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Bitcoin (BTC-USD) is now up over 81% for the year as of my writing this after a spate of high-profile bank failures. March’s chaos sparked intense investor interest in alternatives to the US banking system. Bitcoin’s rally has mirrored a broader explosion in investor risk appetite that has sent Apple (AAPL) up 29% on no news, Tesla (TSLA) up 72%, and meme stocks like Carvana (CVNA), AMC Entertainment (AMC), and GameStop (GME) up anywhere from 30% to 100%. In less than 90 days, investor sentiment has swung from fear to uninhibited greed.
In general, when something surges this much in a short period of time along with other speculative investments, it’s likely to reverse! There are plenty of warning signs that the broader risk-on rally is being driven largely by FOMO. But is there more to the story with Bitcoin than just being caught up in a speculative frenzy among investors? Of the reasons to buy Bitcoin, “because it’s skyrocketing” is probably one to avoid. However, there are some interesting developments under the surface that point towards the fundamental value of Bitcoin increasing. There are some pros and cons to Bitcoin to weigh, and there’s an interesting legal situation that can offer big upside to investors in the popular Grayscale Bitcoin Trust (OTC:GBTC) as well.
Arguments In Favor Of Bitcoin
1. Global Adoption Continues
Inflation in Argentina recently topped 100% annually, Bolivia is beset by a huge dollar shortage and rumors of an impending currency devaluation, and inflation in Turkey is hovering around 50% annually. Moreover, Colombia and Brazil have both elected left-wing governments over the past year, leading many of those with accumulated wealth to head for the exits. Bitcoin is an important check on the ability of governments to redistribute wealth by printing money. The more fear of this there is around the world, the more demand you can expect for Bitcoin at any given time. Overall market data shows steady adoption for Bitcoin, with an all-time record high number of addresses now holding at least one coin. This has allowed Bitcoin to stage an impressive price recovery after being in the dumps in late 2022 during the fallout of several alleged Ponzi-style crypto schemes that failed.
While many of the bets coming in on Bitcoin are related to false rumors of new money printing in the United States, Americans’ worst economic fears have been the day-to-day reality for many third-world countries over the last 150 years. Wherever you are in the world, Bitcoin represents insurance against rampant currency debasement.
Even Argentina has acquiesced to crypto as their political situation has worsened, recently allowing Bitcoin futures to trade in Buenos Aires. The small Central American country of El Salvador has led the charge with Bitcoin adoption by making it legal tender. President Nayib Bukele’s authoritarian style attracted his fair share of controversy along the way. However, under his watch, murders in El Salvador fell by 57% in 2022 and are now at levels comparable to the US. There, Bitcoin makes a nice complement to the US dollar, which is used as the currency in the country.
2. Bitcoin Is Insurance Against Government Default
The market currently believes that the US Federal Reserve will be successful in bringing down inflation. We know this because the 10-year inflation breakeven for TIPS is about 2.3%. If inflation is subsequently higher, then you can buy TIPS and make more than you can make in US Treasuries. If inflation is lower, you’d make more by buying nominal Treasuries. It’s possible for inflation breakevens to be wrong- after all, they didn’t predict the inflation surge of the 2020s so far.
Of course, you can buy TIPS and make more if inflation comes in higher, but Bitcoin offers a hedge against a potentially more severe outcome, that being the Fed throwing in the towel and letting inflation soar to 20% per year or more- effectively defaulting on US government debt and ending the US dollar’s reign as the world’s reserve currency. Rampant vote buying and massive budget deficits are what got countries like Argentina and Turkey in so much trouble, and if the US were to repeatedly make the same mistakes that developing countries have we would eventually get the results they’ve gotten. Such a scenario would be an unmitigated disaster for the US economy and I don’t think it will happen, but if it does, you’d be glad you owned some Bitcoin, as people in the US would dump savings held in dollars en masse for alternatives like crypto. For these reasons, Bitcoin carries some insurance value against huge devaluations in the dollar.
For the record, after studying the situation extensively, I don’t think will be America’s future. Replacing the patchwork system of state and local sales taxes with a 20% VAT (like a national sales tax) would effectively fix government budget deficits, and could be paired with modest tax cuts in income taxes. I firmly believe that the US would rather do this than devolve into economic and political chaos, but you never know! That’s why Bitcoin is so attractive now, and why gold has held its appeal for thousands of years.
Arguments Against Bitcoin
A couple of arguments worth discussing against buying Bitcoin here.
1. Will More Crypto Misdealings Be Exposed?
Of course, the crypto world has had its own share of characters that have taken advantage of the lack of regulation in the space. These don’t have anything to do with Bitcoin, but they’re part of the broader crypto world. Terra (LUNA-USD) co-founder Do Kwon recently was arrested in Montenegro for his role in the $40-billion collapse of the TerraUSD and Luna coins. FTX CEO Sam Bankman-Fried recently got new charges by US prosecutors added for allegedly bribing Chinese government officials, in addition to the charges from the massive FTX implosion. Crypto mogul Changpeng Zhao has moved to Dubai (UAE) amidst mounting investigations in the US and other countries into Binance’s business practices. The UAE notably has no extradition treaty with the US.
Bitcoin’s early adoption was largely among nerdy libertarians, and the project’s success turned thousands of them into young multimillionaires. However, it didn’t take long for criminals, scammers, and money launderers to follow them into the crypto world looking to make quick money or get around the law. The number of investigations still pending and questions about the solvency of large crypto projects is a shoe that is going to drop for BTC at some point.
I’d view it as a buying opportunity because there would be forced sellers, but this isn’t a risk you can totally ignore. I view the odds that all of the “bezzle” has successfully been rooted out of the crypto ecosystem as fairly low. Rate hikes are likely to expose the rest in time. There’s simply no way to know how much crime is still present in crypto, and we’re less than a month removed from two large crypto-focused banks shutting their doors.
2. Bitcoin Pays No Interest
The clearest argument against Bitcoin now is that you don’t earn any interest on your money. Bitcoin does have a negative real yield as the current rate of inflation is 1.8% (this comes from mining). Next year Bitcoin will undergo a halving that will bring the rate of inflation down, but the US dollar is starting to offer some interesting competition. If we assume inflation ticks down to 3% by year-end and the Fed keeps cash rates near 5%, then Bitcoin will have a similar inflation rate but no interest. Many long-term comparisons of fiat currency vs. gold conveniently omit compound interest for fiat currency. However, choosing the wrong fiat currency has ended in disaster, as investors in China and Russia found out in the 20th century.
All things considered, I do consider it a drawback that Bitcoin doesn’t pay interest when money market funds are paying nearly 5%. Throughout the 2010s and until 2021, this drawback didn’t really exist. If you believe in BTC long-term, this does make it easy to be patient though, because you can have your savings in money market funds and dollar-cost average into Bitcoin over time.
3. Bitcoin Has Maniacal Shareholders
This giant rally in risk assets has stemmed in large part from a belief among speculators that the Fed isn’t serious about getting inflation down. But historically, there’s nothing unusual about a 5% cash rate and a 3% inflation rate. To the extent, BTC is tied to all the other speculative assets, its fortunes in the short term are likely to rise and fall with them. Put another way, it’s a risk when you put your money in the same place as hordes of reckless speculators. Sometimes they’re right about the assets they choose, but often they distort prices with their fear, greed, and FOMO. The thing about Bitcoin is that it’s clear that there’s tremendous value in its existing, but also a wide disagreement over what this value is. Bitcoin’s current market cap is a bit under $600 billion, which is about 50% bigger than the value of JPMorgan Chase (JPM), but only about 1/5 of the value of Apple.
What should the value be for a global system for storing, saving, and sending wealth via the internet and outside of the control of central banks? That’s essentially what Bitcoin is. There’s tremendous disagreement about what the proper value is, but I’d say it’s worth quite a bit.
GBTC: A Higher-Upside Way To Buy Bitcoin
As part of this wide disagreement over the true value of crypto, the market tends to be less efficient than the stock market. For example, Bitcoin futures used to trade at a large premium to the underlying coin, while the Grayscale Bitcoin Trust traded at a large premium as well, and now trades at a big discount.
The discount is currently about 35% to the value of the underlying Bitcoin, meaning you can make a 54% return if the underlying value can be realized. To calculate your return, simply take the value of the NAV divided by the price you’re paying. In this case, 1/0.65= 1.54, or a return of $1.54 for every dollar you put in.
So how would this happen?
Grayscale is currently locking horns with the Securities and Exchange Commission over converting their Grayscale Bitcoin Trust into an ETF. This would allow them to create and redeem shares until they’ve equalized the market value of the ETF with the net asset value. The SEC denied Grayscale’s request but has previously approved a Bitcoin futures ETF (BITO). Grayscale appealed the decision to federal court in DC. This has been going on for over a year, but the reporting from the appellate court is that the judges seem to be open to the idea of letting them convert. I think Grayscale will win here.
Grayscale isn’t the most popular these days, and they’ve also come under immense activist pressure over the persistent discount in GBTC.
One way or another, I expect the billions in sequestered value to be unlocked from this fund. There’s a management fee of 2% per year, but that would pay for well over a decade of the current discount. This has been a trade that’s been dead money for quite a while, but something will ultimately unlock this.
Bottom Line
The broader rally in risk assets is speculative and likely overdone. However, the fundamental case for Bitcoin is intriguing compared with other risk assets. Combined with a roughly 54% kicker if GBTC is able to convert GBTC into an ETF, I believe that the risk/reward is good for a small to moderate-sized investment in Bitcoin via GBTC. A ruling in the case is expected sometime in Q3 of this year.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
