Cryptocurrencies are trending in both financial markets and cultural conversations. Of the estimated four thousand cryptocurrencies currently in circulation, Bitcoin is by far the largest, best-known, and most liquid cryptocurrency.

Bitcoin’s beginnings

Bitcoin traces its origin to a white paper published in 2009 by Satoshi Nakamoto, an anonymous person or group of people, on how to create a decentralized network for transferring value between two parties in a secure, anonymous, and digital manner without the use of an intermediary such as a bank. Since then, the cryptocurrency market has grown and evolved dramatically, to such an extent that Bitcoin now has an active futures market and recently saw the launch of the world’s first physically backed Bitcoin exchange-traded fund (ETF). The individual behind this Bitcoin ETF is Founder and CEO of Purpose Investment, Som Seif, CFA. In a webinar titled “Bitcoin—Are You Ready?”, hosted by CFA Society Toronto on April 26, 2021, Seif discussed cryptocurrencies in general, Bitcoin specifically, and his experience in launching Purpose’s Bitcoin ETF.

The evolution of the Bitcoin market

Seif’s journey toward cryptocurrencies and the eventual launch of Purpose’s Bitcoin ETF started with his background in managing, among other things, a physically backed gold ETF. Although he was initially skeptical about Bitcoin, this skepticism was replaced by curiosity as he started to inquire and learn more about cryptocurrencies in 2016. He strategically surrounded himself with a group of crypto specialists to learn as much as possible in the shortest amount of time. In 2017, Purpose filed an application with Canadian and U.S. regulators to establish the first Bitcoin ETF. This initial application was denied, with the regulators questioning various aspects of the application, ranging from Bitcoin’s legitimacy as an asset and anti-money-laundering concerns to questions about the infrastructure that supports the Bitcoin market such as custody, liquidity, and market-making, all of which are necessary to operate an efficient ETF. Back in 2017, much of this infrastructure was not sufficiently developed, and Seif suggests that in hindsight, it was a blessing that their initial filing was declined.

However, the Bitcoin market evolved, and Seif and his team worked tirelessly on the project despite Bitcoin’s price decline and the resultant drop in market interest from 2018 to 2020. Then, in 2020, they filed another application with the Canadian regulator, and after extensive consultation and close cooperation with regulators over the course of a couple of months, approval was granted to launch a Bitcoin ETF in Canada.

According to Seif, when their Bitcoin ETF was launched in February 2021, global interest in the product was greater than expected, especially given that Canadian products typically do not attract very much attention. Initially, most of the interest was from global retail investors and family offices, with some attention from hedge funds looking to gain secure and efficient exposure to Bitcoin. Once things settled down following the ETF’s launch, some large, long-only pension funds also showed interest, largely to get familiar with the asset class and test the market environment.

Into the future

On the question of whether there is room for more crypto ETFs, Seif believes that, as with gold, it is highly likely that other crypto ETFs will be established over time, which may ultimately serve to broaden the legitimacy of cryptocurrencies as an asset class. More ETFs will increase liquidity, improve risk diversification for investors by providing different custodians, and improve market efficiency in general.

Where does tax avoidance and money laundering fit into this discussion? These issues are not unique to cryptocurrencies, as they also occur with traditional fiat currency. But there is little doubt that governance around cryptocurrencies will improve over time as regulators and tax authorities catch up with the development of this financial market. In fact, this is already underway in Canada. As of June 2020, all cryptocurrency exchanges are required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and to adhere to know-your-client (KYC) compliance regulations such as confirming the identity of all clients, appointing a compliance officer, and maintaining records of clients and transactions.

As far as the drivers of the Bitcoin price are concerned, Seif believes Bitcoin remains a largely sentiment-driven asset with a finite supply. This is not dissimilar to gold, which also faces supply constraints and is influenced by global market sentiment. Also similar to gold, he notes that even if it is possible to transact in Bitcoin, its main utility is not derived from operating as a medium of exchange. Another key potential driver of its price is the concentration of the Bitcoin holder base. There are a few large Bitcoin holders, or “whales,” who could dominate price movements should they choose to trade in large volumes. This holds both price and volatility risk for Bitcoin.

Who will be Bitcoin’s competition in the cryptocurrency space? Seif suggests that over the past eleven years, Bitcoin has proven that it serves well as a transfer of value, although it is not yet functioning very well as a medium of exchange. Ethereum is the only cryptocurrency that Seif could see rivalling Bitcoin at some point in the future.

Conclusion

Lastly, as with other assets, Bitcoin will be scrutinized through the environmental, social, and governance (ESG) lens. Mining Bitcoin consumes a large among of energy, which remains a valid concern. Fortunately, unlike traditional mining of resources such as gold, the energy consumption of Bitcoin mining is more transparent and can be easily monitored throughout the entire value chain. For Bitcoin to be widely accepted, energy efficiency gains will need to be achieved in the mining of these coins. It is still early days, but there is a push toward greater energy efficiency in coin mining by centralizing Bitcoin mining and using renewable energy sources in these centralized locations.

Although only time will tell how large the cryptocurrency market will grow, the pace of innovation has certainly been phenomenal. In the meantime, this relatively new asset class will continue to challenge existing market beliefs on many fronts. Bitcoin—are you ready?