Bitcoin (BTC 1.70%) has lost 75% of its value in the past year. The crypto market may have run too high, too fast in the fall of 2021, setting up just about every digital coin for a sharp correction. Rampant inflation and painful government measures designed to combat it have also weighed on high-risk investments this year, and Bitcoin falls into that category. And if these high-level concerns in the market weren’t enough, crypto investors recently lost some of their faith in the industry after a major crypto-trading exchange collapsed.
There could still be another shoe to drop, further driving down token prices. This ongoing crisis is neither the deepest nor the longest crypto winter on record, as the plunge after the crypto gold rush in the fall of 2017 saw prices plummet more than 80% below all-time highs and the next rally started 14 months later. Still, this 12-month downturn is a force to be reckoned with.
Bitcoin prices have therefore fallen a lot and there is no guarantee that the negative trend will be over. Investors who doubt the long-term value of Bitcoin (or any cryptocurrency) may consider this sharp decline as the beginning of the end. From this perspective, Bitcoin may never see the previous all-time high of $68,790 again, and there is no reason to invest cold, hard dollars in this expired fashion.
However, I cannot fully agree with Bitcoin bears. In my eyes, blockchain ledgers are about to reshape the way business, money transfers and the storage of value are done. Bitcoin holds a special place in this revolution thanks to its unparalleled market reach and anti-inflationary lifetime limit on the number of Bitcoin tokens in the market. From this perspective, the long, deep price drop starts to look like an open invitation to buy digital coins at a fantastic price.
Let’s say you’re ready to put Bitcoin in your wallet – but maybe you don’t really want to own that cryptocurrency directly. You actually have a few options available, and each alternative has a unique set of pros and cons.
Shares in companies holding bitcoins
Some publicly traded companies hold significant amounts of Bitcoin on their balance sheets. In some cases, this choice makes a lot of sense.
Bitcoin miners Digital Marathon (MARA -4.27%) and Riot Blockchain (RIOT -2.79%), for example, currently own around 11,300 and 6,800 Bitcoin, respectively. Marathon mined 615 Bitcoins in October and Riot generated 509 coins during the same period. This is what these companies do for a living, so of course they own a lot of Bitcoin.
But you have to be careful with bitcoin miners. Ideally, they can generate new Bitcoins whose value exceeds the cost of doing all this calculation. Bitcoin prices rise in the long term, as does the miner’s home cryptocurrency token pool. The growth potential of this two-tier business idea is huge.
This doesn’t always happen, however. When electricity prices are high and Bitcoin prices are low, pure crypto mining companies can struggle to keep the lights on. Selling some of those hard-earned Bitcoins just to pay the bills is an option of last resort, especially when the cryptocurrency is cheap. Additionally, miners have to deal with various real-world problems that have nothing to do with the crypto market. In the second quarter of 2022, for example, Marathon struggled with bad weather in Montana and a production backlog due to a dispute over wind energy tax credits in Texas. These headaches can add up to serious financial problems, so crypto miners add a significant layer of additional risk to the already unpredictable crypto market. That is why these stocks are much more volatile than Bitcoin itself:
Other bitcoin holders are less obvious. Fintech giant To block (SQ -4.64%) does not mine Bitcoin, but CEO Jack Dorsey sees great value in the largest crypto token and Block has invested $220 million in Bitcoin so far. It’s a drop in the bucket next to Block’s $4.3 billion in cash equivalents and $1.1 billion in short-term debt, but this collection of around 8 000 Bitcoins is still respectable. Investing in Block gives you a small exposure to Bitcoin and cryptocurrencies, backed by a larger financial services firm. This is one of the surest ways to dip your toes in the waters of digital currency.
At the other end of the spectrum, you will find a business intelligence expert MicroStrategy (MSTR -1.94%). Under the leadership of former CEO and current Executive Chairman Michael Saylor, this company has amassed 130,000 Bitcoins. MicroStrategy invested most of its cash reserves in cryptocurrency and continued to fund more through free cash flow from the software operation. MicroStrategy is also willing to take out loans and sell additional shares in order to buy more Bitcoin. In a recent twist, the company secured a $205 million loan from Silvergate Capital (IF -9.46%), where collateral for the loan is MicroStrategy’s Bitcoin holdings. Of course, the Silvergate loan was immediately invested in more Bitcoin.
MicroStrategy’s Bitcoin is worth around $2.14 billion at current prices. That’s 35% more than the market capitalization of $1.58 billion. The software company provides a safety net in case bitcoin investing doesn’t work, but in many ways MicroStrategy is like a bitcoin miner without the mining activity. This stock is a high-risk, high-reward route to the crypto market, with a risk profile closer to that of Marathon and Riot than that of Block.
Funds and trusts
Many financial companies want to introduce exchange-traded funds (ETFs) that mirror the price of Bitcoin but are traded like common stocks. However, the Securities and Exchange Commission (SEC) continues to reject these proposals, arguing that they do not provide sufficient protection against fraud and money laundering issues. If and when the constant stream of rejections ends, a Bitcoin-based ETF could become a solid combination of familiar trading rules and a direct link to Bitcoin’s price.
But we are not there yet. Meanwhile, investment management experts have come up with few close but not quite alternatives.
- Grayscale Bitcoin Trust (GBTC -3.42%) is almost an ETF. The trust holds 633,600 Bitcoins worth $10.5 billion at today’s prices. The Grayscale fund is trading at a 40% discount to this Bitcoin value, primarily because the fund structure lacks many investor-friendly features. Investors expect this discount to disappear once Grayscale is allowed to convert this security into a suitable ETF.
- ETFs like the ProShares Bitcoin Strategy ETF (BITO 0.15%) provide the desired ETF structure, but the market value of the fund is not backed by a reserve of Bitcoin. Instead, fund managers attempt to reflect the true price of Bitcoin by trading US Treasury bills and Bitcoin futures. This idea works, but the price match is rarely perfect and the intense management effort adds overhead that reduces returns for investors.
The Grayscale Trust and futures-based ETFs like the ProShares fund above tend to underperform Bitcoin over the long term. Until investors can get their hands on full Bitcoin ETFs that wrap the currency’s performance in regulated collateral, it’s probably best that you own Bitcoin outright. The exception to this rule of thumb is that the grayscale trust comes with a built-in advantage that should be triggered whenever the SEC starts creating Bitcoin-Based ETF Securities. The massive discount indicates that many investors do not expect this to happen.