High institutional demand, supply shock could boost Bitcoin further

New entrants should invest systematically with at least a three-year horizon

The price of Bitcoin has surged from $24,327 to approximately $52,088 over the past year, more than doubling in value. Although there is still a chance to profit from the ongoing rally, it is important to approach this asset cautiously.

 

Spot ETF launch driving rally          
 

The primary reason for the increase in the price of Bitcoin is the approval of spot Bitcoin exchange-traded funds (ETFs) in the United States (US).  They have attracted substantial institutional interest. “Entities like BlackRock and Fidelity are required to purchase actual Bitcoins to offer spot ETFs. The daily buying pressure from these large funds is driving prices up,” says Parth Chaturvedi, investments lead, CoinSwitch Ventures.
 

Another factor is the halving event scheduled for April. “Typically, after a bear phase of one-two years, excitement builds up around an upcoming halving event, which cuts Bitcoin’s production rate to half, triggering a supply shock,” says Rajagopal Menon, vice-president, WazirX.  
 

At present, around 900 new Bitcoins are mined daily, a figure that will drop to 450 post halving. With recent demand from spot Bitcoin ETFs averaging over 5,000 Bitcoins a week, the increasing demand against the backdrop of reducing supply is pushing Bitcoin’s price higher. The expectation that the US Federal Reserve may cut interest rates this year is boosting all risk assets, including equities. Bitcoin, too, has benefited from this.
 

Investor sentiment, too, is playing a part. “As Bitcoin’s price rises, the fear of missing out is pushing more people into buying it,” says Menon.

 

Beware its high volatility
 

A key concern when investing in Bitcoin is its significant volatility: its value can soar or plummet sharply.  
 

There is also the risk of a global regulatory clampdown on Bitcoin, though the probability of this happening seems increasingly remote after the launch of a regulated product in the US and growing acceptance in other regions. In India, the Reserve Bank of India frequently cautions about Bitcoin’s unregulated status and the government has not yet issued regulations for cryptocurrencies.
 

Cryptocurrencies are at times used for illegal activities. This poses a risk as a regulatory crackdown could erode the value of investments.
 

Cryptocurrencies do not yield any value. “A share derives its value from a company’s earnings performance. Bonds pay interest. Cryptocurrencies do not generate any value. Their prices are determined solely by demand and supply,” says Arnav Pandya, founder, Moneyeduschool. When demand evaporates, the price falls sharply.  
 

Cybercrime also poses a risk. Many investors hold their cryptos in online wallets belonging to an exchange. “If these accounts are compromised, there is no recourse as there is no regulator one can turn to,” says Pandya.

 

Rally may continue
 

While the price of Bitcoin has more than doubled over the past year, market participants say there is steam left in the rally. Some believe it could even surpass it previous peak of $68,789 (reached on November 10, 2021), following the halving in April.
 

The ETF launch marks the legitimisation of Bitcoin as an asset class, with more institutions likely to hold it in their portfolios. Fidelity Investments Canada has begun a 1-3 per cent Bitcoin allocation into its “All-in-One” asset allocation funds, which incl-ude spot Bitcoin ETFs. More investment managers may allocate a portion of their portfolios to Bitcoin in the future.
 

Currently Indian investors do not have access to bitcoin ETF via crypto currency exchanges. They may, however, invest in them via the liberalised remittance scheme route.

 

Limit your exposure  
 

Financial planners suggest that investors with a conservative or moderate risk profile should steer clear of cryptocurrencies because of regulatory and other risks. “If you do invest, treat it as part of the speculative portion of your portfolio, allocation to which should not exceed 5 per cent of the total portfolio,” says Pandya.
 

Menon recommends that newcomers focus on blue-chip crypto-currencies. If investing in Bitcoin, adopt a three to five-year horizon and invest systematically to gain from its volatility.
 

Existing investors with goals within the next year should consider booking profits gradually. Those whose goals are more than three years away may stay invested.

Avoid offshore crypto exchanges

·       Recently, there has been enhanced regulatory scrutiny on offshore exchanges, primarily because they do not adhere to the same KYC (Know Your Customer) and AML (Anti-Money Laundering) compliance practices that Indian exchanges are required to

·       When selecting a cryptocurrency exchange, opt for a well-recognised Indian platform

·       The exchange should comply with Indian tax laws and other regulations

·       It should have a mechanism in place for deducting TDS (tax deducted at source)

·       It should be registered with the Financial Intelligence Unit (FIU)