Ripple of uncertainty

Cryptocurrencies are drawing more attention – especially from high-profile techies like Elon Musk – than in previous years. The most recent is Tesla’s $1.5bn bet on Bitcoin, a cryptocurrency its CEO (Musk) once likened to fiat money (value is largely based on the public’s faith in the currency’s issuer, usually a sovereign state or central bank).

Although, some economists perceive the “Musk-effect” on cryptocurrencies to be irresponsible market abuse and an attempt to manipulate the market to gain personal advantage. Since Elon became a public crypto proponent via his Twitter handle – towards the end of January – the price of Bitcoin has advanced by over 70% m/m in Feb-21, a move like the patterns associated with the cryptocurrency’s 2017 rally.

The recent cryptocurrency rally has been fueled by demand from institutionals, unlike 2017’s rally that was fueled majorly by retail investors who had varying degrees of experience with, and knowledge of cryptocurrency. Validation from high-profile investors like Elon Musk, hedge-fund managers like Paul Tudor Jones, large corporations like Square, and social media company – Facebook – planning to launch its own cryptocurrency (Diem) later in the year, is increasing the acceptance of cryptocurrencies by mainstream companies and financial institutions.

The institutional move into cryptocurrency appears to be driven by a desire to hedge against macroeconomic uncertainty, which of course has not been in short supply since last year. Given the current monetary policy stance being pursued by global central bankers, institutionals are turning to cryptocurrencies to hedge against the impact of inflation on their portfolios. While cryptocurrency has attracted rising interest from professional investors, many remain skeptical. Thus, the influx of corporates into the crypto world has amplified regulatory concerns, relative to 2017.

By nature, cryptocurrencies are freewheeling, not beholden to country borders or specific agencies within a government, and their growing popularity has also resulted in growing ambiguities about their usage, operations, and regulations in financial markets. This is one of the issues impeding the acceptance of cryptocurrencies as legal tenders. Regulation is among the most important factors affecting the pricing of cryptocurrencies. Existing cryptocurrency regulations vary from jurisdiction-to-jurisdiction. While its status remains unclassified in some jurisdictions, others attempt its regulation based on what they categorize cryptocurrencies to mean.

For instance, in the US various regulatory agencies classify cryptocurrencies differently. While the IRS classifies cryptocurrencies as non-taxable properties, the SEC treats them as securities, the FinSEC views them as currencies, while the CFTC ascribes commodity status to them. The fact is, there are divergent perspectives on the status of cryptocurrencies. This lack of clarity has contributed immensely to the factors impeding its regulatory framework.

The second impediment to cryptocurrency acceptance has been its anonymous/semi-anonymous nature that makes them well suited to facilitate criminal behavior such as money laundering, drug trafficking and even financing terrorism. This prompted the recent move by Nigeria’s central bank to re-emphasize an existing banking ban on cryptocurrencies as a means of payment in Nigeria, even though its legal status remains ambiguous unlike its North African counterparts (Algeria, Egypt, and Morocco) where any form of bitcoin trading attracts steep penalties.

There will always be legal issues associated with almost every financial activity in the world and cryptocurrencies will not be an exception. Every new technology is fated to encounter difficulties, from mainstream acceptance to misuse and abuse. Although, the peculiarity of cryptocurrency is contributing to the difficulties associated with its regulation globally, the global financial system is no doubt embracing the current transition from physical currency to technology-driven digital currencies.

The ability to trail concealed transactions in the crypto world is vital to reducing the associated legal risks, ensuring accountability, and eliminating frauds. As earlier observed some countries have taken notable steps in expanding their laws on money laundering, counterterrorism, and organized crime to include cryptocurrency markets, thereby requiring bank and non-bank financial institutions to handle cryptocurrency transactions with utmost due diligence.

While it is impossible to say with certainty that cryptocurrency prices will continue to rise, the current Bitcoin price surge portends positives for cryptocurrency — not just because prices are rising, but because of why they are rising. The shift in investors’ profile from less experienced, retail investors to savvier and more strategic institutional investors who are buying Bitcoin to fulfill specific investment objectives – rather than to speculate on the hot asset – is indicative of an optimistic outlook for the asset.

For instance, if Bitcoin can continue to be an effective hedge against macroeconomic trends, we believe more and more institutional investors will put money into the asset, leading to even more mainstream adoption. However, that does not mean we will not see more peak-and-trough cycles. Bitcoin’s history is full of narratives about upcoming shifts or regulatory changes that would change the market fundamentally, ultimately resulting in the asset’s highly volatile nature.

Although traditional financial assets may have their shortcomings (there is no foolproof asset), that does not suddenly make Bitcoin a haven asset or a hedge even though its correlation with haven assets (Dollar & gold) has been relatively positive since 2020. Bitcoin still has a fairly stronger positive correlation with high-risk assets (EM currency & equities), than it does haven assets.

Cryptocurrencies still pose a threat to global financial stability and political/economic power. The current pattern of new, larger, and longer-term investors’ growing involvement is likely to continue in the near to medium term, but cryptocurrencies will be risk-on investments for the near future, and investors should still treat them per se.