One of the most profitable areas for investors in 2020 was Bitcoin, which started the year at just under $7,500 and finished it above $29,000. But it is hard to think of any other asset that sparks such fierce debate.
Bitcoin is the oldest of the world’s crypto currencies with the rationale behind it explained in a white paper published in 2008 by its pseudonymous founder, Satoshi Nakamoto. The paper says that it should serve as a proof-of-concept technology and function as “a purely peer-to-peer version of electronic cash.”
Crypto is designed to act as a decentralised payments system that enables people to transfer value without the need of financial intermediaries like banks. Unlike the normal paper currencies the monetary supply cannot be affected by government agencies, which should mean that they are unable to devalue it at will.
Because of this some argue that Bitcoin is the digital equivalent of gold and will do well as the authorities continue to ramp up their money printing policies. In theory it has a 21 million supply cap, which is where the value comes from, but with no underlying fundamentals it is essentially worth what someone else is willing to pay for it, hence the huge volatility.
Bitcoin has many firm adherents, as well as plenty of people who believe it is a speculative bubble. Whichever camp you fall in it is worth remembering that the last time it shot up in value like this was in 2017 when it got close to $20,000, before losing 80% of its value over the next year.
Insurance policy
One of the first mainstream funds to buy into it is the £475m Ruffer Investment Company (LON:RICA), which has used Bitcoin to diversify the part of its portfolio that hedges against wider market risks after taking some profits in gold.
They described the 2.5% allocation announced in November as ‘a small but potent insurance policy against the continuing devaluation of the world’s major currencies. Bitcoin diversifies the company’s (much larger) investments in gold and inflation-linked bonds and acts as a hedge to some of the monetary and market risks that we see.’
RICA’s bitcoin is held in a segregated account by the world’s largest custodian of digital assets in safe, offline, cold storage and covered by an industry-leading insurance policy. I would expect the managers to regularly rebalance the holding to ensure that it continues to provide downside protection without exposing the fund to unnecessary levels of volatility.
To buy or not to buy, that is the question
Adherents of Bitcoin believe that there will be a wall of institutional money flowing into it in the near future that will propel the price much higher, but for retail investors there are plenty of risks. If it turns out to be a bubble you could easily lose most of your money and even if it continues higher, crypto is a notorious area for fraud and theft.
It is not easy to find a regulated alternative as the Financial Services Authority has banned cryptocurrency ETPs and ETFs from sale in the UK with effect from 10 January. This means you will either need to buy the Bitcoin directly or spread bet on the price and accept the even higher risk of trading it on margin.
VanEck has recently submitted an application to the US Securities and Exchange Commission for approval for a Bitcoin ETF in the States, but all previous proposals have been turned down and this one will probably suffer the same fate. The reasons given in the past were that the market was not large or liquid enough to be ready for an exchange-traded product.
I personally think that Bitcoin is in a bubble and wouldn’t touch it with a barge pole, although I am a long-term holder of RICA and can vouch for their ability to provide effective downside protection in a whole manner of challenging market conditions.