Square’s Investment In Cryptocurrencies Acted As A Catalyst For The Surge In Its Stock Price

Summary

• Since the U.S. equities markets crashed in March 2020, most companies and major indices have rebounded to records highs.
• In Q3'20, Square’s revenue jumped 140% compared to the same quarter last year with its Cash App registering a revenue growth of 574% in the same period.
• The price surge of cryptocurrencies in 2020 has definitely reshaped the attitude of retail and institutional investors toward crypto.

Since the U.S. equities markets crashed in March 2020, most companies and major indices have rebounded to records highs. However, the price movement of Square (NYSE:SQ) has been particularly interesting, as it has gone up from $32.33 per share in March 2020, to $246.49 per share on January 4, 2021, representing an astonishing appreciation of 662.42%.

Figure 1: Bitcoin vs. S&P 500 Weekly Price Chart

Why Cryptocurrencies Surged in Q3’20

The COVID-19 pandemic and the subsequent shelter-in-place policies adopted by the government caused widespread closure of main street businesses, resulting in spikes in unemployment claims, and as a consequence, major stock markets crashed in March 2020. To maintain price stability and stimulate the economy, the Federal Reserve pumped trillions of dollars into the economy since then. While traditional commodities used in inflation hedges, such as gold and silver, have gained considerably over the last year, the emergence of cryptocurrencies as an inflation hedge asset among investors was noticeable in 2020.

Moreover, institutional investors started showing tremendous interest in the cryptocurrencies. Cryptocurrencies gained tremendous mainstream approval after famous investors like Paul Tudor Jones and Stanley Druckenmiller publicly endorsed this new asset class and mentioned that they have considered allocating a portion of their portfolios to crypto assets, namely Bitcoin. While crypto asset companies like Grayscale have been around for years prior to the COVID-19 crisis, they gained popularity among retail and institutional investors as mainstream financial media started giving them airtime once again.

Square’s founder and CEO, Jack Dorsey, has been an avid supporter of cryptocurrencies for a long time and owned an undisclosed amount of Bitcoin. In fact, Square decided to accept Bitcoin as a payment method for its Cash App, the company’s mobile payment app, back in 2014. After Square allocated $50 million to buy Bitcoin as an investment in October 2020, its key rival, PayPal (NASDAQ:PYPL) announced it would allow its U.S. account holders to buy, hold, and sell Bitcoin in November 2020. As more people could easily invest in Bitcoin—and they did—its price soared to record highs and topped $40,000 per Bitcoin in January 2021.

What Drove Square’s Stock Price to Skyrocket in 2020

While a lot of technology companies benefited after shelter-in-place directives prompted people to start relying on digital services and entertainment at home, Square’s price surge since March has many other catalysts.

One of the keys to understanding investor interest in Square is the advent of the Bitcoin Lightning Network. While its core technology is complicated for average consumers to understand, the easiest way to describe it would be comparing it with traditional payment companies like credit card service providers.

Bitcoin’s blockchain-based transactions are very slow compared to electronic payments such as using centralized servers that companies like Square, PayPal, and Visa or Mastercard. However, with Lightning and its “layer 2” technology for Bitcoin and other cryptocurrencies is supposed to make payments instant and practically free by making the transactions off-chain.

Jack Dorsey happens to one of the largest promoters of this Lightning Network. Also, Square has a patent to use real-time crypto-to-fiat currency swaps. Meaning, Square would have a huge competitive advantage in cryptocurrency transactions involving fiat currencies like the U.S. dollar or the euro over its competitors.

After Lightning Labs secured Series A funding of $10 million in February 2020, investors started bidding up the stock of Square in anticipation that it would bite into the market share of traditional payment network providers.

In Q3'20, Square’s revenue jumped 140% compared to the same quarter last year with its Cash App registering a revenue growth of 574% in the same period. Even after excluding Bitcoin sales, Cash App’s revenue went up by 174% in Q3’20 compared to Q3’19 and year-over-year, its gross profit was up by 212%, which catapulted Square’s stock price.

Square’s gross payment volume came out in Q3'20 at $31.7 billion compared to $28.28 billion in Q3’19, which represented an increase of 12.4%. By contrast, Square’s key competitor PayPal’s gross payment volume increased from $178.67 billion in Q3’19 to $246.69 billion in Q3'20, representing a 38.07% increase.

Figure 2: Comparison of Surge in Prices of PayPal and Square in Q3’20

While PayPal’s stock price has surged by around 28% since the start of October 2020, Square’s stock price has gone up by over 48%. Despite having a lower rate of increase in gross payment volume, Square’s stock price has performed better than PayPal because of a combination of factors such as the potential of the Lightning protocol and the increasing popularity of cryptocurrencies that Square is in a unique position to leverage in the coming years.

Takeaway

Over the last year, investors have focused on the tech sector as government policies and consumer behavior indicated huge growth potential. At the same time, a lot of people are afraid of missing out. With the gigantic interventions from the major central banks that would likely increase liquidity in the market going forward, we should not shrug off the idea that Square or major cryptocurrencies like Bitcoin have already reached a record high could continue to break its own records.

The price surge of cryptocurrencies in 2020 has definitely reshaped the attitude of retail and institutional investors toward crypto as an emerging asset class, especially as an inflation hedge that would surely compete against commodities in the future.

As the interest in cryptocurrencies has reached institutional investors, it would help tame volatility going forward. Hence, adding exposure to Bitcoin or companies like Square that are likely to benefit from this increasing popularity is logical for retail investors as a strategic move to hedge against tail risks. After all, equities markets in the U.S. are trading with historic P/E ratios and likely are in overbought territory.

However, keep in mind that such exposure to cryptocurrencies is not a free lunch, and there many risks involved, as the volatility has remained pretty high. And the downside risk becomes nonlinear when the price keeps going up.