Last Thursday, the price of bitcoin was trading near its all-time high, at about $1,150, when it lost more than 20% of its value overnight. It stumbled again on Friday, again losing a fifth of its value and briefly hitting a low of $819. (It has been trading in the $850-$900 range over the weekend.)
Both times, the cause of the drop was statements and actions by the Chinese government, which boosted the value of the Chinese yuan and warned bitcoin exchanges about following regulations such as know-your-customer and anti-money-laundering requirements. The vast majority of bitcoin trading (more than 95%) takes place in China, giving events there an enormous influence on the price.
However, the tumbles obscure a more encouraging story about bitcoin’s fundamentals, according to an updated white paper by ARK Investment Management, the first public fund manager to invest in Bitcoin, and cryptocurrency exchange Coinbase.
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First published in June, the paper, titled “Bitcoin: Ringing the Bell for a New Asset Class,” argued that bitcoin represented a new asset class, for four reasons, with the most notable being that it is uncorrelated positively or negatively to any other asset class.
The authors have updated the white paper using full data from 2016, and while the events of the first days of 2017 are not included, it seems bitcoin is further maturing as an asset class. And while the coauthors, Chris Burniske, ARK’s blockchain products lead, and Adam White, Coinbase’s general manager and head of its professional trading cryptocurrency exchange Global Digital Asset Exchange, GDAX, are aware of China’s outsize influence on bitcoin, they don’t see that as cause for alarm.
Volatility Down
Bitcoin’s notorious volatility isn’t as bad as you may think. The one-year trailing volatility of daily percent price changes was 28% lower on January 1, 2017 than it had been on January 1, 2016.
“Most people equate a rising price with increased volatility,” says coauthor Chris Burniske, ARK’s blockchain products lead. (The price of bitcoin rose from about $400 to about $1,000 over 2016, outperforming every other currency, index fund and commodity contract.) “But we actually didn’t see that in 2016 because as bitcoin has matured and become more liquid, it’s able to absorb more demand and not necessarily become extremely volatile.”
Its weekly volatility was 7% — just one percentage point higher than that of oil.
Returns Per Unit Of Risk Up
A comparison of the return given per unit of risk taken is called the Sharpe Ratio. “In 2016, bitcoin best compensated investors for the risk they took and did nearly twice as good a job as US stocks,” says Burniske. However, the Sharpe Ratio for bitcoin varies widely on when you buy your coins.
For anyone who bought six years ago, their compound annual returns would be almost 300% (which would have turned $10,000 six years ago into $2.3 million today).
However, someone who bought three years ago would only have seen a 9% return. In 2016, the return was 129%.
Trading Volume Increased
Over the final three months of 2016, just over $3.5 billion of bitcoin traded, which is three times as much volume in the Spider Gold Shares ETF and almost 10 times as much as that of the Vanguard REIT ETF. However, this isn’t a direct comparison since the ETFs are securitized assets, and the vast majority of the trades occurred in China when many expected the yuan to continue to be devalued.
Burniske surmises that the Chinese may have been interested in bitcoin because of the devaluation of the yuan. Noting its near-zero correlation to other assets, he said, “If you as a Chinese citizen are trying to store your wealth in an area not affected by other macroeconomic forces, then bitcoin appears like a safe haven.”
But that doesn’t mean increased volume was restricted to China only. White says that during the period, new user signups at Coinbase.com grew 50%. And trading volume on GDAX, which is typically around $2 million to $3 million a day, shot up to $25-$30 million last week, as the price gyrated on the news out of China.
White also points out that the price of another cryptocurrency, ether, part of the Ethereum network, had risen about 50% from $7 to more than $10 and that volumes were more than five times their average.
Transactional Volume Went Up Too
Similarly, on Coinbase, transactional volume — how much bitcoin was being used to, say, pay a merchant or friend or send a family member a remittance — more than doubled from 2015 to 2016.
In recent years, the ratio of trading to transacting behavior on Coinbase had gone up, with those treating it strictly as an investment accounting for 44% of users in 2012 and 64% in 2015. However, in 2016, that ratio reversed course, and the percentage of those who only held bitcoin as an investment dropped to 54%.
White said Coinbase, which does payment processing for 45,000 merchants in 32 countries mostly in North America and Europe, says its merchants doubled their volume in dollar terms and in number of transactions.
“This shows evenhanded growth between bitcoin as a means of exchange and store of value,” says Burniske. “People very often like to discount bitcoin as just a speculative story, and it’s not just a speculative story.”
But What About China?
Though some worry that China’s influence on bitcoin has grown too large, Burniske says, “I think too many people see them as a threat or worry about them, and sure, there’s miner centralization there and the government could take a swipe, but China is now providing a lot of brain power and innovation chops for bitcoin.”
China has been instrumental in the manufacturing of specialized bitcoin mining chips, and many of the mining companies are based there. Also, Chinese venture capitalists such as Fenbushi Capital are making investments into blockchain startups.
While acknowledging that government actions in China will of course impact the price because the vast majority of trading volume takes place there, White is sanguine on China’s attitude toward bitcoin going forward.
“I don’t see China being so shortsighted that the Chinese government would outright ban bitcoin,” he says. “I think they would apply intelligent, targeted regulation of the bitcoin exchanges, much like the US and Europe has done — but an outright ban on open source, decentralized technology won’t work.”
Bitcoin’s Price in 2017
Going forward, several developments could plummet bitcoin’s price back to earth or send it soaring even further.
Burniske says a quickly rising price could create a bubble and foment volatility, which isn’t conducive to stable growth. Additionally, the community is currently attempting to adopt technical change that could enable faster and more payments but will only kick in if 95% of the computers running the network choose to adopt it. But a small minority could block that. “If we can’t all agree on something, that could have ramifications over time,” he says.
However, if that technical change does go through, enabling even further innovations on bitcoin, White says such a development could lead to a very different update on the white paper, one that shows far more transactors than investors.
White also says clearer guidance from U.S. regulators over how cryptocurrency will be treated could lead to increased trading and a boost in the price. Likewise, the Securities and Exchange Commission will soon rule on the first Bitcoin ETF, and other securitized products based on digital assets are likely to go public this year as well. Those could potentially
A forthcoming fintech charter by the OCC could give cryptocurrency companies access to the traditional banking ACH network without needing a bank partner, further smoothing the on- and off-ramps to the world of cryptocurrency.
But White believes that the true driver of adoption hasn’t happened yet. Now, he says, people choose bitcoin because geopolitical events such as in China, India or Venezuela drive them to seek out a currency that their government can’t devalue or whose movement the government can’t control. However, he believes more people will turn to it when they think about why it is that they’re choosing bitcoin as opposed to another currency or commodity or foreign real estate. “If we looked at bitcoin and it was highly correlated with other FX currencies and had a really bad risk-return ratio, it would be like, well, technically you can [buy it], but it’s not smart,” he says. “It’s amazing that we have a marriage of technically I can, and two, this is a really smart addition to my portfolio.”
GDAX is already starting to see well-known hedge funds and institutional investors create accounts. Recalling how, after Overstock became the first merchant with more than $1 billion in sales to accept bitcoin, a dozen other retailers with similar revenues also signed up, he says, “There’s a first mover hesitancy that for certain exists in merchants and is amplified 10x in financial services, because of regulation and all the risk that goes along with it,” says White. “But I am very confident that when we see that first large, mainstream institutional investor go public and say, we’re buying this and here’s why, you’re going to see a wave of other institutional investors that want to be the fast follower, the me too, and then you’ll see trading volume and demand skyrocket.”
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