Is Bitcoin a new asset class for investors?

Cryptocurrency Bitcoin has risen steeply in value since its inception in 2009, with many calling it a bubble, but Daniele Bianchi, Assistant Professor of Finance, argues it is becoming a legitimate asset class.

The rise of Bitcoin this year has been nothing short of staggering. Having entered 2017 at $966 it peaked at $17,000 on Tuesday December 12 and many are predicting it will soon hit $20,000.

The launch of Bitcoin futures on the Chicago Board Options Exchange (CBOE) has the potential to add further momentum and thus increase the appeal of the cryptocurrency to both institutional and retail investors.

Although it has been thought of as a peer-to-peer payment system, it is evident that Bitcoin is gaining more and more legitimacy as an asset class.

As a matter of fact, the introduction of derivatives provides the necessary market structure for institutions to trade on Bitcoins without owning them as in fact futures contracts on Bitcoin are settled in cash. This is likely lead to the creation of ETFs and other more liquid instruments, potentially increasing market activity and aggregate demand by orders of magnitude.

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Although there are legitimate concerns of a systemic risk due to the clearing of transactions, margins and bid-ask spreads are so high that not everyone is ready to jump into the business, therefore somewhat limiting market activity, at least initially.

It is evident that what is driving the price of Bitcoin at the moment is its legitimacy as an investment asset thanks to an accelerating professionalisation of cryptocurrency trading.

This is set to be given another boost on December 17 when Chicago Mercantile Exchange starts its listing of futures contracts on Bitcoin.

Also more confidence for cryptocurrency investors came after the Australian Securities Exchange (ASX) declared that it will replace its current clearing system with blockchain technology.

Is Bitcoin a bubble?

Although many commentators argue that Bitcoin is a pure bubble, the reality is more likely that people investing in Bitcoin are primarily investing in the blockchain as a technology at the forefront of innovation in financial markets.

Increasing legitimacy of cryptocurrencies as investments is also reflected in the growing number of active exchanges. All this is going to generate increasing pressure on the demand side of the cryptocurrency market, that is, prices are likely to increase further in the short to medium-term.

Despite fears about the Bitcoin 'bubble' bursting, the price of the new digital coins is going through the roof. Indeed, the increasing demand pressure from investors and speculators makes the case for an even further increase in Bitcoin prices in the near future.

As the supply of Bitcoins is kept fixed by the underlying protocol, price increases are essentially due to increasing demand, which makes Bitcoin more like an asset class rather than a method of payment. This is something that the public and regulators should realise to fully understand the price dynamics of Bitcoin.

In a sign of accelerating demand pressure, the number of active Bitcoin wallets has grown almost five-fold over five years. Similarly, the number of exchanges has been increasing exponentially since early 2017, partly driven by the explosion of the Initial Coin Offering (ICOs) as a funding strategy to set new marketplaces, and partly driven by increasing margins and profitability due to increasing Bitcoin prices.

Demand pressure is essentially driven by two things. Firstly, the increasing awareness by both the public and investors that cryptocurrencies are here to stay, and secondly, the increasing professionalisation of cryptocurrency trading.

Daniele Bianchi teaches Emperical Finance on the MSc Finance. Follow him on Twitter @WhitesPhD.