Investors globally are always interested in knowing what drives any asset class, eg fixed income, equities or commodities and their correlation to diversify their portfolios.
But lately they are having a hard time figuring out what moves a cryptocurrency and the most important question is the role it can play when it comes to portfolio construction.
Due to the lack of any established fundamentals, the movement of cryptocurrency has largely been based on speculation, news or even a few “seemingly innocent” tweets from Elon Musk.
The main confusion arises when the cryptocurrency is treated like a currency, as the name suggests, which is misleading as unlike conventional currency, the cryptocurrency is not issued by a central bank or backed by a government.
Therefore, the monetary policy, inflation rate and economic growth measurements that typically influence the value of currency do not apply to the cryptocurrency.
Most of the investors believe that it is much like a commodity as its supply is capped by two key factors.
First, the bitcoin protocol allows new bitcoins to be created at a fixed rate and the rate at which new coins are introduced is designed to slow over time.
Secondly, the supply may also be impacted by the number of bitcoins the system allows. This number is capped at 21 million and once this number is reached, mining activities will no longer create new bitcoins.
A major question arises about uses of cryptocurrencies, which are so far mostly linked to only the notorious financial transactions in the dark and deep web linked to the criminal and illegal activities.
The most recent one was the ransomware attack on Colonial Pipelines Company in the US by hackers known as “Dark Side”, who demanded a ransom of $90 million to be paid in bitcoins.
Later, the FBI recovered most of the bitcoins paid in ransom, which challenges one of the biggest claims by bitcoin followers, ie freedom from state control, but reinforces the other claim about transparency and tracking.
However, the main issue with bitcoin lies in the challenge it poses to the status quo and specifically to the role of central banks in controlling any financial and monetary instrument such as FIAT currencies globally.
The major blow to the acceptance of bitcoin came when Federal Reserve Chair Jerome Powell provided stronger arguments for the US central bank to introduce a digital currency that could undercut the need for private alternatives such as cryptocurrencies.
Chinese authorities have also been working since 2014 to introduce digital yuan and to clear the way for its wider spread and adoption, they have barred all the financial institutions and payment companies from providing crypto-related services.
In June, there was a huge crackdown on the people suspected of using cryptocurrencies for illegal transactions.
Although in December last year there was some interest by JP Morgan and Citi, still there is no such widespread acceptance by large institutional investors, which creates a lot of volatility for the cryptocurrencies.
Bitcoin broke the historical level of 30K recently, but recovered on technical grounds.
However, going forward the headwinds from the systematic crackdown from the so-called “status quo” will keep a lid on the performance of cryptocurrencies.
Also, the extreme volatility will discourage long-term investors from using the cryptocurrencies as a store of wealth.
The writer is a financial market enthusiast and is attached to Pakistan’s stocks, commodities and emerging technology
Published in The Express Tribune, July 26th, 2021.
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