BTC Price Catalyst: Bitcoin Halvings

On the subject of digital currency, the halving of the supply of Bitcoin occurred on 11 May. That has reduced the additional supply from 12.5 bitcoins per block to 6.25. This should increase upward price pressure assuming demand for Bitcoin continues to grow, as was the case after the previous halvings in 2012 and 2016.

Thus, after the first halving on 28 November 2012, Bitcoin rose 85 times in the following 12 months. While the second halving on 9 July 2016 resulted in a 30-fold gain within 18 months (see following chart).

Bitcoin Price

Source: Bloomberg

Remember as part of the algorithm in the bitcoin protocol, block rewards for miners are reduced roughly every four years by 50% (after every 210,000 blocks are mined), ending with the last Bitcoin ever to be minted in around 2140. So far Bitcoin price has risen by 14% since the halving on 11 May.

Protection Against Fiat Money: Bitcoin & Gold

Now it is true that the bitcoin price was hit in the March risk-off, declining by 57% from US$9,184 to US$3,915 in the week to 13 March (see previous chart). Still this does not necessarily mean that Bitcoin is just another high beta asset.

For gold also sold off, and also probably for the same reason, namely the need to liquidate assets where there were profits to take to pay for losses elsewhere. It is also the case that with Bitcoin many investors were holding leveraged positions.

To invest in bitcoin it is necessary to believe the system has integrity in the sense that the supply is truly limited. It also should be a source of diversification in a portfolio, as is gold, precisely because of its truly decentralised nature in stark contrast to the Chinese digital currency (discussed below). It is this feature, combined with the fixed supply, which makes it a hedge against central bank manipulated fiat money.

In this respect, Grizzle continues to believe that investors should own both gold and Bitcoin in the sense that they are not mutually exclusive, though clearly attitudes to both vary according to the demographic profile of the investor.

Meanwhile if institutional ownership of gold remains minimal in a world of passive investing, it is almost non-existent in the case of Bitcoin, though that has begun to change with the development of custody services for owning digital currencies.

It also looks promising from a longer term perspective that there are now about 30m wallets with a non-zero Bitcoin balance and only 3m wallets with more than 0.1 Bitcoin (worth US$970) in existence. The total number of Bitcoin wallets has risen by an annualised 65% from 5.4m at the end of 2015 to 50m (see following chart).

Total Number of Blockchain Wallets

Source: Blockchain.com

China’s Digital Renminbi Pilot Testing

Amidst the focus on the over-the-top monetary stimulus unleased by the Federal Reserve in response to the Covid-19 pandemic, it is easy to miss perhaps the most interesting news in central banking this year. And it has nothing to do with Covid-19.

That is the release by the People’s Bank of China of a digital renminbi for pilot testing. In April screenshots of a mobile wallet interface for so-called DC/EP (digital currency/electronic payment), rolled out by the Agricultural Bank of China, were shared all over social networks in China.

The rationale for China to move into a digital currency is clear. Apart from making use of a new cost saving and secure technology, it also represents a way for the central government to take back control over nominally private companies, such as Alibaba and Tencent, who have in effect controlled payment systems in recent years via the explosion of ecommerce in the mainland economy.

It is also the case that the digital currency will provide increased powers of surveillance for the authorities while providing practical convenience for users.

Digital Renminbi will Enhance Beijing’s Surveillance

The reason it will enhance Beijing’s surveillance is because the digital renminbi will have a centralised as opposed to a distributed ledger. In essence a central bank digital currency is an application of blockchain technology where digital tokens are minted by a central bank.

These tokens are equivalent to and redeemable for the domestic currency. So far as this writer understands the details, and no fintech expertise is claimed here, the central bank digital currency concept is like a blockchain with a master password enabling the central authorities to modify and influence the blockchain.

In this respect, the so-called “nodes” are permissioned by a central authority. By contrast, Bitcoin uses a so-called permission-less distributed protocol, which allows anyone with a server to participate in the network and become a validator of transactions as a so-called “miner”.

Meanwhile a key advantage for a central bank in using blockchain technology to launch a digital currency is that there is no master database which can be hacked or otherwise corrupted.

The pilot scheme has been launched in four large Chinese cities, Shenzhen, Xiong’an, Chengdu and Suzhou, by the country’s big four state banks for their customers in these cities.

There would seem little reason why the digital renminbi should not take off domestically given the central government’s backing and given that China is the biggest mobile payments market in the world with Rmb347tn (US$50tn) of transactions processed last year, up from Rmb22.6tn in 2014 (see following chart).

China Mobile Payment Transactions

Source: PBOC

This is particularly the case if it is the central government’s long-term goal, as it seems to be, to have cash replaced by a digital version.

International use is another matter. But the digital currency option is certainly one way that the use of the renminbi as a global settlement currency could grow by providing a mobile wallet option for foreign governments and citizens. It is also a digital currency option which has sovereign backing.

Meanwhile, the latest errors and omissions data in China’s balance of payments showed an increase in capital outflow pressure in the fourth quarter last year. The net errors and omission deficit rose from US$31.9bn in 3Q19 to US$62.6bn in 4Q19 and was up from US$178.7bn in 2018 to US$198.1bn in 2019 (see following chart).

China Balance of Payments: Net Errors and Omissions

Source: State Administration of Foreign Exchange (SAFE)

Still it has been right so far to continue to give Beijing the benefit of the doubt in terms of the authorities’ ability to manage the capital outflow pressure and certainly the renminbi was remarkably stable during the violent bout of risk off in March.

The renminbi has depreciated by 1.7% against the US dollar year to date and was up 0.3% against a trade-weighted basket of 24 currencies (see following chart).

China Renminbi/US$ (inverted scale) and Trade-Weighted Renminbi Index

Source: China Bond Connect

Here a key positive has been continuing investment inflows, most particularly foreign purchases of Chinese bonds, as foreign ownership of Chinese bonds and stocks has continued to rise from a low base.

Foreign holdings of Chinese bonds for example, have increased by Rmb238.4bn in the first five months of 2020 to Rmb2.426tn, after rising by Rmb457.7bn in 2019 (see following chart). Meanwhile the digital renminbi should in the longer term further enhance Beijing’s powers of control in terms of managing the capital account.

Foreign Holdings of Chinese Bonds

Source: China Bond Connect

 

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

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