Even though the price of Bitcoin has risen significantly in recent weeks, it is still down by 27% in the last year. Since reaching almost $20,000 in the latter part of 2017, it is trading around 75% lower as investors have become increasingly downbeat about its prospects.
Looking ahead, there could be further pain for investors in the cryptocurrency. It seems to lack the potential to replace traditional currencies, while its dependency upon investor sentiment could lead to major challenges over the medium term.
Although digital currencies may eventually replace traditional currencies in the long run, Bitcoin seems unlikely to do so. It appears to lack the infrastructure required in order to replace a traditional currency, while regulators and lawmakers seem intent on blocking its wider usage.
In fact, a number of prominent lawmakers such as Mark Carney, Governor of the Bank of England, have gone on record with their negative viewpoints on the cryptocurrency. This could mean that it ultimately fails to have a purpose, with its limited size also making its adoption as a mainstream currency less likely. As such, it is difficult to see what investors are buying into.
In the past, one of the reasons why investors have bought Bitcoin is to diversify their portfolios. It was previously viewed as having relatively low correlation to the wider economy. However, since it is a high-risk asset which has no fundamentals, its price is entirely dependent upon investor sentiment. As a result, it appears to be highly correlated to the performance of the wider economy and stock market. This may be why it has made gains in recent weeks, with the stock market moving higher and investors being willing to take more risks.
However, with recent economic data released in the US and China being mixed, and the EU still struggling to grow while Brexit drags on, the prospects for investor sentiment could be challenging. It would be unsurprising for investors to become increasingly risk averse – especially as monetary policy in the US tightens over the medium term. This may cause investors to focus on less risky assets, which could reduce the popularity of Bitcoin.
Looking back at the history of the world economy, there are a number of occasions where investor excitement has risen to levels that bear no resemblance to the value of the asset which is increasing in price. For example, ‘tulip mania’ in the 17th century saw the price of tulips rise to levels which were severely detached from the value of the commodity itself. A more recent example is the dot com bubble, where ideas for websites that had no revenue were selling for $millions.
Although Bitcoin may not yet be viewed in the same bracket as either of those two events, it has the potential to post significant falls in the medium term. As such, now could be the right time to sell up and instead focus on buying high-quality stocks trading on fair valuations.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.