Future of cryptocurrencies looks strong

Fears of a bitcoin bubble

The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in Bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision.

The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.

Several studies around market structure have shown that emerging markets with high retail and low institutional investor participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation.

And while more leading financial houses seem to be taking an interest in cryptocurrencies, the level of institutional involvement still seems limited. Too much concentration of the asset is another issue: about 2 per cent of Bitcoin accounts control of 95 per cent of all bitcoins.

In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider Bitcoin as a standalone asset in a diversified portfolio for long-term investors.

An inflation hedge?

As fears of much higher inflation grow as governments turn on the spending taps and central banks flood the market with liquidity in response to the pandemic, might cryptocurrencies hedge against surging inflation? Possibly.

Regardless of its price, bitcoins' production is set on a precise schedule and cannot be changed to meet rising demand for the asset. This could be positive.

But other real assets, such as precious metals, inflation-linked bonds or real estate, already have a long record of hedging against inflation.

Other considerations

Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants that can all certify the transaction. However, there have been frauds and thefts from exchanges.

Another point to consider is the risk of 'losing' bitcoins. According to cryptocurrency data company Chainanalysis, around 20 per cent of the existing 18.5m bitcoins are lost or stranded in wallets, with no means of being recovered.

What about its green credentials? Mining and exchanging bitcoins is highly energy intensive.

According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network may have consumed as much electricity as Switzerland in 2018.

This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a Visa transaction is 0.4g of CO2.

Then there is cryptocurrency’s large amount of electronic waste (e-waste). As mining requires more computational power, Mr de Vries’ study estimates that mining equipment becomes obsolete every 18 months.

The study suggests the Bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.