Ever since it was created in 2008 by an anonymous cryptographer known by the pseudonym of Satoshi Nakamoto, Bitcoin (BTC) has baffled traditional investors. How can bits and bytes on a computer screen be worth money? And some serious money!1 I was baffled by that question myself.

But the answer to that question is simple. Bitcoin, like any other asset, is only worth what others are willing to pay for it. Maurizio Cattelan’s “Banana Taped to a Wall” sold for $120,000 at Miami’s Art Basel festival in 2019. Of course this is an extreme case, but there are many other examples of traditional artwork being sold for well above the cost of materials, associated labor, or utility.

Gold is another example of an asset being worth more than its utility. Small amounts of gold are used in electronics due to gold’s electrical conductivity. However, most of gold’s price comes from the fact that it is shiny and scarce.

Figure 1 – Bitcoin vs. Gold vs. S&P 500 (12/31/19–4/28/21 – Indexed to 100 on 12/31/19)
Bitcoin vs. Gold vs. S&P500
Source: Morningstar Direct, Natixis Portfolio Clarity®
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.

Scarcity elevates value
Scarcity lies at the heart of Bitcoin. There will only ever be 21 million Bitcoins minted. The bulk of the supply has already been created (~18.7 million), with the remainder to be mined until the year 2140.

The process of mining involves packaging 1 megabyte’s worth of transactions into a block and collecting the transaction fee; an associated “block reward” is unlocked with every new block. Block rewards are how new Bitcoins are minted. Blocks are created every 10 minutes, and this will continue as long as the miners are willing to process transactions to earn transaction fees and block rewards.

Block rewards started out at 50 BTC per block. Every 210,000 blocks (roughly every 4 years) the block reward gets cut in half. This is referred to as “The Halvening” or “Halving.” On November 28, 2012 the block reward was cut to 25 BTC per block. On July 9, 2016 the block reward was cut in half again to 12.5 BTC per block. And finally on May 11, 2020 the latest halving of the block reward occurred. The current block reward is 6.25 BTC per block. The next halving will occur sometime in spring of 2024, when the block reward will be reduced to 3.125.

Figure 2 – Bitcoin price index 7/19/10–4/29/21. Indexed to 1 on 7/19/10 with halving dates shown. Logarithmic scale.
Bitcoin Price Index with Logarithmic Scale since July 19
Source: Morningstar Direct, Natixis Portfolio Clarity®
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.

Halving cycles and pricing
Miners expend ever greater amounts of electricity to compete for the benefit of collecting the transaction fees plus the block reward. Electricity expenditure is a cost to the miners, and the ever-decreasing block reward is a declining benefit (in Bitcoin terms). The only way the math can ever make sense for the miners is for the price of Bitcoin to go up.

An interesting price pattern has been observed during “Halving Cycles.” In the past, both leading up to and immediately following halving events, Bitcoin price has experienced a bull run. These bull runs have been followed by crashes. The crashes have been followed by long “crypto winters” where sentiment is at its lowest and major news networks suddenly lose interest in Bitcoin. Until the next halving cycle starts the process again.

Figure 3 – Exhibit 3: Bitcoin Halving Cycles – BTC price index, indexed to 1 on halving dates. Logarithmic scale.
Bitcoin Halving Cycles
Source: Morningstar Direct, Natixis Portfolio Clarity®
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.

We are currently in the middle of another BTC bull run. How long will it last? Nobody knows. As of April 29, 2021 Bitcoin is approaching the date when it peaked in a 2012 halving cycle. The 2012 bull run (peak BTC price) ended on day 372. The 2016 bull run had a more gradual start and ended on day 526.

Legitimate institutions entering the space in various capacities are a positive for Bitcoin adoption – a factor not present during the past bull runs. On the other hand, the ongoing threat of increased government regulation is increasing as more people gain exposure to Bitcoin worldwide. These and other juxtaposing forces make it difficult to use history as a guide to predict the future.
1 $56,608.30/BTC on Coinbase as of 4/29/21.

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