Interactive Investor

Will bitcoin and cryptocurrencies really be worth zero?

9th February 2018 14:40

Gary McFarlane from interactive investor

Equities markets have been crashing but crypto has been pretty stable in recent days, despite the talk of increasing correlation between the two.

Bitcoin is trading at $8,328, according to cryptocompare.com an, notably, Bitcoin Cash has been pumping higher, up 30% yesterday and another 17% today.

Nevertheless, there has been no decisive breakout for the crypto assets that would suggest  the market will reclaim $10,000 imminently. However, the calmer waters when all around is tumultuous is probably a positive sign for crypto.

Reports from Morgan Stanley and others point to the rise of correlation between crypto and equities this year, but, necessarily, that is a backward-looking view and does take account of the most recent market moves.

Data from DataTrek Research shows that the correlation between the daily percentage return on a 90-day basis of the S&P 500 and bitcoin is 0.33, according to founder Nick Kolas. That means that for 33% of the time the S&P and bitcoin move in the same direction. That compares to an average over the long run that is 1%. Other data shows a historical correlation of half that, at 0.5%.

However, looking at the price change from Monday to now (Friday lunchtime, London time) and the S&P is down 7% and bitcoin is 2% higher. That is a negative correlation. If we look at the figures from Sifr Data in its 90-day Cryptocurrency Correlation Matrix, the reading for correlation with the S&P 500 is 0.13. As we would expect the correlation falls to 0.11 on a 180-day view with the 365-day coming in at a lowly 0.08.

We can conclude from that those figures that correlation with equities has been increasing of late but that could be a blip.

The thesis advanced by Morgan Stanley analyst James E. Faucette this week draws another conclusion from the correlation data - that bitcoin is a leading indicator, as its fall preceded the correction in the equity markets.

In a research note published on Wednesday, he said: "The idea is that as institutional investors seek out increasingly higher level of risk/return, that bitcoin may represent the most risk/potentially highest return available, and hence could be evolving quickly into a primary barometer."

Faucette added that "our conversations with investors give weight to that view".

The Morgan Stanley analyst concludes, "the correlation with the broad equity market has not been fully established".

Judging by the view of Goldman Sachs, which thinks most crypto assets will eventually go to a zero valuation, equity investors will be hoping that there is no positive correlation with crypto, because if they did move in the same direction equities would fall to zero, which is obviously preposterous.

The investment bank's head of global investment research Steve Strongin wrote in a note to clients on Monday that "the currencies that survive will most likely trade to zero" on the basis that the market is similar to the dotcom bubbles of the late 1990s.

He continued: "If you believe this is a 'few-winners take-most' situation, then the potential for retirement depreciation should be taken into account. And because of the lack of intrinsic value, the currencies that don't survive will most likely trade to zero."

Strongin sees it as a sign of the irrationality of the crypto market that all crypto assets tend to move in the same direction, with no account taken of differentiated values, and he finds that worrying because "new currencies don't seem to reduce the value of old currencies. Or put that another way, there is little discrimination in the buying pattern of market participants.

He concludes that most altcoins "will never see their peaks again".

Giant fund manager Vanguard's chief economist is a of a similar view. In a blog post entitled "Bitcoin: Digital gold or fool's gold", Joe Davis thinks the currency use case prospects for bitcoin and other coins focused on becoming new means of payment "seem dubious". Davis says, for bitcoin "I see a decent probability that its price goes to zero".

"With no cash flows and extreme volatility, the investment case for Bitcoin is hardly compelling," he concludes.

Davis goes on to distinguish between crypto in general and blockchain technology, seeing the later "adopted by governments and enterprises for specific purposes".

Those views contract starkly with that of the Winklvoss twins which are among the largest investors in bitcoin. In an interview with CNBC, they implied that the analysts at the investment banks are getting is all wrong. "Cryptocurrencies aren't really important for human-to-human transactions... but when machines-to-machines trade economic value, they are going to plug into protocols like bitcoin and Ethereum," Tyler Winklevoss explained.

And his brother Cameron repeated the Gold 2.0 valuation line. "We believe bitcoin disrupts gold. We think it's a better gold if you look at the properties of money. And what makes gold gold? Scarcity."

The views of bulls and bears couldn't be much more polarised. The bullish twins, for example, argued that bitcoin could be trading at around 40 times today's value in 10 to 20 years.

Another bull, Jamie Burke of Outlier Ventures, a blockchain incubator investment form, thinks bitcoin will enter a bull market this year that will be more dramatic than 2017's. "We believe after February the market will likely go on a bull run comparative if not greater than last year potentially reaching the trillion-dollar mark before a proper crypto winter sets in where the market becomes more focused on proper market fundamentals."

Gatecoin's Thomas Gluckman is targeting a price of $50,000 by December, on the assumption that bitcoin makes progress on the scaling issue with the Lightning Network solution gaining traction.

Helping to stabilise the crypto market were favourable commentary emerging from the Congressional hearings on cryptocurrency, with the regulators focused on driving out bad actors and protecting investors rather than banning the asset class.

Jay Clayton, the chairman of the Securities and Exchange Commission, said: "I think our Main Street investors look at these virtual currency platforms and assume they are regulated in the same way that a stock is regulated and, as I said, it's far from that and I think we should address that."

And Christopher Giancarlo of Commodity Futures Trading Commission argued for the intrinsic value of bitcoin and was positive about the futures market, commenting "…With bitcoin futures we're now having visibility into underlying markets and spot markets that we would not otherwise have."

Clayton in remarks concerning initial coin offerings said "I believe every ICO I've seen is a security" and went on to warns ICO promoters in uncompromising language. "Those who engage in semantic gymnastics or elaborate re-structuring exercises in an effort to avoid having a coin be a security are squarely in the crosshairs of our enforcement provision."

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