Should Your Business Invest In Bitcoin?

Investing in Bitcoin is a hotly debated topic, with some arguing that it's an excellent way for businesses to diversify their portfolios and hedge against inflation, while others warn of the high risks associated with the volatile nature of cryptocurrencies. Bitcoin has seen a surge in popularity in recent years, with some well-known companies investing significant amounts of money into it. However, it's important to remember that the crypto market is highly speculative and prone to dramatic crashes, as evidenced by the 2022 crypto crash. For businesses considering investing in Bitcoin, it's crucial to carefully weigh the potential benefits against the significant risks.

Bitcoin's emergence from a financial crisis

Bitcoin emerged in 2008, at the height of the global financial crisis, as a groundbreaking electronic cash system. Its creator, the pseudonymous Satoshi Nakamoto, sent an email to a cypherpunk mailing list in October 2008, outlining a white paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System". This email was sent at a time when the world was in the midst of the 2007-2008 global financial crisis, which was caused by excessive risk-taking by international financial institutions, the build-up of toxic assets within banks, and the bursting of the US housing bubble.

The crisis culminated on September 15, 2008, when Lehman Brothers filed for bankruptcy, triggering a wave of crises in national economies worldwide, known as the "Great Recession". Against this backdrop, Nakamoto proposed a decentralized electronic cash system that would be "fully peer-to-peer, with no trusted third party". This system aimed to address the instability and lack of trust in traditional financial institutions that had been exposed during the crisis.

On January 3, 2009, the Bitcoin blockchain went live when Nakamoto mined the genesis block, embedding a message referencing the instability of traditional finance: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". Days later, Nakamoto sent an email announcing the first version of Bitcoin, explaining the basics of mining and sending coins, as well as touching on the total supply and the concept of Bitcoin halving.

The emergence of Bitcoin during this period of financial turmoil was significant. It represented a response to the crisis of confidence in banks and governments, offering a new way to conduct transactions without the need for a trusted third party. Bitcoin's digital nature and peer-to-peer network provided users with a degree of anonymity, making it attractive for illicit activities and powering the darknet of illegal online commerce.

While Bitcoin's price volatility and slow transaction speeds have made it less viable as a medium of exchange, its emergence during the financial crisis highlighted the potential for decentralized digital currencies to revolutionize the future of money and finance.

Bitcoin as a hedge against inflation

Bitcoin has emerged as a potential option for those seeking a hedge against inflation. Its design, characterised by a fixed supply of 21 million coins, safeguards it from the inflationary pressures that traditional currencies face. By nature, Bitcoin cannot undergo dilution through inflation, making it attractive to investors. Additionally, its decentralised architecture frees it from manipulation or control by central banks and governments, adding a layer of security for investors.

However, the unique design of Bitcoin does not guarantee its viability as an inflation hedge in all circumstances. The value of Bitcoin is driven by market demand and supply, and it is not backed by any tangible asset. As a result, its price can be highly volatile, experiencing significant fluctuations over short periods. For instance, between late 2017 and early 2018, Bitcoin's price dropped from nearly $20,000 to just above $3,000. This volatility poses a risk for investors, especially those who may need to liquidate their holdings during market stress.

Compared to traditional investment vehicles like gold, Bitcoin has a shorter history, making it challenging to predict its performance in diverse economic scenarios, particularly during inflationary periods. The regulatory landscape surrounding cryptocurrencies is another critical factor, as they are still subject to legal and regulatory uncertainties across different jurisdictions. Despite these risks, Bitcoin's potential as an inflation hedge is recognised.

When considering Bitcoin as a hedge against inflation, it is advisable to incorporate it as part of a diversified portfolio. By spreading investments across various asset types, investors can balance the potential benefits of Bitcoin with the risks it carries. Additionally, hedging against inflation is a long-term strategy that requires patience and discipline. While Bitcoin's price may fluctuate in the short term, its overall trajectory since its inception suggests a positive trend.

In conclusion, Bitcoin has potential as an inflation hedge due to its fixed supply and decentralised nature. However, its inherent volatility, regulatory uncertainties, and shorter historical record compared to traditional hedges like gold add a level of risk. Therefore, a careful, well-informed approach, combined with diversification, is crucial when considering Bitcoin as part of an inflation-hedging strategy.

The institutionalisation and regulation of Bitcoin

The institutionalisation of Bitcoin refers to the process of large financial institutions such as banks, hedge funds, and investment firms incorporating Bitcoin into their business models. This process has had a significant influence on Bitcoin's price and adoption.

The Impact of Institutionalisation on Bitcoin's Price

Bitcoin's price has been volatile since its creation in 2009, but as more institutional investors have entered the market, the price has stabilised. Institutional investors are typically long-term investors who prioritise portfolio diversification and risk management, making them less likely to sell their Bitcoin holdings during market volatility and thus limiting price swings. Additionally, institutional investors often invest large sums of money in Bitcoin, which can help keep the price stable. For example, when Tesla invested $1.5 billion in Bitcoin in February 2021, the price of Bitcoin increased by more than 10% in a single day.

Institutionalisation's Influence on Bitcoin Adoption

Bitcoin's institutionalisation has also impacted its adoption. Initially, Bitcoin was primarily used for peer-to-peer transactions by individuals and small businesses. However, as more institutions have entered the market, Bitcoin has gained acceptance as a form of payment. For instance, PayPal began allowing its users to buy, hold, and sell Bitcoin in late 2020, making it easier for people to transact in Bitcoin and interpreting this move as a significant endorsement of Bitcoin by a mainstream financial institution.

Challenges of Institutionalisation

While Bitcoin has benefited from institutionalisation, it has also faced challenges. One significant concern is the possibility of market manipulation by large institutional investors. If a small group of investors controls a significant portion of the Bitcoin market, they may be able to manipulate prices by buying or selling large amounts.

Additionally, the increased regulatory scrutiny that comes with institutionalisation may pose difficulties. Regulatory authorities may impose restrictions on the use of cryptocurrencies or strict reporting requirements on institutions, resulting in additional costs and administrative burdens. Finally, Bitcoin's increasing centralisation may raise concerns about the founding principle of decentralisation. As more institutions become involved, there is a risk of Bitcoin becoming more centralised and controlled by a few players.

The Regulation of Bitcoin

The regulation of Bitcoin and other cryptocurrencies is an ongoing process, with regulatory bodies such as the United States Securities and Exchange Commission (SEC) providing guidance. The regulatory context of cryptocurrency varies across jurisdictions, with some governments classifying it as a unit of account and others as a financial instrument. As Bitcoin and other cryptocurrencies gain prominence, regulators face the challenging task of balancing risk management with encouraging innovation.

Greater regulatory clarity is needed for the crypto industry to continue its upward trajectory. Increased regulation may benefit the industry in the long run, enabling more institutional players to enter the market and increasing their stake in the space. Exchanges are also feeling the pressure to ramp up ID verification processes and meet compliance obligations with robust Know Your Customer (KYC) and Anti-Money Laundering (AML) measures.

Bitcoin's volatility

Bitcoin is considered a volatile asset, and its price is highly variable compared to other assets such as stocks and ETFs. This volatility is measured by how much Bitcoin's price fluctuates relative to the average price over a given period. The volatility of Bitcoin is influenced by the speculative nature of the cryptocurrency industry, where investors bet on its price increasing or decreasing to make profits, resulting in sudden price surges or drops.

Volatility is a measure of the risk associated with holding a financial asset. A volatile asset is likely to experience substantial price fluctuations, making it riskier to hold. Higher volatility leads to a higher cost of hedging, impacting the price of merchant services. However, Bitcoin's volatility has been declining and is expected to continue doing so.

When compared to other assets, Bitcoin's volatility stands out. Gold, for instance, has a volatility average of around 1.2%, while major currencies average between 0.5% and 1.0%. This highlights the relatively higher volatility of Bitcoin when compared to traditional financial instruments.

Despite its volatility, Bitcoin has been less volatile than some prominent individual securities. For example, over the last two years, Bitcoin's volatility averaged 46%, while Netflix stock's volatility averaged 53%. Additionally, Bitcoin's volatility is not significantly higher than that of some large-cap and mega-cap stocks. As of October 2023, Bitcoin exhibited lower historical annualized volatility than 33 out of approximately 500 companies in the S&P 500.

While Bitcoin's volatility poses risks, it also presents opportunities. Historically, periods of low volatility in Bitcoin have been followed by steep rises in price. This suggests that low volatility could be a precursor to significant price increases. Additionally, investors have been well-compensated for Bitcoin's volatility, as evidenced by its Sharpe ratio of 0.96 from 2020 to early 2024, indicating that the returns have outweighed the risks.

Bitcoin's tax implications

Bitcoin is taxed, but how it's taxed depends on how and when you acquired it. The IRS treats bitcoin and other "convertible virtual currencies" as property, more specifically a capital asset, rather than a currency. This means there are tax consequences whenever bitcoin is bought, sold, or traded.

If you're based in the US, the long-term capital gains tax rate for bitcoin held for at least a year is between 0% and 20%. Some individuals may be subject to a net investment tax if they sell their bitcoin or use it as payment for goods and services.

If you're paid in bitcoin for goods or services, you must include the fair market value of the bitcoin in US dollars in your gross income. Transactions using virtual currency should also be reported in US dollars.

If you invest in bitcoin and then sell or trade it for a higher price than you bought it for, you owe capital gains taxes. If you own bitcoin and use it to make a purchase, that is also considered selling it, so you will have to pay capital gains taxes if the bitcoin you own is worth more than what you paid for it.

If you sell Bitcoin for a profit, you're taxed on the difference between your purchase price and the proceeds of the sale. This doesn't only mean selling Bitcoin for cash; it also includes exchanging your Bitcoin directly for another cryptocurrency, and using Bitcoin to pay for goods or services.

If you acquired Bitcoin from mining or as payment for goods or services, that value is taxable immediately, like earned income. You don't wait to sell, trade or use it before settling up with the IRS.

If you're based in Germany, the difference between private and business assets is significant. All the things you might have heard, like tax-free after one year, do not apply for business assets. Germany does not have the concept of a taxable event for business assets. A German business needs to do its accounting with these assets. Every transaction needs to be reflected in the accounting. So no matter if this is a buy or sell, there needs to be some reflection in the company's accounting. The profit and loss will then be calculated by the end of the year based on the overall properties of the company in the balance sheet.

For a UK-based company, cryptocurrency is considered an intangible asset and is, therefore, a chargeable asset for tax purposes as it meets the following two criteria: it is something that is capable of being owned, and its value is capable of being realised. If the company held cryptocurrency as an investment, then the disposal of the cryptocurrency will give rise to a chargeable gain/loss. If the company makes a chargeable gain from cryptocurrency disposal, it does not pay capital gains tax, instead, the company pays corporation tax (19% based on the tax rate for the 2019-20 tax year).

Frequently asked questions