Crypto Redux or: How I Learned to Stop Worrying and Love Bitcoin

Timing is everything. I had to do it. I hit the publish button on a Bitcoin story the same day its value dropped by 20%. If I were better at timing the market, I wouldn't be writing these articles; I would be trading and anonymously enjoying the spoils of my skills in a warmer climate tax haven. Such is life.

Back in December 2017, the price of Bitcoin approached $20,000 for the first time. Knock-on effects included the annoying behavior of the newly minted Bitcoin millionaires. They quickly discovered their inner douchebags and exposed them for all to see. Equally, if not more, annoying were the folks who swear they bought a few hundred Bitcoin a few years ago but can't find the phone or laptop or hard drive that housed the wallet. These folks reveled in their phantom wealth and the cautionary tales that they had become. You never hear anyone say they bought 100 shares of Microsoft five years ago, and now they can’t find them.

Another impact was traditional financial institutions whose job is to serve investors' needs started to look at crypto-assets and Bitcoin more seriously. I remember many conversations with risk management committees, chief risk officers, and operations executives around the implications of holding these assets either on their balance sheets or in accounts on behalf of their clients. It was clear that they didn't want to delve into this space. They were scared, but their clients were dragging them, kicking, and screaming to the party. A typical question at the time was, "If we accept bitcoin into our custody, how do we know that same Bitcoin was not previously used to finance an illicit or terrorist action?” The answer – you can't. Another question was, "If someone gets a hold of our crypto keys, can they steal our Bitcoin?” The answer – yes.

It became clear to these companies that the risks of participating in the Crypto asset markets were significant and required new capabilities to mitigate them. They needed to learn about chain analysis tools, zero-knowledge proofs, and cold storage. Thankfully, the price of Bitcoin dropped from nearly $20,000 to below $5,000 in 2018, reducing the urgency of dealing with these issues. Most large institutions did invest in crypto capabilities. The broader fintech ecosystem continued to embrace crypto as an asset class. Central banks published whitepapers, and some even issued digital versions of their currencies. Banks issued stablecoins. Many asset managers started to offer access to or trading in a select set of crypto assets, including Bitcoin. Lastly, many startups started offering crypto services to consumers, businesses, and financial institutions.

Wind the clock forward to 2020 and the crazy pandemic-driven year. We had unemployed millennials pouring enhanced unemployment checks into Robinhood accounts and buying Bitcoin. The initial run up in Bitcoin value was quiet as many investment professionals and observers dismissed the price movement as a flash in the pan and not something to pay attention to. The price of Bitcoin was $5,375.33 on March 2nd, 2020, and $11,913.65 on August 3rd, 2020 – a more than doubling in five months. It then moved to $19,345.55 on November 23rd, 2020 – near doubling in two months. The slope was increasing, but the month of December turned it into a rocket. On January 8th, 2021, Bitcoin peaked at $40,729.44 and then dropping to $32,135.21 at the time of writing this sentence (January 11th, 2021, 9:35 AM CST). That’s an over 100% increase in one month and a 21% decline in two days.

GUYS, GUYS. THIS TIME IT’S DIFFERENT. RIGHT?

The most dangerous words that investors can say is, "This time it’s different.”

So, what has changed? Is the current run-up, and potential sell-off, of Bitcoin a replay of December 2017? The difference is that the financial services industry has got more comfortable with the financial and operational risks associated with crypto assets. The answers to the two operational risk questions listed above have not changed. There are efforts to help better understand the provenance of Bitcoin through exchanges providing this information on an opt-in basis, but that still only represents a portion of the total transactions on the Bitcoin network. The cybersecurity risks associated with crypto are better understood. Yet, over 20% of Bitcoin has been either misplaced or stolen, and new high-profile cyber attacks occur every week. Just ask the above-mentioned Robinhood investors who got an unrequested two-factor authentication verification a millisecond before their accounts were drained.

So, where are we? Grayscale, a single hedge fund, say they have accumulated over 3% of the total supply of Bitcoin. Microstrategy, a publicly-traded software company, has purchased over $1.125 billion in Bitcoin and is holding it as part of their corporate treasury. The 100 largest Bitcoin wallets hold over 14% of the total in circulation, close to $80B in value. All this institutional participation and concentration presents a very attractive target for the black hat hackers out there, many of whom are government-sponsored. The Solarwinds hack demonstrated something that most cybersecurity professionals believe – given enough time and resources, a hacker is going to get in.

Hang on, folks, it's about to get interesting.

This reminds me of a scene from the West Wing TV show where they discussed the potential fall out from congress' unwillingness to pass an increase to the debt ceiling. One character asks the critical question – "Is this a routine thing or the end of the world?" The answer – yes.