When people say, ‘it’s the economy, stupid’, an increasingly appropriate response would be: ‘actually, it’s the demographics, stupid.’ Demographics explain a lot about the economy and investing; and no more so is this the case than in the opaque world of cryptocurrency markets, as younger cohorts of investors are accepting of a technology that leaves older, richer, groups confused.
The price of Bitcoin has risen to its highest level in almost three years, surpassing $15,000 for the first time since the 2017 boom-and-bust, which in the process is fuelling fresh debate about whether cryptocurrencies are about to enjoy another melt up. A purely speculative bubble may be far from what the next phase in the crypto market is all about, however, as Bitcoin (and some peers) seem to be beginning to mature as legitimate financial instruments.
Since sinking below $4,000 briefly during the peak of the global market sell-off in March, prices have risen steadily and come close to $16,000 – levels not seen since the bubble popped at the end of 2017/early 2018. While it is easy to accuse them of talking their books, many investors are now confidently talking about Bitcoin making fresh all-time highs above $20,000.
The latest surge in Bitcoin came after PayPal said it will enable cryptocurrencies on its platform. Initially it will allow users to buy, hold and sell Bitcoin, Ethereum, Bitcoin Cash, and Litecoin in the PayPal wallet. The decision sparked an immediate rally in the price of those cryptocurrencies, with the focus as ever on the daddy of them all, Bitcoin. PayPal also said it will enable users to spend cryptocurrencies for purchases at its 26m merchants worldwide.
What’s important about this seems more about removing some of the mystique around Bitcoin rather than doing anything particularly new or amazing. It is hard to know for sure right now what it means, but because of PayPal’s sheer scale and reach, it accelerates the process of ‘mainstreaming’ Bitcoin in the financial world, supporting the usage case for cryptos generally, which would tend to underpin renewed bullishness around prices. At least that what some bank strategists say; with Bitcoin nothing is ever so simple, but it’s clear that the decision by PayPal led to an increase in prices. But after a rocky couple of years since the crash and getting caught up in the ‘sell everything, raise cash’ markets collapse in March, Bitcoin has been making steady gains. PayPal’s decision is just yet another bullish catalyst for prices, not the sole reason for achieving multi-year peaks.
So, it’s worth considering just why the is happening under the bonnet of financial markets: what is driving Bitcoin higher and why this force could send prices up significantly. First, we need to think about the function of cryptocurrencies as both a ‘store of wealth’ and as a ‘means of payment’, which makes it rather like cash in many ways, not perfectly aligned but similar. It’s still not terribly easy to buy and sell things with Bitcoin, which hampers its adoption. But things may be changing.
Corporate support via the likes of Square and MicroStrategy in recent months – and now with PayPal – is important. Last month Square added $50m in Bitcoin – some 4,709 coins – to its balance sheet. In August Microstrategy, a Nasdaq-listed business intelligence company acquired 21,454 Bitcoins as part of its "capital allocation strategy".
PayPal’s endorsement looks to be another step towards widespread corporate support for Bitcoin, which will facilitate the use case for Bitcoin as another form of currency. In a recent Flows & Liquidity report, JPMorgan strategists highlight that the market value of cryptocurrencies could rise significantly above where they might be justified as a ‘store of wealth’ due to their utility as a means of payment. “The more economic agents accept cryptocurrencies as a means of payment in the future, the higher their utility and value,” they explain. “Cryptocurrencies derive value not only because they serve as stores of wealth but also due to their utility as means of payment.”
Widespread adoption of cryptos has been held back by their limited utility as an instrument of exchange, which is due to price volatility, cost and transaction speeds. However, PayPal notes that “the promise of advanced technological platforms offers the possibility of mainstreaming digital currencies”. One in 10 central banks are looking to issue their own digital currencies within the next three years, according to the Bank for International Settlements. "The shift to digital forms of currencies is inevitable, bringing with it clear advantages in terms of financial inclusion and access; efficiency, speed and resilience of the payments system; and the ability for governments to disburse funds to citizens quickly," notes PayPal CEO Dan Schulman.
While the JPM strategists, led by closely followed quant Nikolaos Panigirtzoglou, argue that Bitcoin may be overbought in the near term, they simultaneously avow that the potential long-term upside is considerable as it starts to compete with gold as an ‘alternative’ currency. Quite the change of tone from the US investment bank – in 2017 CEO Jamie Dimon described Bitcoin as a “fraud”. And we should stress that not everyone is getting chirpy about Bitcoin – Goldman Sachs analysts warned in May that “a security whose appreciation is primarily dependent on whether someone else is willing to pay a higher price for it is not a suitable investment for our clients”. But GS may be playing catch up.
The use case for Bitcoin as a means of payment is intertwined with the investment thesis as a store of value. And here we need to take a sidestep and look at demographics: millennials are buying Bitcoin because they buy into the idea. Charles Scwhab, the US broker, found in a survey last year that Bitcoin was the fifth most popular holding among millennial investors, or at least the Grayscale Bitcoin Trust which offers direct exposure to the price of the largest cryptocurrency. Millennial investors aged 25-39 were found to be investing more in Bitcoin via this investment vehicle than they were in the likes of Walt Disney, Netflix or Berkshire Hathaway. Incidentally, the top four holdings among this cohort were, unsurprisingly: Amazon, Apple, Tesla and Facebook.
“Indeed, an important divergence between the behaviour of the older versus younger cohorts of the retail investors’ universe has been their preference for ‘alternative’ currencies,” write Panigirtzoglou and his team. While the older cohorts prefer gold, younger groups of investors are seeking out cryptocurrencies. As a result, both gold and Bitcoin ETFs have seen strong inflows this year, but from different groups.
But is Bitcoin really a hedge, or a safe haven in the same fashion as gold? There is no cash flow like bonds (although that is somewhat moot these days since yields are negative on a lot of government debt), price volatility is extremely high, and unstable correlations with other financial assets mean it lacks certain diversification benefits.
The JPMorgan team note that Bitcoin’s volatility and correlation with the S&P 500 suggests it is a ‘risk’ asset. But they also note that in 2020 gold has exhibited similar tendencies. “In other words,” they write, “both Bitcoin and gold could be more characterised as ‘risk’ rather than ‘safe’ assets based on their behaviour this year and investors’ preference for them is likely more of a reflection of a need for an ‘alternative’ currency rather than a need for a ‘safe’ asset or ‘hedge’.” Paul Tudor Jones, the veteran US investor who called the 1987 stock market crash and who surprised the investing community by indicating his support for cryptos earlier in the year, notes that the “most compelling argument for owning Bitcoin is the coming digitisation of currency everywhere”.
So, is it a risk asset that will be an alternative currency, or a safe asset that will protect against inflation? Most likely it’s a bit of both – the reasons are inextricably linked, and both gold and Bitcoin act as inflation hedges and as alternative currency. For both Bitcoin and gold, which offer zero yield, the reason for owning them is about finding an alternative to fiat currency in the wake of the pandemic and the central bank intervention that has crushed nominal and real yields. For a great many investors, Bitcoin is seen as a hedge against inflation. The fact it has not offered inflation protection thus far is because we have not had any inflation – it's not been tested, yet. In a zero-yield world where inflation is being engineered, younger investors want something that acts as a store of value but also want to place a side bet on Bitcoin’s utility. The very design of Bitcoin – a fixed and slowing rate of supply – makes it the epitome of scarcity value, and entirely the opposite of fiat currencies.
Paul Tudor Jones argued earlier this year for a ‘Great Monetary Inflation’ to occur as a result of the vast increase in the money supply (see Modern monetary theory or magic money tree?). In any event, when it is the stated aim of central banks to diminish the value of the fiat currencies that they print by 2 per cent a year, it’s no good holding cash. In the words of Ray Dalio, founder of the world’s largest hedge fund, Bridgewater Associates, “cash is trash”. And so, we come back to the usage case – while we must hold some cash to buy things, the utility value of Bitcoin increases the greater the corporate support emerges to make payments using it, rather than cash. Again, the utility and investment theses are interwoven.
“Owning Bitcoin is a great way to defend oneself against the GMI, given the current fact set,” Paul Tudor Jones wrote earlier in the year. He now has about 1-2 per cent of assets invested in Bitcoin despite being about as far away from the world of ‘crypto bros’ as it's possible to be. “I am not a hard-money nor a crypto nut. I am not a millennial investing in cryptocurrency, which is very popular in that generation, but a baby boomer who wants to capture the opportunity set while protecting my capital in ever-changing environments,” he said in his widely read letter to investors.
Can it go up more?
The big, indeed some would say only, question for investors is whether it’s got upside. Back to Mr Panigirtzoglou and co, who write that given that millennials will become an ever-larger part of the investor universe Bitcoin “could compete more intensely with gold as an alternative currency”. This is important due to the sheer size of the gold market. Gold ETFs are worth $240bn – almost identical to the total market cap of Bitcoin today. But the total stock of gold bars and coins, excluding those held by central banks, is estimated at about $2.6 trillion. Given how big the investment in gold, it would not take much of a shift by investors (millennials) to exert a very powerful lever on Bitcoin prices.
Remember both gold and Bitcoin are being viewed as powerful inflation hedges. Paul Tudor Jones notes that “gold, in a low-carry world, gold remains a very attractive hedge against the Great Monetary Inflation and hedges against other risks clouding the outlook, including a renewed flare up in the China-US relationship where financial sanctions could eventually be used in a brute-force decoupling”. Under valuation metrics based on the increase in the supply of money in 2020, he says gold could rally to $2,400 to reach a level consistent with the lowest of the last three peaks, and as high as $6,700 to match the 1980s extremes.
But, increasingly, more younger investors are looking past gold to Bitcoin – millennials, so it’s thought, are set to drive demand for Bitcoin. According to Mr Panigirtzoglou, millennials hold the key as they become a larger chunk of the retail investor crowd: even a “modest” crowding out of the gold trade would imply “doubling or tripling” Bitcoin prices. “Millennials and corporates endorsement of Bitcoin have also induced greater interest by institutional investors,” he adds. The thinking is that if gold is set to make further gains due to low rates, etc, then Bitcoin, given the market dynamics and investor preferences, should piggy back that ride up.
At the end of the day, says Paul Tudor Jones, the best way to maximise profits is to own the fastest horse. He explains: “Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be Bitcoin.” Demographics would tend to back this up.
Neil Wilson is chief markets analyst at Markets.com