also advanced substantially compared to 2017, from regulated on- and off-ramps allowing users to switch in and out of bitcoin and fiat currency, to custodial services by large and regulated institutions that safeguard digital keys to users’ bitcoin vaults.
Reinventure’s Cant says a confluence of factors drove the bitcoin price in 2020, but the biggest driver has been more investors searching out a hedge against inflation.
“People are acutely aware of what feels, at times, like excessive money printing, particularly by the US,” Cant says. “The US enjoys global reserve currency status, so other nations holding foreign reserves largely in US dollars can see those reserves potentially devalued whenever those money printers are running. And again, we are seeing those printers being turned on aggressively.
“The infrastructure that has been built since the last bitcoin bubble is substantial and at every layer more is going on: there are more developers, and more people holding it.”
When The Australian Financial Review covered the dizzying days of the bitcoin bubble in late 2017, we met some enthusiasts in a pub in Sydney, members of a techno counter-culture carrying bitcoin on USB sticks in their backpacks.
In December – in a sign of the times – we met the local boss of one of the world’s largest bitcoin exchanges, Kraken, in the exclusive Tattersalls Club.
“There’s lot of interest in Australia in the bitcoin market,” Jonathan Miller, CEO of Kraken Australia, explains. Like Cant, he reckons the global central bank response to COVID-19 has spurred interest.
“An unprecedented amount of money printing has accelerated people’s concerns about the stability of fiat currencies,” he says. “It raises questions about trust over what a medium of exchange is.
“The quality of the US dollar is a function of our trust in it and there are risks of holding fiat currencies in markets where there are very low interest rates. This has driven a consideration for alternative hedges. Bitcoin is now a possibility for fund managers that would have discounted it in the past.”
Kraken entered Australia via the acquisition of Bit Trade in January, and is regulated by AUSTRAC. It has a banking licence in the US state of Wyoming and a multilateral trading facility (MTF) to run a market in Britain. Miller says volume for its over-the-counter product is up 260 per cent quarter-on-quarter in Australia, and there’s been a 50 per cent increase in sign-ups in the past six months.
Independent Reserve, another cryptocurrency exchange, released a survey in December reporting 25 per cent of Australian respondents as owning some form of cryptocurrency, up from 17 per cent in 2019. The number appears high. But the survey points to ownership growth from 25 to 44-year-olds with one in five in that age bracket saying they are considering investing in cryptocurrency via an SMSF.
Independent Reserve found 18 per cent of Australians intend to purchase some crypto in the coming year. Overall awareness is over 91 per cent.
“More and more major players are paying attention, we are seeing a lot of people turn back to crypto and also a lot of new people entering this space for the first time,” says Jeff Yew, CEO of Binance Australia, also a crypto exchange.
SMSFs have been signing up and Binance has recorded a 400 per cent increase in corporate users since the previous quarter. “It is being considered as part of an asset portfolio not correlated to other assets.”
Henrik Andersson, chief investment officer at Apollo Capital in Melbourne, says while one institutional investor has put money into Apollo’s $15 million crypto fund, which is regulated as a managed investment scheme for wholesale investors, there’s been more interest from family offices.
“These investors traditionally would have invested in gold and are looking to crypto to diversify but they don’t want to hold the private key themselves,” he says. “We have seen unprecedented monetary easing in the last few years but COVID has accelerated the trend in a big way.
“Investors see fiat currencies are losing value as banks around the world are printing more and more and that is the impetus to allocate into bitcoin. They see bitcoin as an alternative to gold with a fixed supply, that is easier to store and transact.”
So what of the risks of investing in the brave new world of cryptocurrencies? The main ones remain security, regulation and volatility.
Most dire would be a “51 per cent attack” on the bitcoin blockchain, which could see the ledger recording all the transactions compromised if more than half of the miners which control the validation process come together to co-ordinate an attack.
Like the internet itself, one of the key attributes of bitcoin is its decentralisation. But TokenAnalyst found earlier in 2020 bitcoin infrastructure is more centralised than ever. Five Chinese-based mining entities control half the computing power on the network.
“A miner with more than 50 per cent of hash power can potentially wreak havoc on the network, raising the likelihood of double-counted coins, stopped payments and stalled transactions,” Bloomberg reported in February.
The Independent Reserve survey of Australian users found around 17 per cent see bitcoin as a scam. Regulators will continue to vet companies offering services around it to protect customers. The early days of bitcoin were scarred by hacks on exchanges, including, most famously, Mt Gox in Japan in 2014.
There’s a potential that global regulators, like China, decide to choke off the ability of users to put local fiat currencies in and out of bitcoin altogether, perhaps by pointing to the risk of it facilitating the illicit economy (although cash is likely to remain the favourite payment method for the black market). On December 18, the US Treasury said it was considering imposing new regulations on bitcoin wallets to collect more user data.
Regulators, who sought to clamp down on the “initial coin offering” (ICO) craze that accompanied the 2017 bitcoin bubble, may also limit the use of bitcoin for international money transfers.
Under the global Financial Action Task Force’s so-called Travel Rule, those sending bitcoin across borders could be required to include beneficiary details, which would constrain the globalisation of the cryptocurrency.
There’s also the volatility, which has been explosive in the past and is likely to remain so in the future, and the energy consumption required to validate the ledger in an age of heightened sensitivity towards sustainability.
While bitcoin remains more than five times larger than the next largest cryptocurrency, Ethereum, other players are emerging. One is Diem, formally known as Libra, which was proposed by Facebook and a consortium of other technology companies and is expected to be given the green light by regulators in Switzerland in the new year.
But the focus for Diem, a “stablecoin” that will be pegged one-to-one to a fiat currency, is payments: it will allow money to be sent around the world instantly and cheaply. That’s not the “store of value” dynamic dominating conversation around bitcoin in recent months.
Central banks are scrambling to understand the impact stablecoins and other cryptocurrencies, including bitcoin, will have on their economies. The Reserve Bank is experimenting with a digital version of the Australian dollar in wholesale markets.
“In the last bubble, central banks were still fairly easily able to dismiss bitcoin as a passing fad,” Reinventure Group’s Cant says.
“But when we have one of the largest companies in the world saying it is going to launch its own own currency [Facebook], and with China launching a digital currency as a strategic way to build the dominance of its own currency, central and commercial banks need to think about how they engage with it.”
Six years on from that briefing with Hartzer, Coinbase’s Armstrong says investing in bitcoin is not for the faint-hearted.
“We cannot emphasise enough how important it is to understand that investing in crypto is not without risk,” he wrote in a blog post a week before Christmas. “For one, crypto can be a volatile asset class, often more so than the types of traditional financial instruments that most investors are used to.”