A little over two months ago, I wrote this article detailing the principles behind Bitcoin being the top investment opportunity across all asset classes moving forward. I am revisiting this assertion to analyze the catalysts behind Bitcoin’s and Ether's massive price moves over the past couple of months, as well as provide a basis for their potential going forward.
First, I must point out that my prediction was slightly off the mark two months ago. It turned out Bitcoin was not the top investment opportunity the past couple of months because its price 'only' doubled while the price of Ether (Ethereum's token) quadrupled. An investment 'only' doubling in a two month span is not a bad problem to have, so that's a mistake I will gladly live with. However, I must point out that my time horizon for investment return is not months, but rather years. High volatility investments drum up a lot of noise that is nearly impossible to predict, thus the focus is on identifying the strongest opportunities that will thrive long-term. With that in mind, Bitcoin being the top investment opportunity may still ring true.
Figure 1. Bitcoin's Price Increased from Less Than $1,000 in March 2017 to More Than $2,400 in May 2017
Figure 2. Ethereum's Ether Price Increased from Less Than $50 in March 2017 to More Than $200 in May 2017
Catalysts Driving Bitcoin Higher
The strongest catalyst driving Bitcoin prices recently is a positive regulatory environment, specifically in Japan where the parliament recognized Bitcoin as an authorized method of payment on April 1, 2017. Japan’s Financial Services Agency (FSA), the country’s financial regulator, passed a set of bills recognizing virtual currencies, like Bitcoin, to contain asset-like-values and to be officially recognized alongside fiat currencies. This warranted a major demand spike as stores across Japan began accepting Bitcoin payments and the masses turned to exchanges to stockpile the cryptocurrency.
Another major catalyst is the anticipated resolution of the scaling debate. Bitcoin's rapid growth success has also brought forth its largest vulnerability. The network's capacity (under the 1MB block size constraint) has been reached, which has driven transaction fees, settlement times, and the number of transactions sitting in the backlog to their largest in history, levels that makes Bitcoin infeasible as a universal payment method for day-to-day purchases. The result has been a brutal debate without consensus on whether to enable Bitcoin scaling by activating SegWit, Bitcoin Unlimited, or some other technology. However, several major Bitcoin business owners came to a general agreement at the Consensus conference in New York, agreeing to collectively enable SegWit for Bitcoin scaling and increase the block size limit to 2MB. Increased network capacity will allow Bitcoin to continue its growth trajectory.
The strong bull run can also be attributed to continued fleshing out of the crypto ecosystem. Network effects and further business development on top of the Bitcoin blockchain and protocol have further justified its viability. Sidechain solutions create new opportunities for inter-blockchain value transfers, increased network capacity by reducing the number of on-chain transactions, and faster transaction/settlement times with sidechain transactions, all of which immensely expand the use case potential for the Bitcoin network and extend access to the general public through more user-friendly solutions.
Catalysts Driving Ethereum Higher
Ethereum's price strength is driven by the formation of the Enterprise Ethereum Alliance (EEA), which was founded to connect large companies to technology vendors in order to work on projects using the Ethereum blockchain. Some notable companies involved in the launch included JPMorgan, Microsoft and Intel. On May 23, 2017, the EEA announced another 86 firms joined the alliance, adding further legitimacy to the underlying technology and advancing the value of the Ether token. Samsung, Toyota, and Merck were among the newly added companies to the alliance.
Ethereum is a blockchain-based decentralized platform for apps that run smart contracts, and is aimed at solving issues associated with censorship, fraud and third party interference. Ether, also known as ‘gas’, is the necessary element for operating the distributed application distribution platform, Ethereum. Ethereum does everything that Bitcoin can do, and more. It has been likened to the protocol stack of the web in its disruptive and expansive potential. If this potential comes to fruition, its current market cap ($17B versus Bitcoin's $39B) is grossly undervalued.
More on Ethereum's value proposition and potential can be found here.
Potential Obstacles for Bitcoin and Ether
The main concern is whether the skyrocketing crypto prices in the past couple of months are backed by fundamentals or a result of irrational exuberance where momentum begets momentum. I surmise a little of both.
The Japanese recognition of Bitcoin as an approved currency similar to a fiat currency should generate sustained demand growth moving forward and promote widespread public adoption by other countries' governments and populations, as well. On the other hand, the Bitcoin price may be getting a little ahead of itself. Bitcoin is trading at a $400, or 19%, premium on Japanese Markets as Bitcoin fever takes hold (the JPY-BTC pair is trading at a $400 premium to the USD-BTC market). Moreover, Japanese volumes are 42-50% of total Bitcoin trading currently. Both have pushed up international Bitcoin prices and signal a price surge that could lead to a correction.
As mentioned above, Ethereum's disruption potential could indicate it is still enormously undervalued. Like Bitcoin, however, the price may be inflated with excess speculation on the success of the EEA and strong buying from Korea where the price was recently trading at a 27% premium compared to the USD market. There are concerns over Ethereum's network capacity and the potential for its functionality to be copied, which could bring forth obstacles and competition down the road, but Ethereum also has network effects in play and its network has hardened over time.
Investment Conclusions
Both Bitcoin and Ether have experienced price surges from generally positive regulatory news, global policy uncertainty (cryptocurrencies act as a safe haven, similar to gold), and technological/network advances in the crypto ecosystem. While a price correction is likely inevitable in the not-so-distant future, both are backed by increasingly strong fundamentals and technological opportunities. For a short-term investor, the crypto space is an extremely risky play because of the gargantuan growth in market cap the past couple of months. Despite the recent price surges, however, both Bitcoin and Ethereum retain long-term investment potential as their networks continue to be built out, as long as an investor doesn't mind a little bit of noise and price fluctuation throughout the journey.
Disclaimer: The author is long Bitcoin and Ether. This article represents his opinion and should not be used as the sole source of an investment decision.