January 2021 – Bitcoin: When Fundamentals Overwhelm Technicals

Cryptocurrency Bitcoin enjoyed a tremendous rally in 2020, appreciating from about $7,000 to nearly $29,000, or roughly 315%. The Internet is littered with well-documented debates on the viability of Bitcoin and the sustainability of the rally itself. What do we believe is the most overlooked factor? The fundamentals of the trade itself.

 

Fundamentals, in Bitcoin? Really?

The traditional methods of valuation are impossible to apply Bitcoin. Obviously Bitcoin is not a company or a productive asset that produces cash flow. In terms of a store of value, we can somewhat easily subscribe a replacement cost, or marginal production cost to Gold, but Bitcoin “mining” is not exactly a replacement cost – especially when you consider there are a finite amount of Bitcoins and no more will be created after 21 million. What then, is the most important factor driving the price of Bitcoin higher month after month? The fundamentals of supply and demand.

 

Passive Investing and Bitcoin Driven by the Same Factors

Buyers of stocks and Bitcoin face the same obstacle – they must find newly issued supply such as new shares or newly created Bitcoin. If there are more buyers than new supply, buyers must then convince one of the existing holders to sell their supply. How do you convince a reluctant seller to part with their supply? By raising the price.

 

Fundamentals Overwhelming the Technicals

The above image from @Coin98Analytics sums up the main driver of the Bitcoin rally: buyers are demanding significantly more Bitcoin than is currently being created. When this dynamic persists, no technicals like 200-day moving average breaks of Fibonacci lines will stop it. Think this is ridiculous or too simple? There are similar imbalances at play with passive investing in the S&P 500 as well. Flows are a fundamental factor, and they will overwhelm everything, from technicals to valuations to common sense, until they change.

Sometimes there are good reasons for a deluge of flows into an asset class, and I believe Bitcoin is deserving of those flows. The Federal Reserve has locked interest rates at near zero levels, punishing savers and value-conscious investors alike. Additionally, as the US government deficit-spends, new supplies of US Treasuries must be issued, and in order to keep these sales from overwhelming demand, the Federal Reserve is creating dollars to buy US debt. The Fed’s balance sheet increased from $4.1 trillion to $7.1 trillion in 2020, or 73%. Investors are watching the balance sheet, knowing if Congress declares it legal tender, inflation would explode higher. As government and corporate debt continue to push through record highs, in every subsequent crisis the temptation to use the Fed to bail out everyone increases. Stores of value like gold and Bitcoin make sense in a world of high debt and low fiscal discipline.