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January 25, 2021
After coming into our broader investing consciousness three years ago, cryptocurrencies receded in potential importance when prices declined after the first speculative wave. They’re now roaring back, particularly Bitcoin, which has a 70% market share. The primary driver behind this renewed demand is the continued debasement of global currencies through aggressive money supply growth. The current central bank-engineered financial repression with negative nominal and real interest rates has heightened investors’ need to find alternative stores of value1 to cash. Additionally, it has bid up financial assets to historically high levels.
Bitcoin has been favorably compared to gold, the traditional hedge against governments’ excessive printing of paper money. Gold’s appeal has always been its limited supply and difficulty to mine. Bitcoin has been dubbed “millennial gold” because of its limited supply of 21 million coins. Plus, it’s difficult for computer programmers to create more coins as that supply dwindles. There are roughly 18.5 million Bitcoins in existence today. If supply is truly limited and beyond the control of central banks, potential investors need only estimate demand to determine value, an admittedly difficult task. The value of real assets, including commodities and cryptocurrencies, is based on the intersection between supply and demand. In contrast, cash-flowing assets are rather easily valued by estimating and discounting the future flows at current interest rates.
The comparison of Bitcoin to gold is valid at face value but subject to some important caveats:
Having effectively dismissed Bitcoin as a transaction currency, it appears investors view it more as a speculative hedge in the same way they have used gold. The real possibility that Bitcoin could take substantial market share from gold could be a major driver of significant appreciation over the coming months and years. To truly compete with gold, longer-term investors need to grow more confident in the cryptocurrency’s limited supply nature.
Some institutional investors at hedge funds, university endowments, and pension plans have begun to consider and utilize Bitcoin as an additional investment asset class with its own unique risk and return profile. They hope it will have a low correlation with the other asset classes in their portfolios. Because the asset has a very limited trading history and has been prone to speculative excess, the allocations have generally been small. Still, it’s an encouraging sign of greater stability in the prospective investor base. To the extent Bitcoin replaces gold as a preferred portfolio holding, the price can continue to appreciate substantially from current levels.
Given its relative youth, there have been some growing pains with using Bitcoin as an investment. It appears upward of 20% of the Bitcoin in existence has been lost due to creators and owners forgetting their passwords or losing their cold storage devices (e.g., external drives). This is somewhat akin to 18th-century pirates forgetting where they buried their pillaged gold. From a trading perspective, instances of price manipulation have occurred. Moreover, it’s ironic that a vehicle primarily used by climate-conscious millennials consumes tremendous amounts of energy in its digital mining efforts.
People largely accept that the worldwide supply of gold is limited. And with its commercial use in jewelry and electronics, it is difficult to imagine the price ever declining to zero. In contrast, Bitcoin has no such commercial purpose beyond its role as a currency hedge and potential store of value. Given the astonishing advances in computer technology over the last 50 years, it’s plausible Bitcoin could fall out of favor as the preferred cryptocurrency. If it is eventually replaced or becomes heavily regulated, Bitcoin could be deemed worthless with no other demand sources.
The development of Bitcoin exchange-traded funds (ETFs), like those available for gold, may take some time. More analysis is needed to ensure safe custody and to prevent market manipulation. A few tradable vehicles have been developed that hold Bitcoin in trust, but they usually trade at substantial premiums to the underlying value of the holdings.
Because of its limited track record, we do not yet believe Bitcoin is a separate asset class. Despite some interest as a longer-term investment from some institutions, it is a highly volatile, speculative investment held by short-term, trading-oriented investors. Long-term investors must resist the FOMO (Fear of Missing Out) emotion for the time being. They should wait for more ownership issues to be resolved and for Bitcoin to build a longer track record.
For clients interested in cryptocurrencies, please contact your Cerity Partners advisor to take you through the various ways to participate.
1 Store of value refers to an asset with a relatively stable inflation-adjusted price, meaning if you buy it now and save for future use, the purchasing power should be approximately the same.
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Ben is the Chief Investment Officer and a Partner in the New York office. He leads the firm’s Investment Committee and is a member of...
Tom is the Chief Solutions Officer and a Partner in the New York office. He has over ten years of experience in various investment management...
Jim is the firm’s Chief Equity Strategist and a Partner in the New York office. He has over twenty-five years of experience managing investment portfolios...
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