Bitcoin (BTC-USD) is trading under $60k, selling off since hitting an all-time high of $69k last week. There's not much in terms of headlines to explain the current weakness although it comes in the context of what has been a monster rally with BTC still up around 100% this year and a similar performance just from the lows in July. Some profit-taking was likely overdue against technically overbought conditions and our message here is that a healthy consolidation of recent gains can ultimately set up the next leg higher.
In many ways, we are hoping there is some more downside for the opportunity to buy and add to positions a bit lower. On that point, we expect upside through 2022 as the outlook for Bitcoin and the broader crypto sector remains positive supported by several fundamental tailwinds.
Like clockwork, on any sign of volatility, the bears come out of the woodwork to proclaim "the top is in" or that this is the start of the "crypto winter" which appears to be the buzzword du jour dominating headlines evident through a quick internet search. It's understood that cryptocurrencies are highly volatile, and the latest move is otherwise completely normal for the asset class.
Getting straight to the point, we believe that the medium-term momentum remains bullish as long as Bitcoin continues to trade above $50k as the next level of major technical support and a key physiological level. From the chart above, Bitcoin has made several key pivots around $50k going back to February of this year. We expect the bulls to put up a strong fight and hold that line if it gets down there, which could be a good spot to add to positions.
By this measure, we have a tactical "hold" rating here at the current price with the assumption that Bitcoin will remain choppy filling out the uptrend from recent months. On the other hand, a break below $50k would signal a deeper correction opening the door for a retest of the July lows to $30k which we view as unlikely and requiring some sort of unforeseen major regulatory setback.
There is a case to be made that some of the current macro trends also represent a headwind right now and has added to the volatility. The U.S. Dollar has gained strength into surging interest rates with the market beginning to price in a Fed rate hike. Bitcoin as a global asset is traded around the world priced against various other currencies. For a given nominal amount of any other foreign currency like the Euro, British Pound, Australian Dollar, or even Mexican Peso, a strong stronger USD makes the cryptocurrency relatively more expensive for those local investors.
Similarly, higher interest rates across the yield curve make risk assets relatively less attractive against higher risk-free returns in new bond positions. These are some of the day-to-day technicalities that drive trading across all financial markets.
At a high level, the impact of a weaker Euro by a few percent against the Dollar or a 50 basis-point increase in the 10-year Treasury rate, for example, is only marginal to the price of Bitcoin but ends up impacting sentiment overall. For context, the U.S. Dollar Index has climbed an impressive 7% since the lows of the year and we see some more upside in the near term. As it relates to cryptocurrencies, the long-term outlook is based more on the view that the supply of all fiat currencies is expanding while Bitcoin is limited to 21 million coins against the 18.9 million coins that have already been mined. More paper money chasing Bitcoin is a key part of the underlying long-term bullish thesis for the asset class.
In terms of fundamentals, there have been plenty of positive developments this year which have added to the outlook for Bitcoin. Just this month there was a major "taproot update" implemented on the network protocol which effectively increased the number of transactions that could fit into a Bitcoin block. This is a game-changer for Bitcoin because it facilitates the ecosystem of smart contracts on the network, narrowing the gap of the functionality that has been extremely popular on Ethereum (ETH-USD) this year.
Everything from decentralized finance "defi" to non-fungible-tokens (NFTs) and other applications can now more easily work through Bitcoin instead of the many other alternative cryptocurrencies that have had a lead in this space. We don't believe this recent selloff is related to anything other than a coincidence in timing.
Maybe the most encouraging signal in 2021 was a direct statement from SEC Chairman Gary Gensler suggesting the "U.S. will not ban cryptocurrencies." This follows several steps from the Office of the Comptroller of the Currency (OCC) issuing favorable guidelines permitting regulated financial institutions to provide custody services and facilitate payments for cryptocurrencies. Indeed, the department within the U.S. Treasury just announced a new framework describing the legality of cryptocurrencies within the banking sector.
This is in contrast to efforts in countries like China and India that have taken steps to limit the proliferation of digital assets. On this point, it's encouraging to see that even with China effectively shutting the door on crypto, the market has been resilient.
In October, a big win for Bitcoin was the approval by the SEC of the first exchange-traded fund which tracks the performance of listed Bitcoin futures contracts with the ProShares Bitcoin Strategy ETF (BITO) along with the Valkyrie Bitcoin Strategy ETF (BTF). While the SEC has pushed back on products that invest directly in the spot Bitcoin market citing ongoing market regulation concerns, the growth of listed products including ETFs that track "crypto stocks" adds to capital being funneled into the industry as a bullish demand driver. These include The Bitwise Crypto Industry Innovators ETF (BITQ), the Global X Blockchain ETF (BKCH), and VanEck Vectors Digital Transformation ETF (DAPP) which all launched this year.
This group of funds tracks a growing segment of companies that are well-positioned to benefit from the growth of the crypto market and higher prices between Bitcoin mining stocks, financial services players, and broader blockchain tech names. Overall, there is a sense of continued growth in the broader crypto and blockchain ecosystem which can be positive for cryptocurrencies' prices.
Another theme this year has been a push by companies mining Bitcoin towards sustainability recognizing the strain on power generation infrastructure required to power the data centers. This goes back to a tweet from Tesla Inc. (TSLA) CEO back in May announcing the company would no longer accept Bitcoin as payment citing the environmental concerns. At the time, the repercussion from the position was seen as a catalyst that sent the price of Bitcoin sharply lower.
Fast forward and nearly every Bitcoin mining company like Marathon Digital Holdings Inc. (MARA), Riot Blockchain Inc. (RIOT), Bitfarms Ltd. (BITF), Hut 8 Mining Corp. (HUT) among others are all making (ESG) a major theme in their messaging to investors. Between investments in clean energy generation facilities or commitment to carbon neutrality through credits, it's been encouraging to see the industry's response to one of the main criticisms towards the technology. Riot Blockchain highlights how bitcoin mining operation can ease grid congestion with intermittent demand that further supports the growth of renewable solar and wind projects.
(Source: Riot Blockchain)
Furthermore, to highlight the maturity of the industry, crypto stocks including Bitcoin miners have emerged as major corporations compared to some of their profiles as penny stocks just a few years ago. Coinbase Global Inc. (COIN), one of the world's exchanges, launched its IPO this year with impressive financial trends. The company is expected to generate over $7 billion in revenues over the next year. Similarly, the largest bitcoin miner by market cap is Marathon Digital valued at over $5.5 billion market cap and is expected to approach $750 million in revenue next year according to consensus estimates. We are bullish on this group which is well-positioned to benefit from higher crypto prices and can likely outperform to the upside.
There is a growing recognition that Bitcoin and cryptocurrencies are here to stay. Beyond its utility as a payments method, the acceptance by major financial institutions that cryptocurrencies represent a legitimate alternative asset class has been one of the main drivers of the capital flows into the segment, and in our view the single most bullish driver supporting higher prices into 2022. According to research from Ark Investment Management, institutions worldwide systematically allocating just 1% of capital towards Bitcoin could incrementally add $100,000 to the price.
(Source: ARK Invest)
The group's research also finds that based on their simulated portfolio optimization model, a 6.55% allocation to Bitcoin would maximize the risk-adjusted portfolio returns potential in terms of the Sharpe Ratio. While this scenario may be years away, institutions allocating towards Bitcoin at this level could incrementally increase the price of Bitcoin by $500,000. There are indications that U.S. pensions funds are just beginning to give Bitcoin a serious consideration including reports of the first U.S. fund in the Houston Firefighters' Relief and Retirement Fund making a $25 million investment.
Looking ahead, we expect these trends to continue including steps from insurance companies and sovereign wealth funds which add to the underlying demand. Moves by companies like MicroStrategy (MSTR), Square Inc. (SQ), and even Tesla Inc. buying bitcoin as a balance sheet cash alternative could become commonplace over the next decade.
To conclude, crypto bulls should welcome the near-term volatility as offering an opportunity to accumulate larger positions and average in at a lower cost basis. Our conviction is that the price of Bitcoin will continue to climb over the long-run supported by several tailwinds. It won't be a straight line higher but all the pieces are in place for the crypto sector to continue growing. The first step for the broader crypto segment to regain momentum would be a rally in BTC back above $60k which would set up a retest of the all-time high. We also believe that once BTC approaches $75k to the upside in 2022, $100k would represent the next target for the market as an important milestone.
We've used the term Bitcoin and Crypto interchangeably in this article based on our view that BTC is and will continue leading the sector as the "gold standard" of cryptocurrencies. That said, we are also bullish on Ethereum which benefits from some technical advantages making it a competitive alternative benefiting from several of the same fundamental tailwinds as Bitcoin. This year, several smaller tokens have made headlines with spectacular gains in everything from Cardano (ADA-USD), Solana (SOL-USD), Dogecoin (DOGE-USD), and Shiba Inu (SHIB-USD).
Our take is that while some of these have interesting applications, we don't see them overtaking Bitcoin in terms of its appeal to institutional investors. In our view, there's enough risk and potential upside in Bitcoin as-is.
Speaking of risk, it goes without saying that the weakness in BTC could accelerate sending crypto prices even lower. The best strategy to position for this uncertainty is to keep position sizes small and trade in the context of a diversified portfolio beyond crypto. The biggest risk we see that could undermine the long-term outlook for Bitcoin would be some type of catastrophic security breach of the blockchain protocol undermining the confidence of the technology. Any steps by regulators reversing the trend of easing restrictions on the legality of crypto would also force a reassessment of the long-term outlook.
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Disclosure: I/we have a beneficial long position in the shares of BTC-USD, MARA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.