Historically, the stock market has gained 7% per year, inclusive of dividend reinvestment. When compared to practically all other assets, such as commodities and bonds, the strategy of buying and holding high-quality stocks over the long term has yielded the best returns. Then cryptocurrencies came along and blew every other asset completely out of the water.
Since the year began, the aggregate cryptocurrency market cap has increased from roughly $17.7 billion to just shy of $150 billion as of Oct. 8, 2017. That works out to a nearly 750% return in just over nine full months. By comparison, it's taken the broad-based S&P 500 almost three decades to deliver similar returns to investors.
The two fundamental catalysts driving bitcoin
At the heart of the cryptocurrency buzz are two tangible catalysts: blockchain technology and a weaker dollar.
Blockchain is the digital and decentralized ledger that records transactions without the need for a financial intermediary like a bank. Blockchains are customizable, though they're usually open source, which makes altering data within the blockchain practically impossible without someone else finding out. This security is what makes blockchain technology so attractive to enterprise customers.
In August, when bitcoin forked into two separate currencies, bitcoin and bitcoin cash, engineers implemented a software upgrade to bitcoin designed to go after enterprise clients, rather than simply relying on it being a preferred digital currency payment platform. This software update took some information off the current blockchain to improve capacity, lower transaction fees, and improve settlement times for transactions. Given the surge in bitcoin since the upgrade two months ago (it's more than doubled), investors are clearly excited about the upgraded blockchains' prospects.
The other clear catalyst here is the falling U.S. dollar. Weakness in the dollar usually indicates uncertainty about the U.S. economy, albeit it can help boost exports to foreign countries. Investors, however, dislike seeing their dollars devalue. Historically, gold has been the go-to investment when the dollar declines, mainly because gold is a finite resource and is viewed as the perfect store of value. Not surprisingly, gold tends to move opposite of the U.S. dollar.
In recent months, though, some investors have flocked to bitcoin instead of gold as a store of value. Aside from the fact that bitcoin's year-to-date return has crushed gold, bitcoin can also, in a sense, be viewed as a finite resource. Its protocols limit the number of coins that can be mined to 21 million, placing a cap on future mining dilution and creating a perceived store of value.
This investment banking giant is seriously thinking about trading bitcoin
But it's not these fundamental catalysts that have been causing bitcoin's price to surge of late. Instead, it's the interest being shown by giant investment firms and banks into bitcoin.
For those who may not recall, it was recently announced that Fidelity Investment, which has $2.3 trillion in assets under management, has been mining both bitcoin and Ethereum for a profit. Its CEO, Abigail Johnson, announced this news at the Consensus conference in New York. Actively mining bitcoin and Ethereum comes atop Fidelity's efforts to integrate data from Coinbase into users' account pages. Doing so allows Fidelity users to check their cryptocurrency holdings directly from their Fidelity account.
The newest buzz now comes from investment banking giant Goldman Sachs (NYSE: GS), which is apparently considering its own bitcoin trading operation. According to anonymous sources at The Wall Street Journal, Goldman Sachs' currency trading and strategic investment divisions are in the early stages of considering whether or not to engage in bitcoin trading. Goldman's entrance into the bitcoin space isn't a guarantee given that a majority of its clients are corporations and financial institutions themselves, who are far less likely to be intrigued about bitcoin than retail investors. Nevertheless, CEO Lloyd Blankfein is clearly leaving the door open for his company to have a future with bitcoin.
Not everyone is onboard with the bitcoin hype
Of course, not everyone is onboard with the bitcoin craze. Front-and-center of the pack when it comes to the opposition is JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon. Dimon has referred to bitcoin as a "fraud," and has suggested that any employees within the nation's largest bank would be fired for trading it or any other digital currencies. Meanwhile, digital-currency proponents suggest that Dimon's defensiveness has everything to do with him being worried about digital currencies cutting banks out of the equation.
Investment mogul Warren Buffett isn't a fan of cryptocurrencies like bitcoin, either. Buffett, back in 2014, suggested that bitcoin is a mode of payment much like a check, but opined that checks have no inherent value.
However, there may be bigger things to worry about for bitcoin than merely the opinions of top finance gurus. Regulation is obviously a major concern, albeit a two-headed one. On one hand, increased regulation would help validate bitcoin as a currency. Then again, tougher regulations could clamp down on bitcoin's opportunities to expand its reach. Both China and South Korea have recently closed the door on initial coin offerings (ICOs) in their respective countries, with China going one step further by announcing its intent to bar domestic cryptocurrency exchanges.
The low barrier to entry into the digital currency realm is another major concern for bitcoin. Sure, it's the leading cryptocurrency now, but there are no guarantees that bitcoin's blockchain will remain near the top of the pack at any point in the future. The prevalence of ICOs, and the ease by which companies have been able to band together to develop their own blockchain and/or virtual currency, should have bitcoin investors very worried about its long-term outlook.
Even if Goldman Sachs gets involved, I would caution investors keep their distance from bitcoin.
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