By now we all know someone who has made some serious profit from investing in cryptocurrency. Crypto has traditionally been seen as extremely high risk, but with institutional investors getting involved, is there still a chance crypto markets could crash?
Bitcoin began trading back in 2009 when you could grab yourself a single Bitcoin for an eight-hundredth of a cent. Now a single Bitcoin is worth around $63,000 USD showing the phenomenal growth of the cryptocurrency over such a short period. Last year saw Bitcoin boom, but can it keep it up?
Bitcoin is a perfect 12-year-old bubble. The cryptocurrency has no intrinsic value so is a purely speculative asset whose value is controlled by market forces. There are a few other things that make Bitcoin special, including the fact that you still have a cost of production or “mining” as well as there being a total known quantity of 21 million.
While you might think Bitcoin is best placed next to the word bubble, there are other speculative bubbles out there. There are real-world cases of hyperinflated or valueless money out there. Most fiat currencies fall into a fundamental equilibrium where the value of the currency is stable, yet in a few cases such as Venezuela or Zimbabwe this fundamental equilibria that is relied upon has gone wrong and the price of money exploded. While most fiat currencies opt for the well-behaved fundamental equilibrium, there is an infinite range of equilibria that can support a stable currency price, and if this can happen to fiat currencies there is the potential for cryptocurrencies to stabilize too.
Bitcoin is currently on a non-fundamental explosive price equilibrium and so does not make it seem like a low risk asset to invest in. Furthermore, Tesla’s recent Bitcoin buy-in boosted the crypto’s price significantly demonstrating that the exit of a large player could make Bitcoin price fall. We can use the case of GameStop to show how risky it is in theory to invest in an asset that’s price volatility is not based on a value anchor.
The odds of Bitcoin crashing to zero at around 0.4%
In 2018, two Yale University economists (Yukun Liu and Aleh Tsyvinski) published a report titled ‘Risks and Returns of Cryptocurrency,’ that examined the risk of Bitcoin collapsing to zero within a day. They used Bitcoin’s historic returns to calculate the probability of a crash to zero at between 0% to 1.3%. If we compare this to a fiat currency, the same economists found the euro has a 0.009% chance of collapsing to zero, so falls within the calculated range. While many try to argue that the lack of an intrinsic value means Bitcoin could collapse the mathematics and consumer confidence support Bitcoin.
It might seem sensible to turn to the 2017 bubble to see how crypto’s can have a snap change in price. However, while the bubble back then was based on hype and alt streams of investors, the rise in crypto over the past year has a stronger base. So why is that?
- A safe investment: Firstly, with the threat of economic reckoning due to Covid-19 many investors are switching from properties, savings and bonds to safe-haven assets and digital stocks. As Bitcoin is essentially a mix of both with the added bonus that some governments and large firms such as Paypal are adopting it as a valid payment method mark cryptos as a winner.
- Tech upgrades: Crypto technologies are being updated so they don’t require such energy-intensive computing processes which saves those who avoid crypto’s based on environmental grounds. There are also new layers of blockchain being developed to integrate crypto’s better into financial markets.
- Institutional security: Many institutional investors are now investing in cryptocurrency which gives a safety net for any big price changes in crypto.
While half a decade ago you would be right in saying that cryptos are high-risk and a foolish investment, recently there has been a huge amount of support from large organisations.
In recent months, there’s been a flood of institutional investment in Bitcoin, with companies including MicroStrategy, Tesla, Square, and Aker ASA buying Bitcoin for their corporate treasuries. Simultaneously, Canada’s Purpose Bitcoin ETF was launched as the first of its kind. This institutional investment has supported Bitcoin’s current bull run and counts as proof that cryptos are here to stay.
While it is a fact that all cryptocurrencies are volatile and will remain speculative assets, the support of institutional investors and the solidification of cryptos as a new economic infrastructure means that cryptos are here to stay.
With the odds of Bitcoin crashing to zero at around 0.4% it would take a monumental feat and would be nearly impossible to achieve. Do you support crypto?