The pandemic showed there’s a need for digital currencies, especially bitcoin

This certainly looks like 2017 all over again — a powerful correction could also be in the cards. To see what the future holds for bitcoin, I spoke with Juan Manuel Villaverde of Weiss Ratings, an independent ratings agency.

Villaverde is an econometrician and mathematician who has been tracking and studying cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created the Weiss Cryptocurrency Ratings.

MarketWatch: Is bitcoin’s rapid rise a surprise?

Juan Manuel Villaverde: It was bound to happen. We saw demand for bitcoin grow steadily even as crypto assets entered a bear market in early 2018 and through most of 2019. Since mid-2019, we saw a growing disconnect between improving fundamentals and user adoption. And yet prices meandered sideways, unable to get any traction. The crypto rally we saw in 2020 was simply the culmination of those improving fundamentals, finally translating into higher bitcoin valuations.

MW: How is the current bitcoin surge comparable to the one in 2017? How is it different?

Villaverde: It is comparable to 2017 in two ways only: Prices have reached similar levels to those we saw at the end of the 2017 bull market, and a lot of people have been caught off-guard by the surge as they swore bitcoin could never rise again. It’s very different in that the tone has shifted substantially — where 2017 was dominated by retail investors, 2020 is largely driven by large institutional investors — such as [Stanley] Druckenmiller or [Paul] Tudor Jones — who commit a small amount of their portfolios to bitcoin. As a matter of fact, we’ve recently said in a note to our clients that retail is missing in action in the current bitcoin surge.

This speaks to us about a market that is becoming more professionalized, with deeper liquidity and better infrastructure to support large volumes of capital moving into the space. In addition, retail involvement is usually correlated with the tail end of a bull market. The surge we’ve seen so far in 2020 has taken place without broad public participation, which [indicates] healthier fundamentals underlying price action compared to 2017.

MW: What’s the place for bitcoin in a post-COVID 19 world?

Villaverde: COVID has sparked a conversation about the necessity of fully digital versions of the money created by central banks. This was largely a result of central banks having found they had no adequate tools to target the broad public when they want to stimulate the economy. One of the cool things about central bank digital currencies (CBDC) is that every citizen gets an account with the central bank. This, in turn, means that should the need arise, central banks could opt to put money directly in the pockets of citizens during sharp economic downturns, as we saw in 2020.

The flipside, however, is that this new form of monetary policy gives total control of the money supply — and who has access to it — to central banks. If the past 10 years of monetary stimulus did not cause widespread inflation, it was largely [because] that new money creation went only to commercial banks, which in turn chose to deposit that money back at the central bank. If central banks are able to target the public directly, there’s a very good chance we will see a lot more consumer price inflation than we’ve seen in prior decades.

This creates a need for safe haven assets unlike anything we’ve seen before. Bitcoin fills in the role of sound money in this purely digital world, and it does so arguably better than gold, as anyone in the world can have direct custody of this asset, regardless of how much or how little they buy.

Not only that, but a digital version of money would make the average citizen a lot more comfortable with the idea of digital assets than they are now. The bottom line is that COVID has accelerated the transition to natively digital government-issued money, and this will create both the need and the means for the masses to purchase crypto assets.

MW: Recently, BlackRock’s fixed-income CIO, Rick Rieder, predicted that bitcoin would become a reserve asset that will replace gold in the long term. Are we there yet?

Villaverde: We’re not there yet. Gold is still the go-to asset for large fund managers to diversify into alternative safe havens. Gold is a $10 trillion asset, while bitcoin is still tiny in comparison, at around $360 billion. Large fund managers are sitting on some $30 trillion worth of zero-yielding government bonds. They need to diversify this part of their portfolio, and as much as they may want to go into bitcoin, the fact is that they cannot. For them, gold is the only game in town.

This isn’t to say that bitcoin won’t beat gold’s price performance by several orders of magnitude as the world looks for alternative safe havens. We fully expect it will. But this will be a function of its lower liquidity rather than most capital going into into it. Beyond that, it’s too soon to say whether or not bitcoin can fully replace gold as the go-to safe haven asset.

MW: What is bitcoin’s upside potential?

Villaverde: At $360 billion in market cap, bitcoin is currently deeply undervalued. Even if we expect it to take a small amount of gold’s market share, we’re still talking about a $2 trillion asset at the very least, within the next five or so years. That puts bitcoin’s price at around $100,000 as a conservative estimate. A more realistic estimate for the next five years would be half of gold’s market cap, which would put bitcoin’s price at around $250,000, and that’s assuming gold has zero price appreciation during that time period, which is not realistic. Bitcoin is deeply undervalued at less than $100,000 per coin, and its likely future price will be in the mid- to high-six digits over the next decade.

MW: Is this bitcoin’s institutional FOMO moment?

Villaverde: The key difference between now and 2017 is that the current rally is largely being led by reputable investors dipping their toes into bitcoin. Not only do we have the likes of Stan Druckenmiller or Paul Tudor Jones declaring they are now involved in the crypto markets, we also have die-hard skeptics like Nouriel Roubini conceding that there may be a place for bitcoin in a world of digital fiat money.

Is this enough to cause institutional FOMO? Not yet. It’s early innings still. Even fund managers by and large have yet to take the “orange pill“ and commit a portion of their portfolios into bitcoin. The bulk of institutions are likely to come in only after bitcoin has crossed the $100,000 threshold.

MW: Is this the right time for average investors to get in?

Villaverde: Short-term corrections notwithstanding, bitcoin is deeply undervalued, even at $20,000. That’s at least a five-time return using a very conservative valuation of $100,000 per bitcoin. As long as bitcoin trades below the six-digit threshold, it’s a good time to get involved.

Word of caution, though: Our timing models are indicating — and have been for some weeks — that crypto assets are overdue for a correction in the near future. We would be remiss if we didn’t point out that bitcoin is notorious for experiencing high volatility, both to the upside and the downside. While investing in bitcoin is not for the faint of heart, those who have the will to stomach high volatility can still benefit tremendously, even at current prices.