As a relatively young asset class, the cryptocurrency space is evolving rapidly. In today’s post we review some recent developments and provide a brief look into what we expect from the cryptocurrency market in 2022.
Crypto volatility creates opportunity
Historically cryptocurrency investors have experienced very high volatility. Since 2014, Bitcoin has had an annualized volatility of 81%. This eye-popping number is nearly six times higher than the realized annual volatility for the S&P 500. (Source: portfoliovisualizer.com BTC Jan 2014 – Dec 2021)
Last year saw a similar trajectory. Even though Bitcoin was up 59%, volatility still remained high at 80% with negative returns in six of the 12 months. (Source: portofoliovisuializer.com BTC 2021)
I write this not to scare you, but to illustrate that volatility can be a good thing. If paired with a dollar cost average strategy, volatility can capitalize on opportunities to access this new and developing technology. We see no reason for this volatility to change in 2022, with the first few weeks of the year serving as an admittedly small sample size.
SEC likely to approve BTC ETF
In 2021 the U.S. Securities and Exchange Commission (SEC) approved the first bitcoin ETF, which follows a futures-based strategy.
However, a futures-based strategy may not live up to investor expectations of accurately tracking the price of the underlying asset. Bitcoin futures typically trade in “contango,” a futures market situation in which longer-dated contracts trade at a higher price than shorter-dated contracts.
This can result in significant underperformance, which may persist for as long as Bitcoin remains in contango.
According to the SEC, its mission is “to protect investors; maintain fair, orderly, and efficient markets,” and it “strives to promote a market environment that is worthy of the public’s trust and characterized by transparency and integrity.” Given the potential short-comings of a futures-based strategy, we believe the SEC will likely approve a spot Bitcoin ETF before the end of 2022.
Ethereum moves to PoS
The primary goal of an effective decentralized network is to ensure that nobody spends the same money twice. In order to ensure this goal holds true, networks use consensus mechanisms to validate legitimate transactions. Proof of Work (PoW) and its newer sibling Proof of Stake (PoS) are the two consensus mechanisms used by most cryptocurrencies. PoW networks include Bitcoin and Ethereum, while newer cryptocurrencies like Ethereum 2.0, Cardano and others rely on PoS validation.
While PoW networks have developed a well-established technology and trusted network, there are limits to their growth. Steady increases in the number of transactions result in a serious drawback of PoW networks, the significant energy consumption needed to validate these transactions. In a quest to solve this dilemma, the cryptocurrency community set out to solve the energy consumption issue by creating PoS. Improved energy efficiency is a major driver for the validators staking the network and the driving force behind Ethereum’s move to a PoS network from PoW. It’s expected that this transition will take place during the second quarter of 2022.
Countries adopt Bitcoin as legal tender
2021 proved to be a milestone year for Bitcoin as it continues to evolve from being a small technology project into fulfilling its promise as a medium of exchange. El Salvador was the first country to adopt Bitcoin as legal tender. The rationale for the adoption was threefold:
- to formalize the country’s economy, as most Salvadorans don’t have bank accounts;
- to make it faster and cheaper to send remittances abroad; and
- to attract foreign direct investment into the country.
We fully expect to see other countries to follow El Salvador’s lead and adopt bitcoin as legal tender.
The Global Crypto Adoption Index tracks the on-chain cryptocurrency value received, on-chain retail value transferred and the peer-to-peer exchange trade value, all weighted against the purchasing power parity per capita.
This index shows that Vietnam is well ahead of the world on Bitcoin adoption and is a likely candidate to consider adding crypto as legal tender. Asian countries round out the top three adopters with India and Pakistan coming in second and third, respectively. Ukraine leads adoption in Europe, while Kenya and Nigeria lead in Africa.
These developments suggest 2022 to be an important year in the continuing adoption of cryptocurrencies. Stay tuned for future posts on how to weight cryptocurrency within a well-diversified portfolio.
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