What influences the price of Bitcoin? Mainly sentiment.
Bitcoin proponents tout a variety of reasons why Bitcoin can continue its incredible rise. Among them is the idea that limiting aggregate supply and slowing issuance, known as a “halving,” will act as a long-term tailwind to prices. In basic economics teachings, all else equal, when supply is low, prices are high. However, there is a lot of uncertainty about whether everything else remains the same in the Bitcoin market.
Bitcoin’s demand factors appear to be fickle at best. Bitcoin is not pegged to widespread retail or industrial use like gold or other commodities. They do not generate cash flow or profits like bonds or stocks. Nor is it a widely used medium of exchange like currency. It seems to be driven almost entirely by speculation that others will want to buy at a higher price later on. Demand can change quickly, as it appears to be primarily driven by pure emotion. If demand falls faster than supply, prices may fall.
Furthermore, the supply cap argument does not seem to take into account the thousands of crypto alternatives available to investors. Although Bitcoin remains the dominant force, there are approximately 10,000 competitors vying for relevance (Exhibit 1). With few barriers to entry, potentially unlimited competition can fragment demand, and as more cryptocurrencies emerge, Bitcoin will continue to dominate the crypto market for years to come. There is no guarantee that we will maintain a dominant position.
Exhibit 1: Thousands of cryptocurrencies exist
Source: CoinGecko Research, as of April 1, 2024. Total number of cryptocurrencies according to CoinGecko Research.
Another factor in the supply of Bitcoin is that a small number of owners control a large portion of the unminted coins. In fact, just 2% of Bitcoin accounts control a whopping 93% of the total supply.[i]. This extreme ownership concentration poses significant risk to investors if any of these major owners decide to quickly sell a significant portion of their holdings. Stock investors can sometimes feel like small fry compared to institutional investors. When it comes to Bitcoin, the average investor is like a small fish swimming in an ocean surrounded by whales.
Bitcoin has a relatively short history, and why is it important?
Because Bitcoin has only been around for 14 years, it is difficult to understand how it will perform in different market and economic environments. As Exhibit 2 shows, Bitcoin’s young age pales in comparison to the length of reliable and robust datasets of more traditional asset classes such as stocks and bonds.
For example, contrast the history of Bitcoin with the nearly 100 years of historical data we have on stocks. During this time, stock prices have weathered recessions, wars, natural disasters, monetary policy shocks, commodity shortages, and health crises. You can use that data to assess how stock prices have reacted to these events, perform analysis of the current economic environment, and leverage that information, along with countless other factors, to make predictions. can. Ken Fisher likes to say: “History doesn’t repeat itself. But it does tend to rhyme.”
Exhibit 2: Bitcoin data history compared to other assets
Source: Fisher Investments Research as of March 28, 2024. The chart above illustrates the availability of reliable and widely referenced data across a variety of data sources for a variety of investment assets.
Any investment can involve a trade-off between risk and return, but given Bitcoin’s relatively young history, little is known about its risk and return characteristics. Therefore, it is difficult to determine with any degree of confidence whether Bitcoin is appropriate to incorporate into a broadly diversified long-term investment strategy.
Bitcoin’s extreme volatility—a wild ride.
While most investments involve some degree of volatility, Bitcoin exhibits extreme volatility with surprising “booms” and “busts.” While the potential for huge profits during a “boom” may attract prospective investors, many underestimate the difficulty of dealing with Bitcoin’s wild price fluctuations. There is a possibility.
Predicting Bitcoin price movements with confidence is notoriously difficult due to the frequency and intensity of price fluctuations. For example, as Exhibit 3 shows, since 2017, Bitcoin has had more than 180 days with a single-day drop in value of 5% or more. While some investors are concerned about the volatility in stock prices, there have only been four days in which global stocks have experienced similar declines over the same period. I refuse. Bitcoin’s correction and depth of bearishness could also spook investors. Few people would have the discipline to withstand a 93% (2011), 83% (2017), or 77% (2022) drop in their investment value, as Bitcoin experienced at the time.[ii].
Exhibit 3: Bitcoin’s sharp short-term volatility
Source: Global Financial Data and FactSet, as of April 8, 2024. His GFD Bitcoin per USD, MSCI World Price Index, daily, from January 1, 2017 to March 31, 2024. Displayed in US dollars.
The recent passing of the great Daniel Kahneman is a reminder of his Nobel Prize-winning work in behavioral economics and prospect theory. He documented how investors tend to value profits and losses differently. In other words, prioritize small but steady profits over potential losses. His research was done long before Bitcoin, but it still holds true today. Some Bitcoin investors have benefited from that rally, and it will likely continue. However, we know that when faced with extreme volatility, investors tend to make hasty and counterproductive investment decisions.
Despite the considerations we have discussed, we are not categorically opposed to Bitcoin or other cryptocurrencies. Conceptually, cryptography and cryptography-related technologies have interesting aspects. But we believe investors need to think long and hard about what they should do. know Before making any long-term investment decisions, understand Bitcoin’s risk-reward dynamics and compare it to other available assets.
Want to dig deeper?
In this article, we have looked at what investors should consider before purchasing Bitcoin. For an analysis of another pitfall of cryptocurrency investing: fraud, you can read this article from Fisher Investments. market minder Article: “Due Diligence Lessons from the HyperVerse.”
If you would like to learn more about why the introduction of Bitcoin ETFs is unlikely to change the speculative nature of cryptocurrencies, please also read this article from Fisher Investments. market minder Article “Beyond the Bitcoin ETF confusion”.
