January 27 2021
Bitcoin:
The rise and rise of bitcoin! The name Bitcoin evokes a sense of enigma, curiosity, and a possible peep into the future of money.
Origins of bitcoin can be traced to a blockchain built under an anonymous name – Satoshi Nakamoto. Satoshi was the first to solve the problem of double-spending using peer to peer network. The identity of the brilliant mind who authored the white paper on Bitcoin remains unknown to this day however!
Bitcoin blockchain is a public ledger that records all bitcoin transactions. It is recorded as an addition to the block of transactions without overwriting the earlier blocks. New bitcoins are mined every 10 minutes by generating a code or nonce. Mining of bitcoins refers to solving a computational puzzle and people who solve the puzzle are rewarded with new bitcoins.
Bitcoin has seen a dramatic rise in 2020 – a year marked by events unprecedented both in the real economy and in financial markets. Bitcoin has given a staggering return of 340% in 2020 and 570% from the lows of March 20. Financial markets had a roller coaster ride in 2020 and Bitcoin has been a stellar outperformer beating all asset classes by miles.
Given the powerful rally and rising investments in the cryptocurrency from traditional investors, there is a growing view that the fair value of one bitcoin will be upwards of 1 mn USD if only 2% of investor wealth in currencies is invested in the cryptocurrency.
Given the advantages of borderless and seamless transactions at nil transaction costs in real-time, a huge influx of liquidity by Federal Reserve in the aftermath of COVID 19, audit trail of all transactions, flawless code with complete transparency of the mining process, added cushion of eventual scarcity in the supply of bitcoins coupled with a rally in the cryptocurrency, the argument that it will gradually replace the hard currencies of today seems a more realistic and likely scenario than it was anytime earlier.
We have attempted to put together our thoughts on whether bitcoin will pass the basic tests for being the next currency of the future or it will fade with the eventual rise of digital currencies backed by sovereign nations –
Buoyancy in financial markets, partly driven by the money printing machine of the Federal Reserve in the aftermath of COVID 19 has led to a rally in cryptocurrencies. In a discussion on cryptocurrencies on a business channel a few weeks ago, an “analyst” expressed the fear that economic growth may be impacted as Indians with 20% of the world population own less than 1% of bitcoins. I would not want to debate such comments but cannot resist drawing similarities to the views expressed by analysts in the build up to dot.com boom who suggested companies should be valued based on the number of clicks and that era of valuing companies based on cash flows is passe.
Buoyancy in financial markets is a more recent phenomenon. So, what explains the success of bitcoin? For one, it is a Technological Leap. Secondly, it can be explained by the psychology of human nature. We are fascinated by the future and want to be early adopters of new technology. If our forecast of future on the adoption of cryptocurrency turns out to be correct, we would be handsomely rewarded financially and would also stand out among our peers as the ones who “out called” the future. We get carried away by our fascination for the future and in the process overlook that most forecasts are inherently off the mark!
Bitcoin also runs the inherent risk of a clampdown by regulatory authorities should a terror attack be financed by underlying transactions in cryptocurrency or if authorities decide to clamp down on the dark web which is a source of illicit transactions. As per a study, 1548 cryptocurrencies are in vogue today with transactions running into billions of dollars. It is similar to euphoria before the meltdown!!
Author:
Nitin Grover, a Chartered Accountant with over 20 years of experience in senior roles in ITC & Coca-Cola, with an interest in Financial Markets. He is also active investor/Portfolio Manager. He can be reached at canitingrover1@gmail.com