After Tesla announced that it invested the US $ 1.5 billion in bitcoins and hopes to start accepting cryptocurrency as payment for its electric vehicles in the near future, the price of bitcoin skyrocketed. It went from about $ 39,400 to an all-time high of more than $ 48,000 in less than 24 hours.
The price has now risen more than 50% in the first six weeks of 2021. Led by Elon Musk, Tesla's investment is obviously already in profit: depending on the exact day of the purchase, it is likely to be worth more than $ 2,000. millions. aiming for a paper profit of over $ 500 million. To put that in context, when the electric car maker made its first annual net profit in 2020, it was just over $ 700 million.
Tesla's move to bitcoin is due to a wave of institutional money invested in the leading cryptocurrency in recent months, in addition to many other companies putting it in their treasury reserves. Given that the sixth most valuable company in the world also says it could buy and hold other digital assets "from time to time or for the long term," it must be tempting for other major companies to do the same. Since Tesla's announcement, Twitter CFO Ned Segal has already signaled that his company is considering such a move, while a Royal Bank of Canada research note has explained why it would benefit Apple.
The prospect of a bluechip invasion of bitcoin has caused a lot of excitement among cryptocurrency investors. But if Tesla triggers such a gold rush, there will also be some disturbing consequences.
Volatility spill
Tesla justified this substantial change in the way it manages its cash reserves by stating that investing in bitcoin "will provide us with more flexibility to further diversify and maximize returns on our cash." Corporate treasurers have always used money markets to invest surplus cash for small returns, and it is more difficult than it used to be in today's low long-term interest rate environment.
Regardless, this is very different from standard money management. Bitcoin is a highly volatile asset that you would not normally associate with the cash reserves on the balance sheet of a publicly-traded company worth close to a trillion US dollars. In March 2020, the price fell below $ 4,000. Even in 2021, the price fell more than 30% before its most recent increase.
Tesla has put almost 8% of its reserves in the cryptocurrency. If Apple, Microsoft, Facebook, Twitter and Google did the same, this would translate into almost another $ 7 billion investment. This is less than 1% of the total current value of the bitcoin market, but the signal it would send to other businesses and retail investors would likely trigger a bull run that would make the current market appear comparably stable. Some crypto analysts are already predicting that the price will surge to $ 100,000 or even $ 200,000 before the end of 2021.
Such an increase would raise the value of bitcoin on corporate balance sheets to multiples of what it was at the time of investment. Tesla's 8% allocation may have already risen to 12% of the value of its reserves, for example. And if you go ahead with a potential plan to conserve the bitcoins you receive for electric cars rather than converting them into dollars, that percentage could rise much faster.
The problem is the potential effect on the company's stock prices. Tesla's share price rose 2% on the news of the bitcoin investment, although it has since fallen 5%. But a longer-term example is Canadian technology company Microstrategy. Its share price has increased tenfold in the past year thanks to a heavy investment in bitcoin, but it has also dropped by almost a quarter in the days after Tesla's announcement.
Generally speaking, this could make equity markets much more choppy going forward and vulnerable to a nosedive when the bitcoin bull market ends. It would be easy to imagine that this could trigger a broader selloff as investors seek to cover their deficit positions, which could be very dangerous to financial stability.
What the regulators will do
Global regulators will undoubtedly be concerned about a potential spill-over of digital asset price volatility in traditional capital markets. They may not allow what could quickly amount to effective backdoor approval for companies that have large proportions of a volatile asset on their balance sheets.
We have already seen people like the president of the European Central Bank, Christine Lagarde, and the new secretary of the US Treasury, Janet Yellen, calling for more regulation of bitcoin in recent weeks.
The opinion of the US regulator, the SEC, will be extremely important, and it is difficult to predict the response of the newly appointed director Gary Gensler, who is an expert in cryptography. We may see anything from a wait-and-see approach to a ban on publicly traded companies holding bitcoin-like assets.
But I would expect that if the bitcoin price continues towards $ 100,000, there may be a regulatory restriction on the reserve percentage that publicly traded companies can have in digital assets. This would be similar to the American rule that companies cannot buy back more than 25% of the average daily volume of their own shares. Such a rule would force companies to sell bitcoins if a price increase meant their holdings would exceed the maximum level, creating a form of selling pressure that the crypto market has not seen before.
For now, though, bitcoin still looks like a "buy" asset on the back of the Tesla announcement. The crypto community will be watching to see if other major companies do the same and if Tesla has the conviction to keep investing when its next quarterly announcement arrives. But if this trend continues, make no mistake that a reckoning will come on the prospect of the heady volatility of the crypto market spreading. Look at this space.
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