And 2016’s Best-Performing Commodity Is...Bitcoin?

The cryptocurrency is up more than 100% this year

By Joseph Adinolfi, MarketWatch

Bitcoin has had a banner 2016.

After two years of lackluster returns, the price of a single coin soared more than 100% this year — putting bitcoin on track for its best annual performance since 2013. A wave of exuberance carried bitcoin from around $90 in January of that year to an all-time high of $1,242.

Bitcoin traded as high as $867 on Thursday, according to Coin Market Cap, causing its overall market capitalization to sail past the $14 billion mark, eclipsing the market value of, say, Twitter Inc.

Bitcoin analysts attribute this year’s advance to several factors: increasing adoption of bitcoin among professional investors, improving market fundamentals and a perception that the world’s largest economies are growing increasingly unstable.

“You’re talking about the eurozone fracturing, you’re talking about the Chinese yuan devaluation, you’re talking about Trump’s curveballs,” said Charles Hayter, founder and CEO of CryptoCompare, a company engaged in bitcoin data and analytics.

The shift in bitcoin’s valuation is only part of the story. Trading volume has also increased dramatically in 2016, peaking at more than $330 million a day over the summer. Finally, the bitcoin market is liquid enough to allow professional traders to enter and exit positions without losing their shirt, as Hayter put it.

In September 2015, the U.S. Commodity Futures Trading Commission declared bitcoin and other digital currencies to be commodities falling under its purview. By this standard, bitcoin has been the best performer in its asset class, surpassing coffee (up 9.6%), soybeans (15%), crude oil (43.1%) and gold (6.7%).

On a percentage basis, a few other cryptocurrencies may have outperformed bitcoin, but their extremely low valuations mean they’re largely irrelevant to the global investing community. One example is Ethereum, the world’s second-largest cryptocurrency. In January, a single ether token was worth $1. Now, it’s worth $7. Its price peaked above $20.

China

Investors who’ve held on to bitcoin since the price collapsed in 2014 should be thanking the Chinese government. Trading volume on Chinese cryptocurrency exchanges outpaced volume in the U.S. by several orders of magnitude, Hayter said, signifying a massive increase in demand among Chinese investors.

The sharp decline in the value of the Chinese yuan, also known as the renminbi, has been widely credited for this surge. China’s central bank has tried to slow the currency’s decline by liquidating some of its foreign currency reserves, but still the dollar has risen more than 7% to about 7 yuan — the Chinese currency’s weakest level since 2008.

However, whether this demand is sustainable is unclear. Until recently, Chinese authorities had grudgingly tolerated bitcoin, but that could soon change: In November, Bloomberg reported that the Chinese government is exploring ways to stop citizens from using the digital currency to bypass the country’s stringent capital controls.

Institutional investors warm to bitcoin

Slowly but surely, institutional investors are warming to bitcoin.

Over the past year, the Bitcoin Investment Trust GBTC, +1.22%  , an investment vehicle launched in 2013 by Grayscale, a subsidiary of the Digital Currency Group Co., has seen its assets under management more than double, from $60 million on Dec. 31, 2015, to $139.5 million as of Wednesday.

Shares of the trust have traded at an average premium of 44% on the secondary market, according to Michael Sonnenshein, director of sales and business development at Grayscale. Sonnenshein attributes this premium to the tax advantages associated with owning a titled security, he said. “We’ve seen a sharp increase in allocations to the Bitcoin Investment Trust from institutional investors, including hedge funds, mutual funds, RIAs and ETF managers” he said.

Unfortunately, these advantages have been largely denied to retail investors.

In September, the Securities and Exchange Commission delayed its decision on whether to authorize the Winklevoss Bitcoin Trust, the bitcoin exchange-traded fund created by Tyler and Cameron Winklevoss.

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If approved, the Winklevoss trust would become the first bitcoin-based investment vehicle to trade on the New York Stock Exchange. The SEC should have its final decision by the end of March, but whether they will choose to delay again is unclear.

Some retail investors can access bitcoin without buying the cryptocurrency directly, ARK Invest offers two ETFs that allocate a percentage of their holdings to the Bitcoin Investment Trust, an investment vehicle. Shares of the trust, accessible to accredited investors, are trading at a premium on the secondary market.

The block-size debate

Rules embedded in bitcoin’s software limit each block on the bitcoin blockchain — the cryptographic system that effectively turns every computer operating the bitcoin software into a guardian of the network’s integrity — to one megabyte of data, equal to about seven transactions a second.

Because of this, competition for space on the network has caused transaction fees to triple, from about 5 cents a transaction at the beginning of the year to between 15 and 20 cents, according to Spencer Bogart, a bitcoin analyst at Needham & Co., one of the few Wall Street investment banks that covers bitcoin.

The debate over how best to remedy this situation has divided the bitcoin community into two camps: bitcoin core, which advocates for increasing the block size, and bitcoin unlimited, which wants to leave the network more or less as it is.

In 2015, supporters of bitcoin core proposed what’s called a “hard fork” — a type of software update. After a hard fork, Bitcoin users would need to upgrade their software or be effectively shut out of the network and only able to execute transfers with others who have opted out of the fork.

A similar drama played out in the Ethereum community this year, splitting the network into two disparate cryptocurrencies, which, combined, have a smaller market capitalization than Ethereum had before the split.

Luckily for bitcoin, the two camps have experienced a detente. In October, the bitcoin core camp released the Segregated Witness “soft fork” — commonly known as SegWit — a software update that would make it easier for bitcoin users to funnel certain transactions through a separate network, alleviating some of the pressure on the blockchain. (To learn more about SegWit, check out the guide available on Bitcoincore.org.)

For SegWit to come into effect, 95% of bitcoin nodes must elect to adopt it. Aabout 25% of the network has so far done so.

Courtesy of MarketWatch