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Three factors driving the bitcoin boom and what could kill it

This looks to be a strong year for bitcoin. But many observers are scratching their head over what is driving the boom. The answer is simpler than you might think.

btc, bitcoin,
(Image via Pixabay)

Bitcoin is setting new records and, despite a slowdown in late January, looks set to continue growing over the course of 2021. From a technical standpoint, this bull-market is following similar patterns to those that have come before. But there is one key difference: institutional investors.

What typically drives bitcoin bull runs?
A large driver of stock markets is fear and greed and this is the same for Bitcoin. The price of BTC will usually rise fairly rapidly as the bitcoin-curious are fearful of missing out (FOMO).

This has been a big factor as bitcoin is not only traded via futures on the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE) but also on crypto-specific exchanges and on retail broker platforms. Both the former (see this) and the latter have seen significant increases in crypto trading.

The trigger behind this rise is usually an announcement of more BTC utility, such as PayPal’s announcement that it would allow its users in the US to buy BTC on its service. This increases the positive exposure of the currency, causes an uptick in purchases, and drives the price of BTC up.

Eventually, the FOMO begins to fade and informed investors begin to sell, often hoping to buy the dip, and the market becomes spooked by sudden price drops, as it did in 2018. However, this is unlikely to happen this time around because of a combination of three factors.

1. Bitcoin’s role as digital gold
Certain crypto enthusiasts will angrily disagree, but bitcoin still has limited utility beyond acting as a store of value. This is important because it means that bitcoin is not a currency (at least not yet). It functions more like an asset, such as gold.

Bitcoin has a limited total supply. Thus, sudden influxes of capital create scarcity. As stronger hands force weak hands to sell, it causes significant upward pressure on price as the supply of BTC is less able to meet new demand. This has always been an important factor in any bitcoin run, but it has become even more important thanks to institutional investment.

2. Institutional capital is forcing significant price pressure
The big change in this bull cycle is the heavy involvement of institutional capital. To date, Greyscale Capital alone has acquired more than $26.6bn in BTC, and a number of other big Wall Street names are piling into the crypto sector. This is significant for two reasons.

The first is that this level of purchasing is unprecedented. Greyscale alone has outbought new BTC supply by around three-fold. The immediate effect of this is a supply squeeze, as more bitcoin is taken off the market the amount of liquid BTC assets will drop significantly, forcing companies and individuals to pay a premium if they want to get in on bitcoin.

The caveat here is that for the moment institutional capital needs to keep flowing. If it begins to tail off then the bull-run may begin to slow down and we’ll see a sustained period of corrections. Of course, other factors could provide a boost to bitcoin.

3. Enhanced utility
In the last 12 months, the utility of bitcoin has begun to broaden. We’ve already mentioned PayPal. But it’s much bigger than this. The growing interest among institutional investors and the advances of decentralized finance have opened up a number of financial instruments based on bitcoin that will make it easier to make creative trades.

Specifically, there is the ability to trade in bitcoin futures and the ability to use wrapped BTC (WBTC) to access flash loans on the Ethereum blockchain. These add more utility to BTC than previously existed, and give it a stronger underlying value, beyond just acting as a store of value.

The ability to stake BTC to lend it is also powerful, as it brings the cryptocurrency one step closer to acting as a decentralized bank.

Could anything bring BTC crashing down?
There are a number of things that could derail bitcoin at this point, some more realistic than others. Most recent anxieties include fear that Tether has artificially inflated the price of BTC, and the (false) double-spending scare spread by Coinbase.

  • Double-Spending Scare

Let’s start with the latter. While a real double-spend would be disastrous for bitcoin, in this case it was simply an example of a higher fee transaction beating out a low fee transaction for the same amount. In other words, it was a sign that the blockchain is working as intended. A key takeaway here is that even the crypto-savvy media is perfectly capable of spreading false information that could negatively impact the price of BTC.

  • Tether

Tether poses a trickier challenge. There are serious concerns surrounding Tether itself, particularly the false statement that it has reserves backed 1:1 by dollars. Additionally, there is an ongoing investigation of the company.

Tether is a major liquidity provider for the market, and if it is shut down, it would have a serious impact on BTC itself. However, there are alternative stablecoins that might limit the damage.

  • Institutional speculation

The bigger challenge may actually come from institutional investors themselves. For the moment, the data appears to show that the majority of investments by companies like Greyscale are speculative. This means there is a very real chance that these big investors decide to sell when they believe BTC has reached its limit.

This could lead to a catastrophic collapse in the price of BTC in the short to medium-term as a string of sell orders are triggered.

The simple fact is that it is exceedingly difficult to predict the future of BTC. It is still a relatively young asset class and it is still considered a speculative investment by the majority of the big money companies.

You should think carefully about your investment and accept that there is still a risk that BTC could go to zero.

Why is bitcoin outperforming gold during this bull run?

Institutional capital has flooded into bitcoin to the detriment of gold. Is this the sign of a new normal?

bitcoin gold

(Image via Pixabay)

Crypto investors have a lot to celebrate as 2021 gets started. The BTC ‘bull run’ has continued unabated. If the price predictions of institutional investors are anything to go by, it won’t stop anytime soon. There are a lot of reasons for this.

Investment opportunities have expanded. In addition to futures available via the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE) and trading on popular crypto exchanges like Coinbase and Kraken, there are decentralized exchanges. 

Demand is also growing: ICE has reported record trading volumes and retail commodity brokers, known for making trading easy for novices to learn, are reporting the same

Institutional investment has also risen sharply with continued growth expected on the horizon. But there’s more.

This bull run seems to have drawn capital away from gold and put it into the ‘digital gold’ of bitcoin. Could bitcoin replace gold as the go-to safe haven asset? 

Gold should be performing more strongly 

At its peak, gold was trading for just over $2,000 per ounce in the first half of 2020. This was driven by investors seeking a safe haven asset against economic uncertainty about the COVID-19 pandemic. 

Once we hit August, however, the picture began to change and gold lost momentum. According to conventional wisdom, this was due to investors cycling back into higher-risk assets in anticipation of an economic recovery. However, there might be another explanation, bitcoin. 

bitcoin gold

Gold lost momentum in mid-2020 (source: Goldprice.org

gold bitcoin

While BTC saw steady gains from October onwards (Source: Coinmarketcap.com) 

Taking a decidedly unscientific look at the performance of BTC vs Gold over the past year tells an interesting story. For the majority of 2020, BTC was holding steady at under 10K until it experienced explosive growth, beginning in late August and early September and running well into January. By contrast, gold performed strongly across the first half of 2020, only to begin losing momentum as capital was placed elsewhere. 

Markets are complicated, and gold and BTC are not a zero-sum game. There were undoubtedly other factors including optimism about a COVID-19 vaccine that led to gold losing steam in the latter half of the year. However, bitcoin does appear to be muscling in on gold’s turf as a safe haven asset, and institutional capital appears to agree with this analysis. 

Institutional capital believes BTC will draw investors away from gold 

Bitcoin’s explosive growth didn’t come from nowhere. According to JPMorgan, it has been heavily reliant upon an influx of capital from institutional investors. This influx of capital has created a liquidity crisis, driving the price of BTC up further, and making it more attractive to institutional investors. This means that even if analysts think BTC is overvalued right now, companies will likely continue to pump money into it, propping up the price. 

The capital directed at BTC has directly impacted gold. JPMorgan’s quantitative analysts believe that billions of dollars of capital will be shifted from gold to BTC over the coming years. This will create significant ‘structural headwinds’ for gold and could act as a suppressor on the price for years to come.  

A key indicator of the health of BTC is the Grayscale Bitcoin Trust. The assets under the fund’s management climbed from $2bn at the start of December 2020 to over $13.1bn by late December. This is compared to outflows of around $7bn for exchange-traded funds backed by gold. 

BTC gains could become a self-fulfilling prophecy 

Any gold bulls in the stands may have noticed a theme here. The BTC bull-run appears to be fuelled by demand creating an artificial liquidity squeeze. If this is the case, then there is a very real risk that slow-down in capital will bring BTC crashing down, and put gold back at the fore. 

gold bitcoin

Demand for BTC isn’t decreasing (Source: Coinmarketcap.com)

This is entirely possible. Indeed, it is a risk that has been highlighted by JPMorgan and others. However, this crash hasn’t yet materialized. Demand for BTC has continued to grow, and lack of liquidity has helped to sustain record prices. And the liquidity crisis is acute

bitcoin gold

The majority of BTC is illiquid (image via glassnode) 

Analysts at glassnode currently estimate BTC’s supplies at: 

  • Illiquid: 14.5m BTC
  • Liquid: 1.2m BTC
  • Highly Liquid: 3m BTC

This means that the vast majority, 78% to be exact, of BTC is unavailable to the market. This figure has risen by more than 1m BTC ($34bn) over the last 12 months. As more institutional investors enter the market with the intention of holding BTC, this supply-side crisis will become more severe, driving the perceived value of BTC even higher. 

Is bitcoin better than gold? 

For an institutional investor, bitcoin’s gains of over 316% during the last 12 months are attractive. However, when and if BTC starts hitting the price targets of major analysts, or around $146,000, there will likely be a slowdown of capital. Additionally, a severe shortage of BTC could lead to investors returning to more traditional safe-haven assets, such as gold. 

That being said, gold still maintains one key advantage over BTC, a price floor. Gold is a physical asset, which gives it a more understandable and tangible value than BTC. In contrast, bitcoin is designed to be a store of value. In this sense, it acts more like a fiat currency, where the value is tied to trust in the backing organization (in this case the people actually investing in BTC and its blockchain technology) rather than any physical backing. This means that a major negative event, for example, a 51% attack on the Bitcoin blockchain could conceivably take the cryptocurrency to zero, if trust were completely broken. 

Gold investors will also be able to find solace in the fact that gold is still outperforming the wider commodity market. Gold has grown by more than 28% in 2020 and predictions for 2021 are positive, with Goldman Sachs suggesting a price target of $2,300 per ounce.  No matter what happens, gold will continue to perform strongly so long as economic uncertainty persists, and it remains a lower-risk alternative to investing in emerging asset classes such as cryptocurrency.