Words can't accurately describe what an amazing year it's been for cryptocurrencies. Whereas the stock market has been shown to be the greatest creator of long-term wealth, with an average annual return of 7%, inclusive of dividend reinvestment and adjusted for inflation, virtual currencies have left them in the dust this year.
Bitcoin has become the face of the cryptocurrency revolution
Perceived to be leading that charge is the world's most popular, most tradable, and most valuable cryptocurrency by market cap, bitcoin (CCY: BTCUSD). Having begun the year at just below $967 per coin, bitcoin is valued, as of Dec. 14, at over $16,500 per coin. That's a healthy return of better than 1,600% in just 11 1/2 months. In other words, we're talking about a lifetime's worth of gains for some folks in less than a year.
The catalysts behind bitcoin's ascent are aplenty. For instance, there's a lot of buzz surrounding the use of blockchain, which is the technology that underlies most cryptocurrencies, including bitcoin. Blockchain is the digital and decentralized ledger that records all transactions without the need for a third-party, like a bank. It's believed that blockchain could have the potential to lower transaction fees since there's no middleman, improve network security since it's decentralized, and quicken transaction settlement times since transactions are being proofed 24 hours a day, seven days a week. Blockchain is particularly attractive to the financial services industry.
Bitcoin investors are also encouraged by the uptake of virtual currencies as a validated form of payment. After snagging five brand-name merchants in 2014, bitcoin has picked up a steady stream of new retailers with each passing year. Also, Japan began accepting bitcoin as a regulated legal form of tender earlier this year, while CBOE Global Markets launched bitcoin futures trading this month, further validating bitcoin's ascent to becoming a validated asset.
On a more fundamental basis, bitcoin has also benefited from a weaker dollar and low interest rates. When the dollar drops in value, those holding cash usually seek out investment opportunities that'll help preserve the value of their cash. In the past, gold has been the primary asset they'll turn to, since it's scarce and has been used as a currency for more than 2,700 years. However, bitcoin's protocol limit of 21 million mined coins also creates a sense that it's a scarce asset. Combined with low interest rates that are leading to minimal returns for bond and CD investors, bitcoin has looked pretty attractive.
A truly crazy bitcoin fact
Yet there's a truth that bitcoin investors need to come to terms with in 2017: Bitcoin has actually underperformed its peers. I know that sounds crazy considering that bitcoin is up more than 1,600% year to date, but it's the truth.
Since the year began, the aggregate value of all cryptocurrencies, including bitcoin, has increased from $17.7 billion in value to $517 billion in market cap as of Dec. 14. That's an increase of more than 2,800%. Now, if we remove bitcoin from the equation and just look at the aggregate market cap increase in all other cryptocurrencies since Dec. 31, 2016, they've grown from $2.24 billion to $238 billion – an increase of 10,500%!
Virtual currencies that are currently trailing bitcoin in market value have really been the stars in 2017. Ethereum, which now sports a market cap of $66 billion, is up 8,500% through Dec. 14, while Ripple and Litecoin, which are respectively the third- and fifth-largest cryptocurrencies by market cap, are up a respective 12,600% and 6,300%.
Why has bitcoin underperformed its peers in 2017? It probably boils down to two factors.
First, we have the rule of large numbers. With a market cap of $276 billion, it's perceived to be psychologically much harder for bitcoin to double in value from here than it would for, say, a virtual currency worth $500 million or $1 billion. This cash inflow into nascent virtual currencies is a big reason why the crypto-rally has really picked up in the fourth quarter.
The other reason bitcoin's peers have outperformed is that a lot of investors are eager to "find the next bitcoin." Being the first mover does have its advantages, but in this instance investors seem to be more focused on finding the next virtual currency with payment facilitation or blockchain potential like bitcoin rather than buying bitcoin itself.
Is this a bubble? Probably.
However, investors should also understand that while the cryptocurrency market hath giveth in a big way in 2017, it could just as easily taketh away next year.
One of the bigger reasons digital currencies have done so well is the lack of what I'd call a "fair" market. With institutional investors predominantly sticking to the sidelines, it's allowed retail investors to drive virtual currencies higher. But these investors are limited on cryptocurrency exchanges to just buy and sell orders. With traditional equities, investors have the option of short-selling or using futures to bet against an equity in order to make money (thus a "fair" market, where everyone can be a winner). As cryptocurrency trading becomes more mainstream, the trading options should open up, allowing skeptical investors a chance to voice their opinion, and put money behind that opinion.
Historically, we also have to take into account the fact that investors are notoriously bad at overestimating the adoption of new technology. For instance, 3D printing, human genome decoding, and internet business-to-business commerce are all successful technologies today that were hyped into a major bubble when first introduced. This leads me to believe that while blockchain technology and their tethered virtual currencies may have a role in the future, their immediate adoption by big business is unlikely.
Long story short, don't expect the chatter that bitcoin and other cryptocurrencies are in a bubble to die down in 2018. If anything, I'd expect it to accelerate.