It’s a mess out there; let my friend explain it to you
Put your terribly made coffee down and get ready to have your brain energized by good old-fashioned stats and analysis. This issue is a special one, as the entire thing will be a guest feature.
Hello reader, put your terribly made coffee down and get ready to have your brain energized by good old-fashioned stats and analysis. This issue is a special one, as the entire thing will be a guest feature from Takudzwa Ndachena, an insanely intelligent colleague of mine, specializing in financial writing and analysis. Takudzwa, here, takes a high-level look at the digital currency landscape, its interactions with traditional market participants, and how or if these assets will become widely adopted; all using BTC as a sort of ad-hoc case study. Now, put your Zoom meeting on mute, and enjoy (I won’t tell HR).
Everyone loves digital currencies (not really)…
As we know, Bitcoin allows quicker and less expensive transactions than conventional financial systems (possibly disrupting the financial sector). However, several obstacles (like lack of oversight and volatility) might prevent Bitcoin from being widely used. Regulators and the public are concerned about its links to criminal activities, its value and adoption rate may also be impacted by limited supply and other cryptocurrencies. etc.
Still, Bitcoin has promise as a store of value and a possible substitute for conventional currencies. Its expanding popularity as a payment method by consumers and institutions, as well as by merchants and financial organizations, raises the possibility that it may become more generally recognized in the future.
Investments in emerging asset classes like Bitcoin have been slow to come from traditional money managers. Most are just starting to explore these novel asset classes, but are hesitant to embrace Bitcoin and other cryptocurrencies due to regulatory issues and risk aversion. Additionally, money managers may be restricted by strict investment mandates, preventing investments in non-traditional assets.
Famed investor, Ray Dalio (don’t be lazy, just Google him), claimed that cryptocurrencies lack inherent worth and are ineffective repositories of wealth. Furthermore, he emphasized that the lack of widespread acceptance of cryptocurrencies as payment options restricts their utility as money.
Bridgewater Associates did a great job analyzing the quantitative and qualitative variables that impact the future of cryptocurrencies, particularly Bitcoin, as a potential reserve currency or digital gold. In summary, since supply is known (21 million units are hard-coded) and the demand is unknown, bitcoin prices depend heavily on who is buying it. For example, a prominent institutional investor or central bank accepting bitcoin in significant quantities could increase the price and its adoption as a reserve currency. However, if a country were to ban the use of bitcoin or crack down on its use, it could decrease the demand and impact the price.
Where are the institutions?
Most of the buying to date has been from retail investors. Other participants have chosen to be idle because of the inflexibility of the cryptocurrency, notably the big-money ones, are: (r/wallstreetbets aside, of course):
Institutional Investors
Corporations
Government-funded organizations
The Government
Institutions have only begun to wade into digital currencies. While this new influx of buyers comes with a hefty war chest of cash (affecting demand positively) – their interest always attracts the prying eyes of regulators. It is doubtful that corporations, government-funded organizations, or the state will adopt digital currencies, en masse, soon. Infrastructure questions, safety, lack of oversight, and the potential for illegalities contribute to their consternation. Overall, the future of digital currencies as mainstream assets will depend on their ability to overcome these challenges and gain wider acceptance.
How bad can it really get?
El Salvador declared Bitcoin legal tender (facilitated by their Chivo Wallet app) in September 2021, as written about in a prior issue (hint…go read it), and had that go disastrously.
In theory, developing nations are excellent candidates to adopt cryptocurrency (due to their large amounts of unbanked individuals and distrust in Central Banks). However, the reality in El Salvador was much different, due to the impracticality of BTC as payment method:
What are the suits saying?
Many investment managers have different mandates regarding performance and asset allocation. Still, they generally have the freedom to adapt as new technologies allow them to seek value in novel assets.
If Bitcoin is to be an asset that hedges against inflation, it would have to meet specific standards, namely;
used as a medium of exchange,
(most importantly) a store of wealth, and
unit of account
While there have been improvements in these factors, current levels of liquidity still constitute real structural challenges to holding Bitcoin for large traditional institutions such as hedge funds and their clients, as moving large volumes efficiently may be an issue. Due to the small and illiquid nature of the Bitcoin market, it can be difficult for large traditional institutions to buy Bitcoin at attractive prices, as their purchases can directly affect the current price of Bitcoin. Defiantly, some institutional investors have turned to liquidity providers, to help buy and sell large volumes of Bitcoin (which comes at a cost, of course) without significantly impacting the price. In general, liquidity is an essential factor for investors to consider when buying securities, as it can impact the ease and cost of buying and selling assets.
Let me wrap this up…
I’ll leave you with this, fresh from a first-year business textbook:
All in all, it seems wise for retail investors like myself to wait for institutional buying to get involved after regulations have been put in place that will allow the bitcoin market to work more "efficiently" – and ground our projections.
Last Word
As you read, digital currencies for the Average Joe (yes, I’m looking at you, Mr. Generic Hobbies) are a far-off way from mass adoption and from any meaningful vote of confidence from institutions. I mean, the Dogecoins will (hopefully) fall to the wayside (you Elon fanboys can give your head a shake…Dogecoin is useless) and leave room for those assets with utility and sustainable value…time will tell. Thank you again to Takudzwa for the succinct writing. As always, if you liked what you read, please consider subscribing and telling a friend to do so.