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Recently, Sotheby’s auctioned a piece of art that included a frame around a banana duct-taped to a wall. The work entitled “Comedian” fetched US$6.2 million at auction. The winning bid from Justin Sun, a Chinese crypto-currency entrepreneur, came about because he considered it conceptual art, representing “a cultural phenomenon that bridges the worlds of art, memes, and the cryptocurrency community.” For his US$6.2 million investment, Mr. Sun received a “certificate of authenticity” and instructions how to duct tape a banana to a white background and surround it with a frame. To my mind, the purchase represents the unbridled optimism that underpins Bitcoin’s surge since the election of Donald Trump as the next president of the United States.
Since Trump’s election win, the cryptocurrency Bitcoin has risen from about US$70,000 in early November to touching US$106,000 on Dec. 16 before pulling back. The rationale for the price surge is Mr. Trump’s positive views on crypto coupled with an influx of crypto currency-friendly politicians in the U.S. Senate and House of Representatives.
The Bitcoin community envisions a future where Bitcoin isn’t just a speculative asset but a mainstream medium of exchange. However, the value of Bitcoin as a medium of exchange brings to light a fundamental paradox that is tough to reconcile.
A recent paper published in the Journal of Behavioral and Experimental Economics examined what makes Bitcoin investors tick. It found that these investors aren’t just financially motivated, they’re driven by a strong desire for financial autonomy and a deep distrust of traditional institutions. They favour meritocratic over welfare-oriented systems.
In other words, they believe in a free-market system where income is distributed based on individual ability with less government intervention, as opposed to a more equitable distribution of wealth facilitated by social programs and policy. In essence, they’re rebels seeking to upend the status quo.
This mindset aligns with Bitcoin’s original allure as a decentralized currency free from government control. It’s no surprise that Bitcoin-heavy investors differ significantly from traditional stock investors who, comparatively, prioritize stability and are more accustomed to regulatory oversight. They tend to be risk-takers, often exhibiting higher levels of novelty-seeking and even gambling tendencies.
At least some crypto-enthusiasts could just be straight-up anarchists: Dogecoin, a cryptocurrency which was explicitly created as a joke, doubled in value since the election and spiked yet again after Mr. Trump announced that the new Department of Government Efficiency (DOGE) would be co-led by Elon Musk. Mr. Musk has a history of cryptic postings about Dogecoin on X, which are often followed by heavy price fluctuations.
But here’s the paradox: If Bitcoin were to become widely used as a currency, it would inevitably require more government regulation. The very decentralization that attracts investors and speculators could lead to financial chaos if left unchecked. Without some form of higher regulation, widespread Bitcoin adoption could pose significant risks to financial stability and consumer protection.
But the paradox doesn’t end there. If people believe Bitcoin’s value will keep soaring, they have little incentive to spend it. Why use Bitcoin to buy a coffee today if it might be worth double tomorrow? This speculative holding reduces Bitcoin’s effectiveness as a currency. Currencies need to circulate to facilitate trade and economic activity.
If everyone holds on to their Bitcoins, it can’t function as a medium of exchange. So we’re left with a conundrum. For Bitcoin to achieve mainstream adoption, it would need to embrace the very regulations and oversight it was designed to avoid. This clashes directly with the beliefs of its core investors, who value decentralization and freedom from government intervention. Additionally, overcoming the hoarding mentality would require shifts in how investors perceive and use Bitcoin.
Bitcoin stands at a crossroads. The very features that make it appealing are the same ones that hinder its ability to function as everyday money.
As individual investors, you can’t ignore these paradoxes when considering Bitcoin as part of your investment portfolio. The allure of massive appreciation can be tempting, but it’s important to approach cryptocurrency with caution. Bitcoin’s volatility means its value can swing dramatically in short periods, which can have a significant impact on your financial well-being if you’re overexposed.
Financial advisers often recommend that high-risk assets like Bitcoin should make up only a small portion of a diversified portfolio, some going as far to cap their recommendations at 1% of a portfolio.
Regularly rebalancing your investments also ensures that no single asset class becomes disproportionately large, which could expose you to undue risk. By keeping your Bitcoin holdings to a reasonable percentage, you can participate in potential gains while mitigating potential losses.
In the end, whether Bitcoin can overcome its inherent paradoxes and evolve into a mainstream currency remains uncertain. Its future needs some sort of balance between the ideals of decentralization and the practicalities of regulation and everyday use.
Richard Croft is Founder, Chief Investment Officer, and Portfolio Manager of R.N. Croft Financial Group Inc.
Disclaimers
Content © 2024 by R.N. Croft Financial Group Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently, and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
R N Croft Financial Group Inc. is a Licensed Discretionary Portfolio Management and Investment Fund Management company serving investors and investment professionals across Canada since 1993.
Image: iStock.com/SlavkoSereda
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