There was no stopping this week. The Bitcoin price soared to the USD 16,000 mark, strengthening the crypto currency's title of "Best performing Asset 2020". How can the sharp rise in price be explained, and what does the future hold?
Thanks to this week's price rally, Bitcoin is once again making it onto the front pages of traditional media. In fact, with an annual performance of 108%, the crypto currency left all asset classes behind. Even the annual winners such as gold (+27%), silver (+39%) and the Nasdaq Index (+38%) were unable to keep up.
Even when adjusted for risk, no asset class in 2020 comes close to the no. 1 crypto currency. However, the eleven-year path from a few cents to five-digit dollar amounts currently paid for a Bitcoin has been anything but linear. It has been characterized by considerable price fluctuations. It is important to not only consider price developments, but above all, the factors which created the foundation for the Bitcoin price to reach new yearly highs.
Tears in March
With Bitcoin reaching current highs (last seen over 1000 days ago), we must remember the world-wide market collapse amidst the Corona shock in March this year. Even the largest crypto currency by market capitalization got caught in the downward spiral and within a short time, lost 60% of its value. Bitcoin could not escape the "risk off" wave, and fears were expressed that the crypto currency was only a speculative object, correlated to the stock market. Although a close correlation to the S&P 500 Index was indeed established in the following months, historically, there is still a low correlation. And this is exactly where one should start. Bitcoin is unique - for various reasons.
Young digital currency programmed for scarcity
The still young digital currency is currently perceived more as a store of value than as a digital means of payment. The underlying protocol based on blockchain and cryptography guarantees a disintermediate value transfer via the Internet. Bitcoin is the currency of this decentralized payment network and, like other crypto currencies, is traded around the clock on various exchanges. In addition to the hard-coded upper limit for the maximum supply, the creation of new Bitcoins and thus the inflation rate is clearly programmed.
Bitcoin was designed as a hard currency and possesses unique attributes that could not be covered by any asset until now. The digital currency was designed as a new monetary good, which shares similarities with precious metals like gold and silver. What makes it special is that inflation is decreasing over time. With this precondition, a price increase can be expected if demand remains constant over time. Designed in response to the monetary interventions of the central banks that flared up during the 2008 financial crisis, the characteristics of Bitcoin considered at that time could not be more appropriate in today's world.
Important steps over time - especially in 2020
Since its inception, Bitcoin has developed strongly.. Over the years, Bitcoin has increasingly been able to shake off the shabby image of the "Silkroad currency". This has been achieved through a consistent expansion of reputation and use cases in broader and more legitimate applications. The decentralized payment network has recorded strong organic growth since its inception.This can be seen in values such as the number of wallets, average transaction sizes or the hash rate. The key figures referred and mentioned are all at an all-time high. An increasing recognition of Bitcoin as a store of value and means of payment is clearly visible.
Regulation was one of the main reasons why digital assets were able to penetrate the traditional financial world. The digital currency is now recognized as an official digital asset in a number of countries and regulated accordingly. An important prerequisite for greater adaptation. In 2019 and 2020, banks in major jurisdictions such as the USA and Germany were granted the legal right to acquire and store the cryptocurrencies for their customers. The digital currency is also being integrated more and more into existing traditional financial services as a means of payment. The digital currency is being integrated more and more into existing traditional financial services as a means of payment. Moreover, the young asset class is noticeably finding its way into the large world of institutions. Comparing the current market capitalization of a good USD 280 billion with other asset classes, it is still negligible.
Price development - Bitcoin's volatility
Bitcoin has great fundamentals. Current events on the world markets and the corresponding measures taken by central banks continue to qualify assets with limited supply as attractive investments. Bitcoin could pass its test this year. In the turbulent 2020 its price reached new highs, in fact without any market intervention by the central banks.
Bitcoin's price volatility remains high. Trading the digital currency requires great discipline and strong nerves. The fundamentals argue for a continued medium-term appreciation potential, with a real chance of exceeding the all-time high of USD 20,000 as early as 2021. The risk/return structure allows an investor with a small proportion of total assets to achieve potentially substantial capital appreciation over the years. Due to these characteristics, Bitcoin, properly risk-weighted, is also an ideal addition to a diversified portfolio.
The Bitcoin price has already experienced an unseen increase in value over its short lifetime. The chances of a continuation stand quite well. The risk of price setbacks may not be forgotten however. Even in the past bull markets investors had to accept interim corrections of 60% or more. This is often too much for traders and nervous investors. An alternative to a one-time investment is the "dollar cost averaging" strategy. With this strategy, an average price is achieved over time with smaller investments, and one is not at the mercy of a single price constellation. As in every investment decision, the ability to absorb a loss should be the main focus.