Crypto markets have grown, but they still haven’t grown

Bitcoin and the broader cryptocurrency market have seen a resurgence since Trump’s election victory became clear. An industry once on the fringes of finance has attracted interest from institutions, young investors and those who want to disrupt the current financial system.

The recent change in the political environment will likely lead to a change in the regulatory perspective of the sector, and recent financial innovations have made cryptocurrencies more accessible than ever. Additionally, various interest groups associated with the industry put heavy pressure on the Trump campaign and presented his victory as a major win for the ecosystem.

After the election, crypto assets and stocks associated with the sector, such as crypto exchanges, saw significant appreciation. Recent performance, market scale, and the possibility of a change in the regulatory environment necessitate a discussion on whether or not crypto deserves to be considered as an independent asset class in a diversified portfolio wider. In particular, advocates of the asset class have touted its value as “digital gold,” as a potential payments platform, and as a disruptor of the modern financial industry. Skeptics have pointed out its lack of usefulness, high volatility and speculative nature.

Can you use crypto as a payment system

One of the main arguments for cryptocurrencies among investors is that they offer a cleaner and faster way to make payments. But from where we are today, crypto’s volatility undermines its usefulness in any payment ecosystem. The price swings of most major crypto instruments are dramatic: Bitcoin, the largest crypto asset, rose from less than $1,000 in 2017 to $69,000 in 2021, followed by a crash to $30,000 in just a few month. You need an iron stomach to block out the noise that comes with owning an asset like that. Such volatility is almost unprecedented compared to other stable currencies like the dollar or the euro. On the contrary, this volatility is even greater than that observed on the stock or bond markets, which are much more speculative. The ability to use Bitcoin for peer-to-peer transactions is significantly compromised by price fluctuations. Reliability and price stability are essential for a payment network.

Real-world evidence supports this perspective. Crypto is generally not used for transactions in a location where a stable currency is available. According to the Federal Reserve, only 7% of US households held or used cryptocurrencies in 2023, an 8% decline from 2021. This figure encompasses the vast crypto ecosystem with more than 10,000 different cryptocurrencies – no single asset has a significant payment volume. although some assets like Bitcoin have seen dramatic price increases in recent months. Additionally, when crypto is used for payment, it is often not for the type of purchases that an ecosystem wants to be proud of. Crypto assets like Bitcoin are the preferred route for transactions on the dark web, ransomware attacks and illegal gaming sites, although it is estimated that less than 1% of Bitcoin transactions are criminal.

However, even though a significant payment ecosystem has not yet reached maturity, digital currency technology continues to advance. Big players like Visa and Mastercard are excited about blockchain technology and many start-ups and small companies are working to create blockchain systems explicitly aimed at payments.

Is cryptocurrency digital gold?

So if your average Joe isn’t using crypto to transact, then what’s the value?

Many advocates have highlighted the potential of Bitcoin and other crypto assets as a hedge against inflation and normal market volatility. Bitcoin in particular is attracting attention because its total future supply is capped at 21 million coins. This artificial scarcity distinguishes it from fiat currencies, where central banks control the quantity to be printed into circulation. At a time of rising inflation and unprecedented monetary stimulus, Bitcoin evangelists see it as a potential hedge against the devaluation of traditional currencies and are betting on its recognition as a global store of value. One advocate’s view is not that Bitcoin replaces stocks, but rather an insurance contract against the collapse of fiat currency – similar to the argument used to promote gold.

Gold has long served this function for investors: no one uses gold to transact, but many investors still include it in their portfolios, giving it value. Outside of its few industrial applications, gold prospectors use the metal as a hedge against volatility and inflation, although imagining a situation in which we would trade with gold bars is pure fantasy. The argument that Bitcoin is still worth something without being a particularly useful asset may lead it down a similar path to the metal – a speculative asset lacking intrinsic value and entirely dependent on sentiment.

Are crypto ecosystems disruptive or compliant

Crypto has gone mainstream in recent years thanks to a combination of consistent promotion from exchanges, outsized returns, and a few spectacular crashes. The collapse of exchanges like FTX and subsequent efforts to regulate the sector have made crypto seem less like a disruptive new financial wave and more like another part of the broader financial system. Rather than offering new ways to manage the financial system, crypto assets have actually moved closer to traditional finance. Of particular note is the introduction of ETFs to make it easier for investors to access crypto assets like Bitcoin. Institutional offerings such as ETFs facilitate access to a previously esoteric market.

The introduction of regulated hotspots allows retail investors and institutions to start considering crypto as a potential asset class, rather than having to focus solely on the risks associated with a frontier market. The broader financial system has regulations and systems in place to deter and prevent fraud and mismanagement, such as what we saw with FTX, and the financial system is also accustomed to the risks associated with the effect of leverage and counterparty risk, such as what happened with crypto hedge fund Three Arrows. Having ETFs from established financial institutions like Blackrock can allow investors to start looking beyond systemic issues in the ecosystem.

It is also important to note that although the trend towards crypto in developed economies has been towards regulation, it acts as a disruptive technology in less developed economies. In places where currencies are less stable, crypto has become a way for people to move their wealth outside of the traditional financial system and protect themselves against hyperinflation and the instability of local currencies. Peer-to-peer exchanges are much more prevalent outside of the G7 countries, and in many cases this allows crypto to be more widely received.

Invest upstream

Although investing in crypto assets carries many risks, there are other ways to benefit from the growth of the ecosystem while still maintaining some exposure. One area that is being talked about a lot at the moment is miners whose stock prices generally track the price of Bitcoin but provide investors with exposure up front. Companies like Marathon Digital Holdings (MARA) or MicroStrategy (MSTR) are directly involved in the mining sector and own crypto assets. However, while the idea of ​​investing in a miner may be appealing, they are essentially leveraged bets on the crypto assets they hold. Small changes in the price of the asset they are working with have outsized impacts on the stock price.

If we ignore miners and break down the essential inputs needed for crypto more broadly, we get two sectors with significantly stronger tailwinds. Semiconductors and power. These two spaces not only benefit from crypto tailwinds, but are also exposed to the broader acceleration of AI and technology in general. Chip giants like Nvidia (NVDA) and Advanced Micro Devices (AMD) can not only develop chips used for cryptography, but also have huge opportunities in the AI ​​data center market.

Likewise, utilities providing energy to AI miners and hyperscalers will benefit from ever-increasing competition – whether in nuclear with companies like Talen Energy (TLN) and Constellation Energy Corp. (CEG) or in broader renewable energies like NextEra Energy (NEE). The Bitcoin mining community is already receptive to renewable energy with over 50% of its energy consumption powered by renewable sources. Even companies like Tesla (TSLA) are exposed to the renewable space through the sale of their solar panels, batteries, and energy management systems to power data centers or mining operations. crypto that need uninterrupted power.

Final Thoughts

Crypto assets have become more mainstream as they integrate with the rest of the financial system, but we believe they are still not considered an essential asset class. The absence of intrinsic value and exceptional volatility constitute major obstacles. While price increases can be exciting, this volatility can go either way and losses can pile up just as quickly. Despite the significant increase in institutional adoption in 2024, we believe there are other, more reliable ways to participate in the market. We prefer to look at energy consumption or semiconductor suppliers rather than the crypto assets themselves.