What Drives Bitcoin’s Price? Largely Sentiment.
Bitcoin proponents tout various reasons why it can continue its meteoric rise. Among those is the belief its capped total supply and decelerating issuance—known as “halving”—act as long-term tailwinds to prices. Basic economics teaches, all else equal, lower supply leads to higher prices. However, there’s much uncertainty over whether all else will remain equal in the bitcoin market.
The demand drivers for bitcoin seem fickle. Bitcoin isn’t anchored to many widespread retail or industrial uses, like gold or other commodities. It doesn’t produce cash flow or earnings, like fixed interest or equities. Nor is it a widely used medium of exchange, like currencies. It appears mainly driven by speculation that others will want to buy it at a higher price later. Since demand seems mostly driven by pure sentiment, it can change rapidly. If demand drops faster than supply, prices could go down.
Additionally, the capped supply argument doesn’t seem to factor in crypto-substitutes available to investors. According to various estimates, there are thousands to even millions of crypto assets jockeying for attention. Exhibit 1 shows a narrower estimate of more than 13,000. Not every crypto competitor is popular or durable enough to challenge bitcoin’s hold on the market, but the sheer number of alternatives may prove enough to fragment demand. Whilst bitcoin has remained the most prominent cryptocurrency so far, it isn’t guaranteed it will maintain its dominant hold over the crypto market for years to come.
Exhibit 1: There Are Thousands Of Cryptocurrencies
Source: CoinMarketCap and CoinGecko Research, as of March 2024. Total number of active cryptocurrencies according to CoinMarketCap, 2013 – 2023, and CoinGecko Research, 2024.
The rapid speed at which broader crypto supply can expand to meet—and potentially outstrip—demand poses a risk to bitcoin investors. With equities, supply growth takes time given requirements such as the availability of qualifying private companies and the lengthy, expensive process of taking a company public. By contrast, with little-to-no barriers to entry, the overall supply of cryptocurrencies can quickly expand—potentially overwhelming demand. We believe this is an underappreciated risk for investors betting bitcoin’s finite supply will keep prices high.
Bitcoin’s Relatively Short History—And Why That Matters.
Bitcoin’s brief 14-year history makes it difficult to understand how it might perform across a variety of market and economic environments. As Exhibit 2 shows, bitcoin’s short history pales in comparison to the length of reliable, robust data sets for more traditional asset classes, like equities and fixed interest.
For example, contrast bitcoin’s history with the nearly 100 years of historical data we have for equities. Over that period, equities have weathered recessions, wars, natural disasters, monetary policy shocks, commodities shortages, health crises and much more. We can use that data to evaluate how equities responded to these events, conduct an analysis of the current economic environment and leverage that information to—along with myriad other factors—help inform a forecast. As Ken Fisher, likes to say, “History doesn’t repeat itself. But it tends to rhyme.”
Exhibit 2: Bitcoin’s Data History Relative to Other Assets
Source: Fisher Investments Research as of 28/03/2024. The chart above illustrates the availability of reliable, broadly referenced data across various data sources for different investment assets.
Whilst any investment can involve risk and return tradeoffs, bitcoin’s risk and return characteristics are largely unknown given its relatively short history. Thus, it’s difficult to determine with any degree of confidence, whether bitcoin may be appropriate to blend into a broadly diversified, long-term investment strategy.
Bitcoin’s Extreme Volatility—A Wild Ride.
Some degree of volatility is inherent in most investing, but bitcoin exhibits extreme volatility with spectacular “booms” and “busts.” Whilst the potential for outsized gains during “booms” can lure prospective investors, many can underestimate the difficulty in navigating bitcoin’s wild price swings.
Forecasting bitcoin’s price movements with confidence is notoriously challenging due to the frequency—and intensity—of its price changes. For example, as Exhibit 3 shows, bitcoin has experienced over 180 days where its value dropped 5% or more in a single day since 2017. Some investors fear equity volatility, but over that same time frame, global equities experienced just four days with similar declines. The depth of bitcoin’s corrections and bears can also rattle investors. Few people likely have the discipline to stomach a 93% (2011), 83% (2017) or 77% (2022) drop in an investment, as bitcoin experienced in those years[i].
Exhibit 3: Bitcoin’s Radical Short-Term Volatility
Source: Global Financial Data and FactSet, as of 26/03/2024. GFD Bitcoin per United States Dollar, MSCI World Price Index, daily, 01/01/2017 – 25/03/024. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.
The recent passing of the great Daniel Kahneman reminds us of his Nobel-prize-winning work in behavioural economics and prospect theory. He documented how investors tend to evaluate gains and losses differently—preferring smaller, but steadier gains over potential losses. His work was done long before bitcoin but rings true today. Some bitcoin investors have benefited from its rise, and maybe that continues. But we’ve found that investors can be prone to making rash, counterproductive investment decisions when faced with extreme volatility.
Despite the considerations we’ve discussed, we aren’t categorically anti-bitcoin, or any other cryptocurrency for that matter. Conceptually, there are interesting aspects about crypto and crypto-related technology. However, we believe investors need to think long and hard about what they know about the risk/reward dynamics of bitcoin and compare against other available assets before making a long-term investment decision.
Want to Dig Deeper?
In this article, we reviewed the considerations investors should make before buying bitcoin. To learn more, you can watch our latest video below, featuring Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher.
