A big Morgan Stanley report shows how bitcoin is in danger of becoming a victim of its own success

Thomson Reuters

• Bitcoin has had a rough start to the year, but a note from Morgan Stanley shows there are issues surrounding the coin aside from slumping prices.
• The bank argued institutional money pouring into bitcoin could reduce its usefulness as an asset.
• Further, the cryptocurrency’s energy consumption presents a problem.
• The number of people using credit cards to buy bitcoin is another issue.

Bitcoin is in danger of becoming a victim of its own success.

That’s according to a big note by Morgan Stanley out to clients Wednesday titled “Bitcoin Critics Grab the Mic,” in which the bank examined three issues facing the crypto.

The red-hot digital currency, which soared close to $20,000 in December, has been trading under $10,000 for much of February. Bitcoin bulls point to institutional money diving into the digital coin as a major tailwind moving forward. But an increase in the coin’s popularity among institutions might actually hurt it, according to the bank. That’s because it’ll put the coin’s moves more in line with the broader markets, reducing its appeal as a non-correlated asset. Here’s the bank:

“The idea is that as institutional investors seek out increasingly higher levels of risk/return, that Bitcoin may represent the most risky/potentially highest return available, and hence could be evolving quickly into a primary barometer/leading indicator for broader financial markets and risk appetite.”

That raised a big question among the bank’s investor clients: “If Bitcoin correlation with the broader market fully materializes, does that limit its ultimate potential?”

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That correlation has increased, according to the bank, but there are some caveats. Here’s Morgan Stanley:

“But the current level of correlation still stands below previous periods in the past 14 months. And looking at the overall trend during that period, it is clear that correlation with the broader equity market has not been fully established in the data.”

As a second problem, the energy cost of mining has long been touted as one of the most negative consequences of bitcoin. Miners, the folks are rewarded new bitcoin for processing payments on the coin’s network and running computationally intensive algorithms to maintain the cryptocurrency’s security, have consumed more and more power as bitcoin’s popularity has soared. In mid-December, Newsweek estimated the cryptocurrency was on track to consume as much energy as every country on earth by 2020.

Bitcoin’s price rout has not pumped the brakes on its eye-popping energy consumption.

Morgan Stanley

“And as predicted, even as Bitcoin has fallen in price since Dec 17, we estimate electricity consumption has increased by over 50% to ~4,000MW (~35 terawatt hour/year run rate),” Morgan Stanley said.

As such, if bitcoin’s price were to recover to previous highs, the bank estimates the coin’s ecosystem would consume as much energy as 18 million US homes.

Bitcoin proponents say that having a decentralized financial system is worth the cost.

“Labeling Bitcoin mining as a ‘waste’ is a failure to look at the big picture,” Marc Bevand, a bitcoin miner, wrote in a blog.

Bevand argues that bitcoin’s positive impact on the global economy will make up for its energy costs:

“Even in the future, economic modeling predicts that if Bitcoin’s market capitalization reaches $1 trillion, then miners will still not account for more than 0.74% of the energy consumed by the world.IfBitcoin becomes this successful, it would have probably directly or indirectly increased the world’s GDP by at least 0.74%, therefore it will be worthwhile to spend 0.74% of the energy on it.”

Finally, Morgan Stanley also notes that bitcoin is more leveraged than previously thought — people are taking on debt to buy the cryptocurrency. The bank pointed out “new prohibitions on using credit cards to buy cryptocurrencies, implying that perhaps a substantial amount of Bitcoin buying in 2H17 had been funded with credit cards.”

Already, nearly 20% of cryptocurrency owners went into debt to invest in the market, according to Bloomberg reporting.

The fact that bitcoin is more leveraged than previously thought means it is more risky. Taking on debt to purchase bitcoin could result in amplified losses for someone who sees their holdings depreciate. That’s why a number of banks have lined up to announce a ban on purchasing crypto with credit cards.

In the US, JPMorgan Chase, Bank of America, and Citigroup recently announced they would do just that.