This headline caused a stir worldwide and seemingly triggered a new wave of interest in bitcoin. While the dimension of this development is yet to be determined, it appears that Bitcoin has finally attracted the interest of large companies and investors.
Tesla once again underlined its position as a pioneering company and invested $1.5 billion in Bitcoin. This announcement has brought the value of cryptocurrencies to new highs.
Tesla is another major American company after Microstrategy to invest part of its capital in bitcoin. Some of the reasons for this decision stem from the fear of rising inflation and thus the devaluation of the company’s capital. These fears are also combined with the belief that Bitcoin will be considered as digital gold and its price will continue to increase tremendously in the coming years. Measured against the market capitalization of gold, the price of bitcoin could indeed continue to rise and earn investors considerable amounts of profit which would subsequently protect their purchasing power.
Hence, this article will look further into the previously mentioned dynamics and discuss additional factors. A few main questions to consider are: Will or should more companies jump on the bandwagon? Is it possible for any company to include bitcoin on its balance sheet? Besides the benefits, what are the potential risks? — Author: Stephan Raubach
Bitcoin on the balance sheet
Regarding the subject of Bitcoin, it is worth taking a look at one of the most recent news about blockchain technology, which first came into being with the creation of Bitcoin. On March 13, 2021, China set a huge milestone in the field of blockchain. Blockchain, the technology that underpins Bitcoin, was mentioned for the first time ever in China’s national five-year policy plan. This plan lays out China’s goals for the next half-decade and states that blockchain will play a key role in the country’s digital economy. The plan gives a rough idea of the direction in which blockchain technology is heading toward. Blockchain is no longer a technology that is being observed on Gartner’s hype cycle as it becomes implemented more progressively. Blockchain, the “Internet of Value”, is expected to have a similar disruptive potential as the “Internet of Information.” Thus, blockchain’s potential fields of application are manifold, whereas Bitcoin, the first successful cryptocurrency that has been running smoothly for over ten years now, remains the “mother” of blockchain.
China’s announcement then coincides with the subject of this article, which is also based on equally spectacular news. As part of a new corporate policy, Tesla has decided to invest in digital assets in the future (see Figure 1). In total, Tesla has invested almost 8 % of its reserves in bitcoin. Its goal is to position itself more flexibly in cash management through alternative investments in order to achieve higher returns and counteract the expected devaluation of money in the coming years. According to experts, more and more companies are planning to invest in bitcoin now that Tesla and Microstrategy have taken the first step. Tesla’s investment took place during a wave when institutional money was pouring into the leading cryptocurrency and when numerous other companies were adding Bitcoin to their treasury reserves. Not to mention, even some of the largest university endowment funds such as Harvard, Yale, and Brown have invested in bitcoin.
According to analysts, Tesla has made about $1 billion in profit so far on its bitcoin investment. This means that the company has earned more from its bitcoin investments than from its car sales in the entire year of 2020. Although this may be an extreme case, it sheds light on how bitcoin can be considered a high-return treasury, especially at this point in time. That is, despite strong price gains, bitcoin’s price development is only at its beginning To illustrate, the scarcity and rising demand further solidify the view of bitcoin as a digital commodity. Furthermore, due to potentially inflated stock markets, years of rising real estate prices, and of course, low to negative interest rates, bitcoin very well could be considered as an alternative for treasuries with enormous growth potential.
For bitcoin to successfully and sustainably enter the traditional world market, there are still improvements to be made, for instance, the secure storage of bitcoin. One major topic is the management of private keys that are necessary to transact bitcoin, but that can also easily be lost. Furthermore, storing funds on exchanges with counterparty risks also remains problematic. This makes companies such as crypto custodians relevant. However, the cryptocurrency landscape with its numerous providers is not easy to navigate. Additionally, tax and accounting aspects have to be clarified. Thankfully, specialized companies such as 21Treasury can provide assistance with regard to these matters.
Back in its early days, Bitcoin was perceived to be associated with shady practices, and the lack of regulation did the rest to prevent companies from dealing with bitcoin at all. However, the situation is changing. As a matter of fact, Bitcoin cannot be controlled or shut down neither by any government nor by anyone else. With over 10.000 computing nodes, the Bitcoin network continues to run unstoppably and is not controlled by any single party. These features make the network resilient and decentralized. Of course, that doesn’t mean that dealing with Bitcoin can’t be regulated. Currently, more and more countries are formulating regulations that cover digital assets, including bitcoin, thus creating increased legal security. One example is the European Union’s “Market in Crypto Asset” (MiCA) regulation.
Negative interest rates, devaluation of money, and low returns for treasuries: Can bitcoin, as a store of value, be considered a safe haven?
One reason that is often cited for including bitcoin in the balance sheet is the record low-interest rates of the past months and years. It is true that interest rates for long-dated first-class government bonds such as U.S. Treasuries and Bundesanleihen have been rising again for a few weeks. However, these developments are still very tentative, and there is no telling when global interest rates will improve. German debt securities, for example, are still only just approaching the zero line after coming out of the deep negative territory. Thus, for companies, the inflation problem remains present, and in order to protect their purchasing power, they must look for profitable investment alternatives. Bitcoin can be one such alternative. In particular, bitcoin ($1T) is expected to match or exceed the market capitalization of gold ($10T) due to its ease of access, rapid transfer of value, and faster-declining supply. The result would be an incomparable price-performance.
Companies both large and small are expected to increasingly begin to hold cryptocurrencies. This highlights how the next generation of companies will act quite similarly to investors, that is, holding and balancing their treasuries like funds in multiple asset classes. For a company, there can be significant advantages of adding bitcoin to its corporate treasuries. Also, the rationale for allocating bitcoin is comparable to the rationale for adding alternative investments: portfolio diversification and return enhancement. It can be seen that the low-interest environment is further increasing the attractiveness of including Bitcoin.
A recent analysis on the investment giant, Fidelity, showed the quantitative impact of including bitcoin in a portfolio historically. They measured the impact of a 1 %, 2 %, and 3 % allocation to a portfolio with a ratio of 60/40 equities and fixed income portfolio from January 2015 to September 2020, rebalanced quarterly. The results were astonishing. An allocation of bitcoin would have improved risk-adjusted returns by 34 % (Sharp ratio). Annualized returns were 341 basis points higher for the portfolio with the highest allocation to bitcoin (3 %). While the volatility of portfolios with bitcoin was also incremental, the magnitude of the increase in volatility was significantly lower compared with the increase in returns. Surprisingly, the maximum drawdown, the greatest loss of a portfolio from peak to trough over a given period, was slightly lower for all portfolios with bitcoin exposure. The results are summarized in the table in Figure 2 below.
A global trend
Bitcoin can become both a hedge against rising inflation and the currency or digital gold of the future. The previous estimates of analysts from PwC, among others, assumed that hedge funds’ investments in bitcoin would amount to around $1 billion. By the end of 2020 and the beginning of 2021 alone, the total value of institutional investments reached over $26 billion.
For a glimpse into the future, one can look at other companies that are considered highly innovative, and thus the next possible candidates for such a move, i.e., Apple. Is it conceivable that Apple will invest in Bitcoin? While the exact moment in time cannot be predicted, the general answer is yes. Companies could therefore consider including bitcoin as a means of diversification in their balance sheets. If Apple, Microsoft, Facebook, Twitter, and Google were to follow Tesla’s example and each one were to invest around 8% of their reserves in bitcoin, this would mean a further investment of almost $7 billion. While this would still be less than 1% of the current bitcoin market capitalization, the signal it would send to other companies and investors would likely trigger a bull run. The previous speculations that the price could rise to $100,000 or even to $200,000 by late 2021, are also valid. This development would, of course, be reinforced by the natural scarcity of bitcoin. The total amount of bitcoin is limited to 21 million and about 88% of all bitcoins have already been mined. The number of bitcoin issued is being halved every four years and the latest halving event(the 3rd) has occurred in May 2020. Considering that more and more of the scarce bitcoins are being bought by companies and other institutional investors and would then be taken off the market, a further price increase would be a likely consequence. Figure 3 below shows the estimated price development of Bitcoin taking into account the latest halving event.
Unlike the bull market of 2017, the current surge seems to be based less on hype and more on the acceptance of bitcoin in the traditional financial world and the need to hedge against inflation. This acceptance of crypto assets by companies and institutions has been identified as the driving factor in 2021.
In conclusion, bitcoin’s scarcity, its inherent system resilience, the increasing stability of the crypto market, and, of course, bitcoin’s considerable price potential can make it both an attractive investment opportunity and a hedge against inflation. Bitcoin can therefore be highly interesting as a treasury alternative for companies, both now and in the future.
In any case, it is necessary to first familiarize oneself extensively with bitcoin and to develop an appropriate strategy. Specialized companies such as 21Treasury can support and guide interested companies throughout this process.
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21Treasury offers comprehensive services for interested companies and investors to explore bitcoin, other digital assets, and even Blockchain and other Distributed Ledger Technologies (DLT). In times of increasing inflation due to quantitative easing and low or negative interest rates, companies are steadily realizing the need to rethink their treasury strategies in order to prevent their capital from debasing. Bitcoin and other digital assets have seen a massive influx of corporate and institutional capital which has been partly due to their store of value features. Thus, more and more companies are considering following this approach. Subsequently, this raises the need to understand this new digital asset class.
In addition to thorough explanations and advice regarding bitcoin and other digital assets, 21Treasury offers assistance in exploring Bitcoin investment vehicles and regulatory aspects that need to be considered when investing in bitcoin.