Is the Crypto Boom Over?
Dear Rich Lifer,
A year ago, most investors would have been shocked if you told them bitcoin would rocket past the $50,000 mark.
Cryptocurrencies like bitcoin, ethereum and dogecoin reached record heights over the past year at a dizzying pace. The total value of the cryptocurrency market has ballooned to more than $2 trillion, up from $260 billion a year ago.
Now, many investors are facing a looming question: will the craze last?
A lot of factors over the past year have contributed to the crypto boom. You have people stuck at home in front of their computers with extra stimulus money allowing them to become first-time investors and traders.
With businesses shut down and nowhere to spend the extra cash, individual investing has taken off with a large chunk of change funneled into crypto.
Some investors also believe that limitations on stock trading by brokerage firms earlier this year might have contributed to the increase in crypto investing.
Meanwhile, we had high-profile individuals like Elon Musk publicly embracing cryptocurrencies. At the same time, shares of CoinBase Global Inc., the largest U.S. cryptocurrency exchange, began to trade on the stock market.
Today, we will explore all these factors that pushed up the price of digital currencies and present expert opinions on the future of crypto.
Social Media’s Influence
The influence of social media on asset prices can be clearly seen when we take a look at the dogecoin phenomenon.
Dogecoin was created as a joke in 2013 and was named after an internet meme centered around the image of a Shiba Inu dog with bad spelling habits. Now, the cryptocurrency is far from a joke, rising more than 10,000% in 2021.
Dogecoin’s creators, Billy Markus and Jackson Palmer, never intended for the crypto to have legitimate value. And yet, dogecoin’s total market value exploded to over $80 billion at its 2021 peak, up from less than $600 million at the end of last year.
Its current market value is $67 billion, making it worth more than 75% of the companies listed in the S&P 500.
Celebrity hype from Mr. Musk and Snoop Dogg (among others) made the joke currency the trendiest investment opportunity, leading social media users and meme lovers to jump onto the bandwagon.
There was even a #DogeDay hashtag trending on 4/20 where Twitter users attempted to push the price of dogecoin to $1. Now traders think the value of dogecoin will continue to climb due to social media hype alone.
However, this will likely result in increased vulnerability for investors, when the hype dies down and sharp price swings result.
Latest Bitcoin Trends
These risks can also apply to investors of bitcoin, which has no long-term history as either an inflation hedge or a store of value. At the same time, its value is linked to momentum and sentiment.
The biggest draw of bitcoin is the rising prices, but if sentiment turns against it, the price could easily tumble.
Bitcoin supports have pointed to the widening acceptance of the crypto among institutional investors as a main driver of its rally. However, there are some signs that institutional demand has weakened recently.
According to a report from crypto exchange OKEx, the number of large bitcoin transactions, which are usually made by professional money managers, dropped slightly in the first quarter from the fourth quarter.
London-based asset-management firm CoinShares also reports that flows into crypto exchange-traded products have declined from a peak in January.
Pandemic Fuels Trading
Trading volumes have risen significantly during the pandemic as an increasing pool of investors gain access to crypto markets through multiple platforms such as Coinbase and Robinhood.
Another notable trend is that the value of derivatives volume has overtaken spot trading, and investors have put more than $200 billion worth of bets into digital assets.
This growth of crypto derivatives is telling because investors can use such markets to place outsized bets with a small amount of upfront cash. This basically means they are taking on leverage, the practice of borrowing to increase returns, and highly leveraged bets usually accelerate losses when prices decline.
This increase in futures and options trading has mostly taken place on modestly regulated cryptocurrency-derivatives exchanges that allow a higher degree of leverage than a U.S. exchange such as CME Group.
Looking to the Future
One of the biggest struggles for cryptocurrencies has been finding a use beyond serving as a tool for speculators.
Some believe that it must gain traction as a form of payment to become pervasive in daily financial transactions.
You used to be able to buy a Tesla with your bitcoin (not anymore — for now), but you couldn’t walk to the grocery store and buy a gallon of milk or a roll of toilet paper.
Right now, cryptos like bitcoin are limited to high-end purchases and aren’t easy to spend.
And even though many companies have stated their intentions to accept bitcoin as a form of payment, very few have followed through; even Mr. Musk announced Tesla will halt the acceptance of bitcoins for purchasing vehicles.
Another roadblock to widespread usage is the transaction fees built into the network’s code, which change depending on traffic. You can pay a higher fee to move your transaction to the front of the processing queue, and the increase in popularity of bitcoin has only resulted in larger and larger fees.
A final, more recent, worry centers around the environmental impact of “mining” cryptocurrencies. This mining process relies on different computers competing to unlock new coins by solving mathematical puzzles to secure the network.
Increased bitcoin popularity means more computers are being used to mine, resulting in more electricity being used, which could have an outsized environmental impact.
The Cambridge Centre for Alternative Finance estimates that bitcoin mining consumes about 148 terawatt-hours of energy annually — more than the whole country of Sweden.
This was Mr. Musk’s reason for recently halting the use of bitcoin as payment for Tesla vehicles. In a tweet, he stated, “We are concerned about rapidly increasing use of fossil fuels for Bitcoin mining and transactions, especially coal.” He also said he would not reinstate the use of bitcoin until “mining transitions to more sustainable energy.”
Disputers believe the environmental worries are exaggerated, pointing out that the energy bitcoin uses is equal to about 1½ years’ worth of wasted energy in the U.S. just from devices left plugged into outlets.
Even with all the obstacles, for now, it looks like cryptocurrencies are here to stay…
To a Richer Life,
The Rich Life Roadmap Team