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February 2021 Economic Commentary

Bitcoin – Investment or Currency?

The move in Bitcoin over the last ten years has been nothing short of astounding. A thousand dollars invested in January of 2010 would now be worth well over one billion. How is that possible under a global financial system that prides itself on stability? What fortunes are sitting out there in dark places ready for Bitcoin to be turned into a freely exchangeable currency? How many Teslas will be purchased with Bitcoin in the next five years?

As an investment, Bitcoin has proven itself with staggering returns. Much of that is due to the dynamics behind the security. It has a finite supply unlike gold or sovereign currency which can be mined or printed. The blockchain mechanism behind Crypto is highly complicated and requires tremendous computing power and energy to mine just one coin.

Where Bitcoin came from is also still shrouded in mystery. Who uses it and controls the supply and inventory is completely opaque. There is no true regulated exchange, and as far as we know the origination could be Tokyo, Silicon Valley, or Beijing.

As asset managers, we are approaching Bitcoin with an abundance of caution. As an investment, there potentially exists the opportunity to use Bitcoin as an asset class like gold. The supply and demand dynamic is compelling, and rapid adoption by large financial players could accelerate the already historic move in this digital investment.

What worries us is the transition Bitcoin is making from store of value to currency. Already several large companies have declared they will accept Bitcoin for purchase of their product. The highest profile example is Tesla, which also holds a significant amount of Bitcoin on its balance sheet. This is exactly how the founders of Bitcoin imagined its role as “currency”. Their vision was to create the ability to execute fast and cheap transactions without barriers or borders, and free from the control of any centralized entity (such as government) that could manipulate its value. If Bitcoin does somehow reach the status as a currency more powerful than sovereigns like the dollar or euro, we could be witnessing a watershed period similar to the national banking era of the 1800s prior to the establishment of the Federal Reserve in 1913. During this era, we had many different currencies used to barter for goods and services; we also witnessed five depressions in 1819, 1837, 1857, 1873 and 1893. They were called “panics” at the time, and without a central currency backed by the full faith and credit of the US government, the result was economic chaos.

Of course this is not going to happen, and therein lies our issue with Bitcoin. It may continue to be a store of value and also act in a small but complementary way to the dollar, used for purchases by consumers with enough capital to invest in it. What cannot happen is for Bitcoin to become a widely adopted alternative currency; the regulators will step in and prevent this from happening at the same time tech giants push for it and financial giants dabble in it. Regulation is coming; it’s just difficult to judge how deep and aggressive it will be. The Federal Reserve is already working on its own cryptocurrency, while Treasury Secretary Janet Yellen has repeatedly warned about the possible misuse of virtual assets—so be prepared for more oversight.

Our view is that this can’t end well for Bitcoin and the 4000 other virtual currencies. There may still be some more room in this volatile ride, but our guess is that traditional asset classes and currencies win the day because sounder heads conclude that Bitcoin could represent the next Black Swan—a weapon of mass financial destruction with potential to destroy the dollar and all the benefits we have reaped through its status as the world’s reserve currency.

Please let me know if you have any questions via phone at 804-774-2087 or email at Jesse.Ellington@middleburgfinancial.com.

Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

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