Why Advisors Should Keep Clients Out of Bitcoin This Year

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Whatever you do, don’t let your clients near Bitcoin this year. While it appears to have stabilized in the past week, my view is that there is likely no relief in sight for the cryptocurrencies pain. At best, Bitcoin is dead money, at worst, there could be much deeper declines.

The problem is Bitcoin, which has plunged from a 52-week high in October of $62,201 to a recent range of around $20,309, is not merely a bad performer of late. It, and other cryptocurrencies have disproved longstanding presuppositions about their magical financial powers.

The primary broken promise is the notion Bitcoin was a hedge against inflation. Early verbiage by the Bitcoin progenitor Satoshi Nakamoto in 2010 declared the currency would be safe from the unstability [sic] caused by fractional reserve banking and bad policies of central banks, and that the limited inflation of the Bitcoin systems money supply is distributed evenly (by CPU power) throughout the network, not monopolized by the banks.

Those promises prompted interest in Bitcoin as a haven. Almost a decade ago, The Wall Street Journal was reporting a surprising surge in Bitcoin usage in Argentina, for example. Argentinians, beset with chronic inflation, were enchanted by a store of value unhitched from the Argentine Peso. The country became a hub for cryptocurrency activity.

Pity the Argentinian true believers this year. The Peso is down 17% against the US dollar, but Bitcoin has plunged 56% in that time. And despite the US consumers experience of four-decade-high inflation, just holding dollars would have been smarter than buying Bitcoin this year. At least the dollar is up 8% against the Euro since January.

Setting the Bitcoin inflation fail aside, , its abundantly clear that an instrument that suddenly falls 56% is not a hedge against anything. It provides no stability.

Bitcoin has had many increases and many declines over the years. However, the most prominent company in cryptocurrencies, the currency exchange and custodial firm Coinbase (ticker: COIN), has signaled something different may be happening this time.

During a Piper Sandler investment conference on June 8th, Coinbase’s CFO, Alesia Haas, noted that there had been four major declines in the lifetime of Bitcoin since its introduction in 2009. Each of those declines was significant, as much as 80%. In this latest decline, The one key difference that we have not seen before is the broader macro environment, said Haas.

So, this is the first broader macro change since crypto was adopted, and we now have high interest rates, higher inflation, she said. And we do not know exactly how those will impact crypto.

That sounds ominous, and so do remarks by Coinbases CEO, Brian Armstrong, last month. Asked for his perspective based on prior cycles, Armstrong said, I think there will be real kind of blood running in the streets if it continues for four quarters or something like that.

Now, blood in the streets is not a technical term, but if prior cycles saw declines as large as 80%, as was the case in the 2017 to 2018 peak-to-trough cycle of Bitcoin, it is conceivable blood here means worse than 55%.

If the magical inflation-hedging power of Bitcoin and other cryptocurrencies is indeed broken, then advisors would do well to consider the implications.

One implication is that demand will switch from Bitcoin as a store of value to other instruments as a store of value, including commodities, but also stocks.

While Bitcoin is down 56%, there are lots of other securities trading at suddenly lower prices that are truly investments, in the sense that they are backed by real assets, unlike cryptocurrencies, which are backed by nothing.

Some of the best stocks on the planet are on sale at amazing discounts. If you could put a dollar into Nvidia (NVDA), one of the worlds greatest chip makers, which is down 45% this year, and down 53% from its 12-month high, youd likely be a lot better off with that than a dollar of Bitcoin.

That is to say nothing of the increasing yields on fixed-income products. As an instrument with no yield, Bitcoin is suddenly on the wrong side of the risk-off trade. A two-year Treasury note currently yields around 3%.

Even if speculators dont flee Bitcoin for stocks or bonds, its loss of status as an inflation hedge has a potential knock-on effect that could damage the price of the currency.

One of the most interesting characteristics of Bitcoin is the fact that most people keep it in digital wallets rather than transacting with it. Crypto watchers call the phenomenon of keeping Bitcoin in a digital wallet and not spending it hodling, a play on the term holding.

Any number of websites can show you the latest data on hodlers from the global Bitcoin ledger. The data reveals that the vast majority of Bitcoin is not used in transactions, and, in most cases, hasnt been for years. Its just sitting there. The hodler phenomenon is presumably a reflection of the belief Bitcoin would be a store of value as it increases in price.

If that assumption is now broken with the collapse of Bitcoin in the face of inflation, then there could be fewer parties hodling and more looking to sell

Consider that a growing number of establishments now accept payment in Bitcoin and other cryptocurrencies. The gym chain Equinox, for example, last month told New Yorkers they can pay the $4,044 annual membership fee up-front in Bitcoin and Ether.

What happens as entities such as Equinox receive payment in an instrument that is falling in price? Maybe they’ll keep it, hoping its price will go back up. But its also possible those institutions will sell Bitcoin in order to limit their downside.

Why does that matter? Some academic research has hypothesized that the price of Bitcoin goes down when there are more Bitcoins in circulation. If fewer Bitcoins are kept by parties such as Equinox, increasing the number in circulation, it could have an overall downward pressure on Bitcoins price.

Another factor that may weigh on Bitcoin demand is the loss of the presumption of anonymity. An early promise, along with inflation hedging, was that use of Bitcoin would be anonymous. Yet a research study released two weeks ago by scholars at Baylor College of Medicine in Texas and Rice University, and widely reported in The New York Times and elsewhere, blows apart the presumed anonymity of the Bitcoin blockchain.

The authors write in the report that because there are at most six degrees of separation between any two bitcoin transactions, and usually, four or fewer, it is possible using detective work to de-anonymize any nearly target bitcoin address by tracing at most 6 transactions .

The implications are large for cryptocurrencies in general, which have appealed to criminals because they apparently had no paper trail. The study estimates that 46% of Bitcoin transactions have been linked to illegal activity. If, as the authors suggest, transactions can ultimately be traced, there is every reason to believe that some of that activity will diminish.

To be sure, there will remain many true believers in Bitcoin among the hodlers despite this latest collapse. Bitcoins price of just under $21,000 brings the instrument back to a level last seen in December of 2020. With so many Bitcoins that are sitting in wallets having vintages prior to that time, it is possible that hodlers who are not underwater will look at the drop as a buying opportunity.

But as Coinbases CFO Haas points out, this is the first time Bitcoin has faced a risk-off environment. It was born at the end of the last recession. It is a bubble child, in a sense, a product of a particular 13-year-stretch of risk-on sentiment. Ultimately, it may not have been much more than a product of its time, and as such, destined to be irrelevant and unloved by investors for years to come.

Tiernan Ray is a New York-based tech writer and editor of The Technology Letter, a free daily newsletter that features interviews with tech company CEOs and CFOs as well as tech stock news and analysis.

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