Bitcoin has captured the imagination of investors across the globe, and the cryptocurrency has gained nearly 1,400% since the start of the year. The rally has dwarfed returns from other asset classes like equities, fixed income securities and real estate, even gold. In the first of a two-part BS Special series, Devangshu Datta explores whether this meteoric rise is here to stay and if you should invest in Bitcoin
The incredible returns that Bitcoin has delivered in the past year have fuelled a lot of trading interest. But how easy is it for Indians to invest in cryptocurrencies like Bitcoin in rupees? Easy enough it would seem; in fact, there already are an estimated 150,000 desi traders, and thousands more are signing up every day. But, is trading in Bitcoins
safe? What should a trader consider before taking positions in this virtual currency?
Here are some of the factors you should consider:
No fundamental backing for Bitcoin:
While Bitcoin has a lot of momentum, there is no way to fundamentally value it as a currency. It is backed by nothing and it is not linked to any national economic data, either. So, unlike in the case of the dollar, rupee, yen, or any another currency, you cannot benchmark against terms of trade, fiscal deficit, GDP
growth, etc, to say whether Bitcoin is overvalued or undervalued at any given level.
Too much sentiment here:
Prices are driven purely by sentiment, which, in turn, impacts the supply and demand. The supply of Bitcoin is restricted. It is based on mathematical algorithms which means the exactly known and limited money supply. So, if the demand rises, the price will also rise. The demand is rising at present and might continue to do so for a while, since more and more traders are entering the cryptocurrency
market. With the Nasdaq
and CBoT offering futures on Bitcoin will probably lead to more trading interest, including from institutional buyers.
The risk factor for the long term: Any currency can be viewed as a store of value, a possible unit of exchange and a unit of accounting for financial transactions. Bitcoin, however, is extremely volatile – much more so than gold or equity – so it is an extremely risky long-term store of value.
Also as a denominator or unit of accounting, its volatility makes Bitcoin a really risky asset. The cryptocurrency
has swung by over 1,400 per cent so far this year, and a swing of up to 10 per cent a day is quite common. If, for example, a debt was Bitcoin-denominated, it could have bizarre variations. That is another reason why option or swap contracts on bitcoin would have massive risks attached.
As a unit of exchange, meanwhile, Bitcoin could gain usage. At present, just a few merchants accept it. But if a global e-commerce major or one of the Fortune 500 companies starts accepting it for transactions, there would be a big boost in acceptance of the cryptocurrency.
Currently, only Japan
recognises it as a currency and South Korea
allows it to be used in official cross-border trade. Besides, if there is wider acceptance from central banks, there could be a significant gain for Bitcoin as a unit of exchange. It should be noted, however, that central banks’ acceptance would also mean more regulation that could drive out some speculators. Japan
and South Korea
have both set stringent regulations for the use of Bitcoin.
There are serious technical problems as well. It takes a lot of power to mine Bitcoin and also to verify each transaction, as many high-powered computers have to be run to make the required calculations. There have also been disagreements over the format of the blockchain – it is open source, but traders differ on whether the blockchain should be changed. Plus, there have been some major hacks for Bitcoin as well. These things might get sorted over time, but traders should note that there could also be major disruptions.
Coming back to the technical situation, if demand is increasing and supply is limited, the price could continue to rise. Yes, it is a class bubble, but bubbles continue to inflate while demand continues to rise.
So, should you invest?
You have to be prepared to accept massive swings if you get into Bitcoin, though futures trading will allow some degree of hedging and make it easier to short potential downturns. If you can weigh all these factors and handle the risks, you could make profits.