One of Bitcoin’s biggest strengths could also present its biggest risk

Julie Hyman·AnchorFri, February 19, 2021, 7:18 PM·2 min read

(Yahoo Finance) – The enthusiasm over bitcoin’s rise this year has fed on itself, drawing in new investors and sending the price ever higher. But that enthusiasm — ebullience, even — may also present the cryptocurrency’s current biggest risk.

Part, if not all, of bitcoin’s (BTC-USD) appeal for many investors is that it’s seen as a store of value. That is, it has value because it’s perceived to have value. While longtime bitcoin buyers may believe the cryptocurrency will become a valid alternative currency, or that blockchain is a technology that will fundamentally change the world in various ways, many other buyers — particularly recent ones — are getting in for a simple reason: it keeps going up.

“Sentiment translates into demand, and demand dictates shifts in the market. Sentiment around bitcoin has never been this ebullient,” said Meltem Demirors, chief strategy officer at digital asset manager CoinShares, in an interview with Yahoo Finance Live.

That sentiment is evident in bitcoin’s price, which rose above $52,000 this week — a record. That puts its one-year return at more than 400%, and its gain in 2021 alone at more than 75%. It’s also evident in the number of new entrants, now at a record 35.6 million bitcoin addresses (those receiving or sending bitcoin) in January, according to The Block/Glassnode. Bitcoin saw inflows of $367 million in the week ended Feb. 15, according to CoinShares data.

But the higher bitcoin gets, the more the fear-of-missing-out trade catches fire. Risk-taking behavior might ensue, causing a risk in and of itself.

“My primary concern is the market, when it gets overheated, does tend to become ebullient, and we see a lot of leverage, and the cost of capital becomes expensive,” Demirors said. “Whenever leverage is taken out of the market, we see more drawdowns, which drives fear.”

Bitcoin investors, of course, have been here before, most dramatically at the end of 2017 when the cryptocurrency crashed to $4,000 in December from a then-record of more than $19,000 to less than $14,000 in the span of a week. Even if they don’t believe that crash will be repeated, its memory looms large, and has cemented bitcoin’s reputation as a volatile instrument.

While there hasn’t been a drop of the same magnitude, bitcoin did pull back from a high of around $40,000 in early January and touched below $30,000 a couple of weeks later before rebounding.

That volatility also remains a risk in the eyes of JPMorgan strategists, who earlier this week said bitcoin’s rally would be unsustainable unless price swings calm down.

Julie Hyman is the co-anchor of Yahoo Finance Live, weekdays 9am-11am ET.

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