Leading cryptocurrency Bitcoin (BTC 0.25%) is finally hitting a rough patch. Tesla (TSLA 0.52%) CEO Elon Musk backtracked on allowing customers to use the digital currency to purchase vehicles, and regulators in China have reeled in crypto trading and restricted its use as a form of payment. As of this writing, Bitcoin is down nearly 40% from its all-time high of nearly $65,000 per coin as a result.
Meanwhile Square (SQ -1.92%), which owns popular peer-to-peer payments and Bitcoin trading platform Cash App, is down about 30% from its peak. Square revealed it owned just over 8,000 Bitcoin tokens on March 31 (at that time, valued at $472 million), so the steep drop in Bitcoin price as of late puts a serious dent in Square's balance sheet -- and it's the likely reason for the stock's dip.
In spite of the negative trend as of late, Bitcoin and Square still have promising futures. Which is the better buy? The answer depends on the type of investor you are.
Reasons to buy Bitcoin
Bitcoin is considered to be the first cryptocurrency. It utilizes a decentralized digital ledger system (known as a blockchain, meaning no central bank or government issues it or controls it). It's a highly liquid asset. Bitcoin can be traded 24 hours a day on a crypto trading platform or app. And though one coin is worth tens of thousands of dollars, one Bitcoin is divisible into smaller parts known as Satoshis (like how a dollar can be broken down in cents). One Bitcoin equals 100 million Satoshis.
As Bitcoin has gained momentum among investors and businesses, it has skyrocketed in value in the last decade. It was designed to be a digital payments system that facilitates exchange of goods and services online. But because it has a limited supply (the maximum total number of Bitcoins is pegged at 21 million, and over 18.7 million of them have already been "mined" so far), Bitcoin's price is highly contingent on demand among investors and traders.
In fact, this limited supply and surging demand is the main reason for the cryptocurrency's big increase in value. Amidst rising government spending around the world (which necessitates minting of new money by central banks), some investors view Bitcoin as a better store of value than government-issued fiat currency and as protection against inflation. Because the number of Bitcoins is fixed, a steady increase in demand over time will mean a rising price. And if Bitcoin ever becomes a widely accepted form of digital payment, the increase in circulation could help stabilize the wild ups and downs in price that are inherent in the digital coin at the moment.
Reasons to buy Square
Square (and its subsidiary Cash App) had $3.67 billion in cash and short-term investments on its balance sheet as of the end of March 2021, making Bitcoin worth over 10% of its liquid assets. Square is thus an indirect bet on the price of Bitcoin. However, Square is more than a passive investor in the leading cryptocurrency.
Cash App allows users to buy, sell, and hold Bitcoin in their digital wallet, as well as send and receive Bitcoin to other users (including merchants that accept it as payment). A minimal fee (disclosed at the time of trade and variable depending on current Bitcoin market volatility) is charged. However, Cash App currently generates little value from Bitcoin. Square revealed in its first-quarter 2021 earnings update that it generated $3.51 billion in Bitcoin revenue, but gross profit (revenue minus cost of revenue) was only $75 million.
That doesn't mean Bitcoin is a worthless endeavor for Square, though. It has picked up millions of new Cash App users in the last year by touting the ability to trade Bitcoin, and once onboarded, Square can promote Cash App's digital payments and basic banking capabilities to these new users. Besides a big line item on Square's balance sheet, Bitcoin can be thought of as a marketing campaign to acquire more consumers and businesses on its platform.
Longer term, if Bitcoin does pick up steam as a form of digital payment, Square's transactional business (it earns a fee every time a payment is processed on its network) could be a top crypto beneficiary.
Which is the better buy?
The supply-demand argument for Bitcoin's continual rise over time is legit, but Bitcoin is a type of fixed asset. As the recent price action demonstrates, owning cryptocurrency can be an incredibly volatile endeavor. That may not sit well with all investors. If you don't like extreme swings in your portfolio's value, keep Bitcoin and other cryptocurrencies in general only as a small position (think single-digit percentages or less of your portfolio overall).
By contrast, Square is a dynamic business that uses fixed assets to grow and generate profit. It owns a sizable chunk of Bitcoin, so shareholders will benefit if Bitcoin rises in price. But Square is also using its crypto holdings to build its user base and promote activity on its platform. And because it's a business that generates revenue and profit, a tangible valuation can be placed on Square stock.
Excluding Bitcoin revenue, Square stock trades for about 17 times trailing-12-month revenue. Free cash flow has recently dipped back into the red as the company spends to promote growth, but it demonstrated in 2019 and 2020 that it will eventually be a highly profitable company (it generated several hundred million in free cash flow in both those years).
Bitcoin may have a place in your portfolio, but I personally have a bias toward businesses that utilize assets like Bitcoin as part of their operations. Square stock gets my nod as a better buy right now.