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FUNNY MONEY: The Rise of Cryptocurrencies

Delwin Graham - Apr 28, 2021
The cryptocurrency sector is on a tear. The value of the most popular cryptocurrency, Bitcoin, has surged to a record high of over US$63,000. In fact, the Bitcoin price has more than doubled since the start of 2021.

The cryptocurrency sector is on a tear. The value of the most popular cryptocurrency, Bitcoin, has surged to a record high of over US$63,000. In fact, the Bitcoin price has more than doubled since the start of 2021. At the same time, the largest cryptocurrency exchange in the United States – Coinbase Inc. (COIN:NASDAQ) – started trading at a market capitalization that approaches that of Intercontinental Exchange (ICE:NYSE), the parent company of the largest stock market in the world – the New York Stock Exchange.

Bitcoin was trading at about US$7000 in April 2020 and has had a dramatic bull run over the past year. But Bitcoin has been running on its blockchain for almost a decade. In fact, the first enterprise to use Bitcoin extensively was “Silk Road” – an illegal marketplace that sold drugs, stolen credit-card information, fraud and hacking tools, pornography, and even weapons. All of the sales made through the site were paid for with Bitcoin. The day that the FBI closed Silk Road in 2013, the price of Bitcoin dropped from US$145 to US$108. (Cf., Brayden Simmons, “Will Bitcoin Crash and Burn or Rise Again?”, www.vocal.media, April 14, 2021).

Bitcoin has gone mainstream. In October 2020, online-payments giant, PayPal (PYPL:NASDAQ), announced that it would let customers buy, hold, and sell a range of cryptocurrencies, including Bitcoin, as well as allow them to make purchases with Bitcoin at more than 26-million businesses. More recently, Mastercard (MA:NYSE) said it would process Bitcoin payments on its network in an effort to give businesses and customers “more choice” in how they buy things. The electric-car manufacturer, Tesla (TSLA:NASDAQ), says that it plans to begin taking Bitcoin as payment “in the near future”. (Cf., Taylor Tepper, “Bitcoin Rises Above $50,000. Where Does It Go from Here?”, www.forbes.com, March 22, 2021)

More than a medium of exchange, Bitcoin is coming to be accepted as a store of value. Recently, a trend started where publicly traded companies are beginning to convert cash in their treasuries over to Bitcoin as a safe-haven asset. In its latest annual report, Tesla said that it added US$1.5 billion in Bitcoin as part of a larger policy to earn more on its surplus cash. MicroStrategy (MSTR:NASDAQ), a business analytics company, converted US$425 million worth of cash in its treasury to Bitcoin. Square (SQ:NASDAQ) has also made a US$50-million purchase of Bitcoin. (Cf., Luke Conway, “Why is Bitcoin’s Price Rising?”, www.investopedia.com, November 5, 2020)

While Bitcoin was initially set up to be a completely borderless, unrestricted, ungoverned, decentralized peer-to-peer currency, cryptocurrencies are undergoing a process of regulatory and institutional acceptance. They are going mainstream, and prices are reflecting that popularity. But perhaps the most important reasons for the rise in Bitcoin’s price are two attributes inherent in its design. The first is that there is only 21‑million Bitcoins that will ever exist – no more, no less. In the face of the COVID-19 pandemic, governments around the world have imposed lockdowns to limit the spread of the virus. Lockdowns suppressed economic growth, sparking a global recession, and central banks stepped in to support national economies. For example, the United States Federal Reserve immediately cut short-term interest rates to near zero and began printing trillions of dollars to buttress the economy. Investors began buying up Bitcoin in May 2021 in anticipation of rising inflation. Like gold, Bitcoin is a scarce commodity and considered by many as a hedge against inflation. The meteoric rise in price of Bitcoin could be seen as analogous to the 1970’s gold market. An ounce of gold was worth about US$35 in the beginning of 1970, compared to a little more than US$1,750 now. (Cf., Tepper, “Bitcoin Rises Above $50,000 …”)

With the recent stimulus package, the U.S. has added about US$2.4 trillion to the economy. This has led many to worry about the inevitable decrease in the dollar’s purchasing power and the rise of inflation. Bitcoin is seen by some as a hedge against inflation because only a limited number of tokens can be released into circulation. The total amount of Bitcoin is capped at 21 million – there are currently 18,681,662.5 Bitcoins in circulation. Luke Conway argues that the Bitcoin price has followed its stock‑to-flow ratio very closely, and if it were to continue on this trajectory, Bitcoin’s value should be somewhere near US$100,000 in late 2021. We will see. (Cf., Conway, “Why is Bitcoin’s Price Rising?”)

Bitcoin is not the only game in town. New technologies offering faster blockchains, more secure transfers, lower transaction fees, and more scalability solutions are coming out quite regularly. Bitcoin was created as an alternative to national currencies – that is, it is a “digital dollar”. Ethereum is a ledger technology that companies use to build new programs, especially “smart contracts”, and “Ether” is issued as the cryptocurrency to maintain the ledger. Both Bitcoin and Ethereum operate on blockchain technology, but Ethereum’s technology is a much more sophisticated construction – transactions settle in seconds rather than minutes. Similarly, XRP is built on a much more robust blockchain than Bitcoin, and it is primarily used as a medium of transfer between currencies. It’s benefit for banks is that it allows faster and cheap currency exchanges – the alternative is usually US$. Bitcoins and Ethers are issued out of the blockchain’s user base – that is, they are “mined”. XRP is issued by a private company – Ripple. As a result, the SEC has recently charged the company with issuing unauthorized securities for the benefit of a specific corporation. Of course, regulatory issues, attacks, and hacks are inherent risks for the emerging cryptocurrency sector. Please contact me at dgraham@cgf.com or 780-408-1518 for a few more prudent ways to participate.