Bitcoin Investing: A New Era
by Patrick Oberhaensli, on Feb 2, 2021 1:00:00 PM
Hype around the bitcoin skyrocketed in 2017 with an extremely strong up move, around 1438%. The highest value was reached near the 20’000 USD mark around mid-December of the same year.
After losing about 74% of its value in 2018, we again saw rapid acceleration in value of the bitcoin starting with 90% returns in 2019 and 303% returns 2020.
These significant moves are actually quite common for the bitcoin. Between May 2016 and January 2021, the annualized volatility was 89.30%. But this high level of risk is what (shall) drives the return.
We will explore in this article, what’s to expect when investing in bitcoin, starting with evaluating its value.
Does the bitcoin actually have a value?
Considering the bitcoin has a price – and a history of more than 10 years – you might assume that it has a value: that’s true and false at the same time.
It is true, because the bitcoin has a perceived value meaning that investors– at least a portion of them - trade bitcoin according to the moves they expect. Although, institutional investors have recently started “investing” more and more in the so-called crypto-assets (that bitcoin and beyond): with the hope that its value will go… up.
Their “hope” is supported by the fact that the total issuing of bitcoins is limited to 21million units and about 89% are already on the market (as of January 2021). Although a few institutional investors believe in the potential increase in value, traders should not forget that the bitcoin exhibited a maximum drawdown of 82.7% (between May 2016 and January 2021) and that is way too much for most institutional investors. So, either they don’t invest or they apply very limited allocation despite the fact that the massive drawdown has fully recovered in a matter of months.
On the flip side, we can say that the bitcoin has no related solid collateral, in any form, to support its perceived value. Moreover, there are some highly concentrated positions from which very little or nothing is certain, built from when the bitcoin had a very/extremely low price. If there is a sell-off, it could trigger a very sharp and rapid price drop.
So, now that you’ve heard the two key sides of the bitcoin valuation, have you decided if the bitcoin is an attractive investment for your portfolio? If you said yes, here are some of the easiest ways to invest in the bitcoin – for speculation purposes.
The passive long-only approach
But let’s first have a look at how the bitcoin price developed in the last few particularly relevant years.
For the period starting on the 24th of May 2016 up to the 20th of January 2021, including specific costs, we have following for the Bitcoin passive long-only
The annual return is actually very high: it would be very difficult to find a comparable return for other assets. But that performance needs to be put in relation to the risks. Besides volatility and maximum drawdown, there are also the investment instruments risks to be considered (we explain this further below). Not to mention the fact that the three worst months with losses beyond 30% each, occurred all in 2018 and also (very) close one another. This significant drop certainly affects the trust investors (probably) have in the bitcoin. At the end of the day, considering the performance for this specific period, the Sharpe Ratio of 1.74 is pretty high and gives the investors the impression that they wouldn’t “need to wait long to make good money”.
A passive long-only approach could be considered a potential strategy for long-term investors who are prepared to accept the risk of losing a (very) significant part of the gains and the capital invested, and have the guts (psychologically) to withstand extreme fluctuations.
The instruments for passive long-only investing
One of the key instruments to invest passively long-only is the tracker in the form of a structured product. This can be bought and sold through an account at a bank which also provides a trading platform. In addition to the risk-return characteristics of the bitcoin itself, the investor needs to study beforehand the key features of the structured product in terms of costs and risks. For instance, there could be the credit risk of the issuer of the tracker – credit risk that can be mitigated through the use of a collateralization technique. Moreover, there is an operational risk (that’s how the issuer runs its business activity) that needs to be thoroughly understood. However, investing passively with a structured product through a strongly regulated bank, provides advantages such as stability and security.
If you are investing via a wallet at a crypto dedicated-offering provider/exchange, there are also numerous costs and risks to be clarified in advance. Even though the transparency of the market has improved over the years, there are still risks to consider such as the legal risk from the limited regulation, the credit risk of the wallet provider, and the (potentially high) transaction costs. In summary, if you are analyzing an investment via a wallet, your risk analysis could start with the exchange ownership (who owns it) and its own capital.
The high climax!
One of the most interesting features of the bitcoin over the last few years, is that it has been subject to 2 high-climax: one towards the end of 2017 and now one early 2021. This can be seen by an accelerating up-movement to a new record value directly followed by a very quick down-movement. The interpretation is that the bitcoin is doing a trend-reversal after having reached the top. It was definitely true in the case of the end 2017 climax but will it be the same in 2021? If yes, then it’d be time to lower the exposure – but at the same time the rules to re-enter the market must be clear. The worst situation is going out of a market when it is tumbling and then not be clear about when building up a new position.
The bitcoin can easily be invested applying a passive long-only approach, especially in the familiar context of a bank with a trading platform. But it is essential that the risks and costs are properly analyzed for both the bitcoin and the instrument used to invest (indirectly) in the bitcoin. That being said, if you are up to the challenge, you might be interested in going for a (partly) active strategy…
EVOLIDS FINANCE LLC, Disclaimer:
- This content is not intended to be a solicitation nor an offer
- The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible