While bitcoin's ascent has been giddy, can you stomach the volatility?

The Indian government's ambivalent attitude towards this asset class is another key risk for investors keen to climb on to this bandwagon

Bitcoin is currently trading at around $19,330 apiece. The premier cryptocurrency’s vertiginous rise—almost 160 per cent over the past year—has revived interest in it not just among high net worth individuals and stock market veterans, but even among retail investors.

What is fuelling the bull run?

Growing demand: To support their economies, central banks around the world are providing monetary stimulus in the form of lower interest rates and abundant liquidity. Governments, too, are providing fiscal stimulus. One by-product of these measures is that a lot of liquidity is sloshing around globally, driving asset prices up. Some of this money is finding its way into alternative assets like cryptocurrencies.

Institutional investors have climbed on to the bitcoin bandwagon. Many large hedge funds and mutual funds now enable their customers to invest in it. This year MicroStrategy, a US-based analytics firm, became the first publicly-traded company to acquire large quantities of bitcoin (worth $425 million) to hold on its balance sheet as a treasury reserve asset. Fidelity Investments has launched an arm, Fidelity Digital Assets, that offers broking and custodian services in cryptocurrencies. Payment services companies like PayPal and Square now enable their users to invest in crypto currencies. “As more respected companies join the bitcoin rally, the more reputable and wanted an asset it becomes,” says Ray Yousself, co-founder and chief executive officer, Paxful, a bitcoin exchange.

Limited supply: Only 21 million bitcoins can be mined altogether. With central banks turning on the liquidity cap, the value of fiat currencies is expected to decline. Since the overall supply of bitcoins is capped, many investors believe that it will preserve its value much better than paper currencies.

One event that has affected the supply of bitcoins in recent times is what is known as halving. Bitcoin halving is an event where the reward for mining new blocks is halved. This occurs roughly every four years. The last one took place in May 2020. Halving reduces the number of new bitcoins that are generated. If such halving takes place at a time when demand is strong, it provides an impetus to price.

Outlook remains positive  

If some of the factors that have produced the bull run—high liquidity, growing institutional interest, and limited supply—remain intact, as looks likely, the rally in bitcoin may continue. "With demand rising and supply limited, we expect bitcoin to continue to appreciate in the foreseeable future,” says Sumit Gupta, CEO and co-founder, CoinDCX. But given its innate volatility, the risk of a trend reversal can never be ruled out.  

Don’t overlook the risks

Regulatory concerns: For Indian investors, this is among the biggest risk factors. The Reserve Bank of India had, in April 2018, imposed a ban on banks providing services to cryptocurrency exchanges. This had brought trading in crypto currencies to a virtual standstill within the country. But in March 2020 the Supreme Court overturned this order. Nonetheless, the government’s attitude towards cryptocurrencies remains an area of concern. As recently as September this year, there were news reports to the effect that the government plans to bring in legislation banning crypto trading. “If in future the government bans them, it could possibly create a scenario where even exiting these assets could become difficult for existing investors," says Arnav Pandya, founder, Moneyeduschool. 

Volatile asset: Historically, bitcoin has been an extremely volatile asset. On December 20, 2017, it was trading at Rs 11,41,232. By December 7, 2018, it had slumped to Rs 2,45,051, according to data from Coinbase. Most retail investors would find it hard to stomach a loss of such magnitude.

Bitcoin can decline as much as 10-15 per cent within a day. “The total market cap of bitcoin is around $350 billion. So, even the entry or exit of $10 million can cause its price to fluctuate considerably. Also, unlike stock markets, there are no circuit filters here,” says Gupta. One point in its favour, of course, is that it has recovered from every such correction.

Jump in, but with safety nets

Investors who have an adequate net worth and good understanding of crypto currencies may invest in bitcoin. “If you have an investment portfolio worth Rs 2-3 crore, you may take exposure to this asset class. However, limit your exposure to 5 per cent of your total portfolio,” says Pandya.

Since prices have run up considerably, making a lump-sum investment would be risky. “Spread your investments across time and thereby average out your cost of purchase,” says Gupta. He also suggests having a horizon of around three years. “A long investment horizon nullifies short-term volatility effectively,” adds Gupta.  

Today bitcoin is the market favourite, but tomorrow it could well be another crypto currency. Hence, you need to diversify your bets. “Invest in different coins,” says Youssef.

With the growing popularity of crypto currencies, new ones get issued at regular intervals. These should be avoided. “In stocks you have bluechips and penny stocks, and investors are advised to stay away from the latter. The same way, in cryptos, too, you should stay with the proven currencies that have been around for a number of years,” says Gupta.

The process for starting investment is fairly simple. You need to register with an exchange, which will then do a KYC. After that, you need to transfer money from your bank account to your exchange’s wallet. Thereafter, you can start purchasing cryptocurrencies. However, be cautious in choosing your exchange (see box).  

Points to check when selecting a crypto exchange

• Does the exchange offer insurance on the cryptocurrencies stored with it?

• Does it have a cold wallet facility for storing them safely?

• Does it allow fractional ownership? A lower minimum amount means a lower entry barrier  

• Is the exchange easy to use?

• Is it prompt in handling service requests?

• Does it offer better pricing compared to other exchanges?

• How much does it charge? Some only charge intraday traders and nothing from buy-and-hold investors