Since the year began, the broad-based S&P 500 has been virtually unstoppable. Through May 9, the index is up 14.5%, representing one of the strongest starts to a new year in some time.
Among specific industries, marijuana stocks have been even stronger, with investors drawn to the potential for worldwide cannabis sales growth from $12.2 billion in 2018 to an estimated $50 billion to $75 billion by the end of the coming decade, according to Wall Street. The Horizons Marijuana Life Sciences ETF, the first tradable cannabis exchange-traded fund, is up 38.4% year to date, or close to three times the return of the S&P 500.
But there's one asset that blows both the broader market and marijuana stocks out of the water, in terms of aggregate year-to-date return -- that asset being the largest cryptocurrency in the world, bitcoin, which has rallied by 59% since the year began, and has essentially doubled after hitting a low of $3,169 on Dec. 14, 2018. That's right, folks, bitcoin-mania is back!
Bitcoin is surging, but it's not entirely clear why
For those who may not closely follow bitcoin, its allure has always been twofold. First, it represents a new means of transferring and settling funds between two parties, outside of traditional banking networks. As the first cryptocurrency, bitcoin has become the medium by which most digital transactions are accomplished. With transactions being completed on bitcoin's immutable ledger, settlements can occur in minutes, compared to the multiple-day hold times often seen with traditional banking networks on overseas payments.
Bitcoin's blockchain (i.e., the aforementioned immutable ledger) is also viewed as the backbone of a broader movement to improve the financial system and supply chain management. Although bitcoin is utilized almost entirely as a currency rather than for its blockchain, the company's underlying technology has been the basis of innovation for countless other blockchain projects.
However, the catalysts behind the rally since mid-December in bitcoin aren't quite as clear.
Part of the reason for the rally could be the perceived scarcity of bitcoin. Limited to just 21 million coins, bitcoin is approaching a circulating supply of 17.7 million coins. Since it'll be progressively harder to mine new bitcoin in the future -- mining involves people using high-tech computers to essentially proof the validity of transactions conducted on its blockchain -- its limited supply may be pushing its coin price higher.
Another catalyst behind the rally could be the expectation that the U.S. Securities and Exchange Commission (SEC) could soften its stance on cryptocurrencies like bitcoin. Though the SEC has previously rejected bitcoin-backed exchange-traded funds, it's still reviewing a handful for possible listing. Further, the SEC announced in early April that it plans to hire a crypto specialist, which bodes well for a future bitcoin ETF listing, or at worst some serious discussions on the topic.
Most cryptocurrency deficiencies have yet to be resolved
But should you really care that the highest-flying asset of our generation is back to logging big gains? Honestly, probably not.
Putting aside the complexities of purchasing bitcoin on cryptocurrency exchanges, since traditional brokerages don't typically support purchasing bitcoin directly, there are a number of deficiencies that throttled the crypto market in 2018 that still haven't been addressed.
Topping the list of problems is security. Despite blockchain networks being transparent and immutable, hackers have had seemingly little issue deceiving investors from time to time and absconding with their hard-earned coin. Just this past week, Binance, one of the most popular crypto exchanges, revealed that hackers stole about 7,000 bitcoins, worth around $40 million. It's highly unlikely that any of this stolen coin will be identified, or find its way back to its rightful owners. The SEC has explicitly warned about this in the past, suggesting that because so many crypto transactions occur outside the confines of the United States, its ability to trace and recover coin, as well as prosecute hackers, is limited.
Another pretty sizable problem is that bitcoin has limited utility. Sure, it's the medium by which most cryptocurrencies are purchased (i.e., investors have to buy bitcoin to exchange for rarer crypto coins on many exchanges), but the vast majority of retailers and businesses aren't going to accept bitcoin as a valid form of payment. It's simply too volatile for most businesses to take on that risk. That limits the real-world usefulness of bitcoin.
Even blockchain, which has arguably been the heart of the cryptocurrency rally since the beginning of 2017, has an inherent Catch-22. Namely, businesses are unwilling to lean on blockchain without it demonstrating its effectiveness in real-world testing, but it won't face any real-world scenarios unless the corporate world gives the technology a chance.
Bitcoin is often a purveyor of frustration for investors
Though the recent rally in bitcoin might have investors thinking about dipping their toes into the crypto pond, my suggestion would simply be: Don't! Outside of buying bitcoin directly on cryptocurrency exchanges, which has noted security risks, equities that provide investors with bitcoin exposure are prone to causing plenty of headaches and frustration for investors.
The Grayscale Bitcoin Trust (GBTC -4.04%) is one such means of gaining bitcoin exposure. The Grayscale Bitcoin Trust owned approximately 225,638 bitcoin as of April 30, 2019, which equates to about $1.39 billion in market value. But the actual market value of the Grayscale Bitcoin Trust is pretty much always much higher than the tangible value of its holdings. Right now the premium is only around 5% of net asset value, not counting the absurd 2% management fee you'll pay annually for a portfolio that requires virtually no upkeep. Historically, though, the Grayscale Bitcoin Trust has seen premiums of 25% to 100% of net asset value, making it a speculative investment to avoid.
Bitcoin, and the crypto movement as a whole, has also wreaked havoc on established companies, such as NVIDIA (NVDA -2.51%). In 2017, the graphic cards that NVIDIA manufactures were being gobbled up at an incredible rate by cryptocurrency miners (the reward for mining blocks of transactions is often crypto coin). This, in turn, sent NVIDIA's share price through the roof as a small segment of its sales soared. When the floor fell out of the crypto market in the second half of 2018, so did NVIDIA's growth. Fourth-quarter revenue fell 24% to $2.21 billion from the prior-year period, and tumbled 31% from the sequential third quarter. Even with a modest rebound in the books for most crypto coins, mining isn't guaranteed to be profitable at these levels.
There's no denying that cryptocurrencies have delivered stellar returns since the beginning of 2017, but they don't belong anywhere near long-term investors' portfolios.