“Bitcoin is dead,” proclaimed a well-known cryptocurrency investor at the end of 2018. Erik Finman, 18, had become a BTC millionaire that year. But as Bitcoin (CCC:BTC-USD) Prices fell 75%, even he couldn’t get rid of the feeling that the history of cryptocurrency was over.
The mood couldn’t be more different today. Since the crash of 2018, Bitcoin prices have steadily increased by 1,600%. This week it hit an all-time high of $ 63,729.50, leading investors to invest millions more in crypto funds. (Fortunately, Mr. Finman appears to have stuck with his original investment).
At the heart of Bitcoin’s success was Coinbase (NASDAQ:COIN) and other crypto exchanges. These intermediaries essentially eliminate the high cost of processing Bitcoin by matching orders from the blockchain. They also allow people with no programming experience to open wallets and buy money from others.
The importance of the exchange is difficult to exaggerate. When Coinbase got listed earlier this week, the Financial Times described it as a growing up moment for cryptocurrency. (The New York Times went a step further and called it a “coming-out party” despite the relative asexuality of the cryptocurrency.)
However, the upside hides a growing problem: the same factors that contributed to Bitcoin’s success are now doing so for its competitors. Although the world’s largest crypto could still soar to $ 130,000, Coinbase’s listing means the case for smaller altcoins is growing even faster.
Bitcoin prices at $ 130,000? It is possible…
Cryptocurrencies have long puzzled traditional Wall Street analysts. Bitcoin does not generate revenue, nor is it practical as a medium of exchange. The average blockchain confirmation time can be anywhere from 80 minutes to almost two days.
But Bitcoin is successful for one reason alone: people want to share in its profits.
“Bitcoins are mainly used as a speculative investment,” wrote researchers in the Journal of International Financial Markets, Institutions and Money. “And not as an alternative currency and medium of exchange.”
This crux of the truth has driven crypto exchanges like Coinbase to multi-billion dollar valuations. Today, COIN stock is worth more than the latest private market values from TD Ameritrade, E-Trade, and Robinhood combined. With first quarter sales of $ 1.8 billion and a profit margin of 40 to 45 percent, the company is one of the fastest growing and most profitable companies in America by percentage.
Bitcoin has also benefited from Coinbase’s success. With the increasing security of key exchanges, top-class crypto thefts have become increasingly rare. Today, regular investors have brought the coin to an astonishing market capitalization of $ 1.1 trillion – slightly dwarfing the Japanese yen as the world’s third largest currency. JP Morgan now has a BTC price target of $ 130,000, a 100% uptrend from today’s levels.
… But lessons from Coinbase say caution
However, venture capital investors will immediately feel a problem. Bitcoin rises to $ 130,000, similar to how Coinbase hits a market cap of $ 150 billion. It is possible, but it becomes increasingly difficult to achieve as the addressable market becomes saturated.
To meet JP Morgan’s expectations, Bitcoin would have to outperform the US dollar. At Ark Invest’s $ 470,000 price tag, Bitcoin is worth more than all of the gold ever mined.
Occasionally, prices rise above their potential market value. During the height of Japanese real estate in the early 1990s, Japanese banks began lending to businesses based on the real estate holdings of borrowers, rather than the strength of their underlying business. In the highest mania, the value of Tokyo’s Imperial Palace was worth more in theory than the state of California.
But those bubbles usually burst in phenomenal fireworks and “I told you” wag their tongue. In a world of economic substitution, competitors will always be a challenge for slow moving established companies.
The competition for Bitcoin is intensifying
Coinbase highlights these issues perfectly. The exchange began offering only Bitcoin almost a decade ago, making up for the coin’s technological shortcomings with a user-friendly interface and efficient trading mechanisms. Users no longer had to code their wallets or struggle to find sellers on the dark web. Even Bitcoin’s high fees (which can hit $ 23 per transaction today) have been reduced to pennies thanks to the contract award.
However, Coinbase’s support cuts both ways. In 2016, the exchange added support for Ethereum (CCC:ETH-USD), a competing coin that now dominates NFTs. By the end of the decade, Coinbase would add 50 more altcoins to its list of tradable assets.
Today, investors have a bewildering range of cryptocurrency investments. Small coins like TRON (CCC:TRX-USD) and EOS (CCC:EOS-USD) are now seeing daily volumes rivaling Bitcoin’s numbers for 2019. Meme like coins Dogecoin (CCC::DOGE-USD)Not yet tradable on Coinbase now have so much support on competing exchanges that investors have managed to make it the fifth largest coin in the world this week.
In other words, the exact mechanisms that fixed Bitcoin’s technological flaws are now doing the same for the competition.
A fig leaf of security
Institutional investors did not receive the memo. With each rise in the price of Bitcoin, much of Wall Street has remained optimistic about further profits. Investment bank Morgan Stanley is now offering BTC funds to its wealth management clients, while prominent investors have been asking for even higher prices.
However, it is easy to confuse “large” with “low risk”. Bitcoin still theoretically has an intrinsic value of zero, so a decrease in short-term volatility means nothing about the underlying systemic risks.
Meanwhile, newer coins like Cardano (CCC:ADA-USD) and Speckle (CCC:DOT1-USD) now offer energy-efficient “Proof-of-Stake” protocols (PoS) that can reduce energy consumption by more than 99%. And thanks to the help with exchanging cryptocurrencies, smaller companies like Dogecoin are becoming viable alternatives. Bitcoin may survive a crypto crash better than its peers, but its lower uptrend devours its once-one-sided upside bet.
How high can Bitcoin go? A lesson from the market
In 1910, Standard Oil was America’s Most Valuable Company. Adjusted for inflation, it would have been worth $ 1 trillion today. However, the company spin-offs – a collection of Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and others – no longer dominate Wall Street like John Rockefeller’s company once did.
Many historians could describe the oil giant’s breakup in 1911 as a turning point. The resulting 34 companies were intentionally designed for competition. In truth, however, investors know that Standard Oil’s rapid rise laid the foundation for its decline decades later.
Its dissolution had grown the energy giant so large that it would be worth $ 500 trillion today if it had kept pace with annual US stock market returns of 10%. That’s five times more than all US stocks and real estate combined. Such an assessment is not possible. No asset can grow larger than the market it serves.
Bitcoin falls in the same bucket today. It’s the dominant player by size – over half of all cryptocurrencies are still Bitcoin. As altcoins continue to grow on Coinbase and other crypto exchanges, it is becoming increasingly difficult for Bitcoin to maintain its breakneck growth.
So if you’re looking to buy cryptocurrency next, keep in mind that it is altcoins – not bitcoin – that can offer investors 10, 20, or 50 times the return. Maybe Bitcoin Erik Finman was right that Bitcoin was dead – he was just a little early.
At the time of this writing, Tom Yeung held positions (neither directly nor indirectly) in the securities identified in this article.
Tom Yeung, CFA, is a Registered Investment Advisor committed to making the world of investing easier.