Do We Need Bitcoin For What It’s Become?

Has bitcoin found its identity as an asset class?

Last month, bitcoin briefly “decorrelated” from tech stocks. While benchmark stock indexes cratered, bitcoin firmly held its ground. In September, the S&P 500 and Nasdaq were down 10% and 12%, and bitcoin barely budged (until this week).

What’s going on here?

Your guess is as good as mine because, unlike other asset classes, bitcoin doesn’t have much of a valuation benchmark.

After all, we can’t value it as a currency (or a medium of exchange). There is very little, if anything, we can buy with it without the involvement of a fiat currency. And despite its long correlation with tech equities, we can’t value it as a stock either. It doesn’t generate earnings, nor does it pay a dividend.

So what is it then and how can we put a price tag on such an asset, if any?

A decentralized fairytale

A decentralized currency is a lovely democratic idea, and you can discuss its merits against fiat currencies day and night. But the hard truth is, no government, however democratic, will give away its control over legal tender.

You don’t have to look far back to see what they are capable of.

Take gold. It’s the world’s oldest currency that is still used to date. Even after fiat currencies replaced it, it’s one of the vital reserve assets of central banks and by far the most popular alternative asset class.

And yet, any time gold threatened to strip the government of its power to control money, lawmakers quickly stepped in.

A good example is the U.S. during the Great Depression. In 1931, the nation was in the heat of the worst financial crisis in history. But unlike today, the Fed’s hands were mostly tied.

It couldn’t print that many dollars to prop up the economy because the currency was linked to gold. So Franklin Roosevelt passed Executive Order 6102, later dubbed the “Great Confiscation,”which forced Americans to turn in their gold at well below market rates.

This allowed the Fed to print more dollars to support the economy and shore up the exchange rate. Later the dollar was re-pegged to gold at a ~50% higher price.

And the U.S. is not alone. In the 1950s and ‘60s, Australia and the UK carried out similar gold “confiscations” to stop the decline in their currencies.

Banning bitcoin at this point would be a political walk in the park compared to the Great Confiscation and other measures governments have taken in the past. So we have to get realistic here.

Unless there’s some kind of political cataclysm that shreds the world order as we know it to pieces, bitcoin’s chances as a currency are very slim. If it grows too big to compete with paper money, lawmakers will eat it alive.

But the fact that bitcoin can’t become a currency doesn’t necessarily mean bitcoin is worthless.

Bitcoin

BTC
doesn’t compete with paper money. It competes with “insurance” against paper money

From an investment and ideological standpoint, bitcoin is more like a commodity than a currency. More precisely, gold—one of the most expensive and “useless” commodities in the world.

Unlike other commodities like oil, gold has limited use. For example, ~3,000 tons of gold were dug up and sold last year. And of that amount, just 35% went into electronics and jewelry. The rest was melted into bars and coins and stowed away in vaults

Nor is gold legal tender. You can’t walk into Pizza Hut, drop a sliver of gold on the counter, and expect to get a slice of pizza in return. And yet, central banks hold 34,000 tons of the shiny, yellow bullion bars in their reserves. Institutional and individual investors have sunk ~$2.7 trillion into gold. And every year, gold holdings keep growing and growing.

That’s because gold has just one job: sit tight in a vault and hold its value. And it does that job very well.

In fact, gold has outlived every modern currency ever created. And for thousands of years, it has successfully fought off inflation and even gone up in value.

In other words, gold is the “insurance” against everything that can go wrong with paper money. Inflation, devaluation, and whatnot. Or, as my ex-colleague Jared Dillian puts it: “Gold is a hedge against bad government decisions.”

In form, bitcoin is probably the furthest thing from gold you can think of. But as asset classes, the two are very much alike. Like gold, bitcoin has little utility. Its supply is limited—not by nature but by design. And its value purely depends on supply and demand rather than centralized monetary policy.

Can bitcoin beat gold’s track record?

For a store of value, gold has a hell of a credential.

By ancient sources, it has held its value against inflation for over 5,000 years. (As a rule, an ounce of gold has always been worth as much as a decent suit. If you don’t believe it, look it up for yourself.)

The catch is, if held directly—which makes the most sense for its purpose—gold is expensive to store/trade and illiquid. Plus holding metal slivers in a vault these days is a bit archaic.

This is where bitcoin comes in

Technically, it has it all to replace gold as a more convenient store of value.

Yes, it’s digital but it has a built-in incentive system that makes it scarce. It employs a distributed ledger, which means anybody can mine or use it without centralized oversight like gold. And its “monetary policy,” which is largely deflationary, is dictated by the people who use it.

Its weak spot is that it’s still on a roller coaster. And for a store of value, 13 years and one recession are just baby steps compared to gold’s track record.

So the question crypto investors should be asking isn’t “Will bitcoin replace the dollar?” but rather “Will crypto convince institutional investors to swap their gold with bitcoin as part of their 5%-something allocation in the portfolio?”

Is bitcoin maturing into a store of value?

Bitcoin has come a long, long way and deserves credit no matter where you stand in the crypto debate.

Just a few years ago, it was just this fringe asset that institutional investors laughed off as nerds’ play money. Warren Buffet famously trashed it as “rat poison squared.” But during Covid, investors have come around. They began to recognize bitcoin as a legit alternative to traditional asset classes, one that deserves a place in the portfolio.

Last year was more talk, but this year we’ve seen see some real action.

This past April, Fidelity became the first asset manager to offer bitcoin in 401(k) plans. And later, the Wall Street Journal reported rumors that Fidelity is seriously considering adding bitcoin trading to its 34 million brokerage accounts.

Then, in August, America’s largest crypto exchange, Coinbase, formed a partnership with BlackRock
BLK
—the biggest asset manager in the world—to bring bitcoin to institutional investors at scale.

In short, Coinbase will provide Blackrock’s “Aladdin” clients with direct access to bitcoin. For the first time, most institutional investors will be able to hold, trade, and broker the actual cryptocurrency instead of derivative instruments.

Aladdin is Blackrock’s flagship asset management platform that serves as a “dashboard” for some of the biggest fund managers in the world. As of 2020, it administered a crazy $21.6 trillion, which comes to around 7% of all assets in the world.

Of course, we have to be careful about jumping to conclusions from such moves.

For one, adopting crypto has become sort of a marketing/PR gimmick because it earns a lot of free media and can acquire a ton of diehard customers from the crypto community.

A good example is MicroStrategy
MSTR
. In August 2020, this business intelligence company made a splash by becoming the first public company to plow as much as $200 million into bitcoin and adopting it as a reserve asset.

When the news broke, the obscure Nasdaq company became the talk of the town and jumped ten-fold in a few short months. And despite losing money for three quarters, it attracted $4 billion in capital.

All at the expense of spending $200 million on bitcoin.

(I’m not saying MicroStrategy did it on purpose, I’m just showing the ROI of using crypto as a PR move. Controversy alert!: Who do I think did it on purpose? Musk. Yes, he’s an eccentric nerd who at first might have trolled around for fun. But part of me thinks it later became a conscious strategy to build a retail fan base that can shore up Tesla stock at insane valuations. If he was so serious about making a change, he would have spent more time advocating something of utility like bitcoin or ethereum rather than shitcoins.)

We have to be even more careful celebrating bitcoin adoption by Wall Street because the sell-side doesn’t invest and make money from asset appreciation. They are market makers who earn money from trade commissions. All they care about is volume, and if there’s demand for an asset, they’ll do everything in their power to fill it.

So just because Wall Street lets its clients trade bitcoin doesn’t necessarily mean it has much conviction in it.

What does bitcoin’s price action say?

Another way to proxy the market’s collective opinion of bitcoin is to look at its correlations.

Until Covid, bitcoin prices were all over the place. It was this weird, nerdy thing that a lot of people didn’t get it, and crypto didn’t correlate much with anything. But then the pandemic hit, and bitcoin found its new “identity.”

All of a sudden bitcoin became a mainstream technology play and began moving in tandem with the Nasdaq. That correlation steadily grew for most of the pandemic. And at one point in 2020, it hit 0.8—where 1 means that assets move in perfect sync. For perspective, very few asset classes and sectors have such a strong correlation.

Which means one thing.

The market didn’t buy bitcoin for its original promise. It wasn’t a hedge against fiat devaluation or the end of traditional finance. Instead, it was a highly speculative, risk-on investment.

In fact, bitcoin’s biggest run-up began in late 2020, only when Fed dollars sparked a speculative boom and it became clear there was a lot of money to be made from risky bets. Compare that to gold, which had already peaked at $2,000 by July.

But now, at least briefly, bitcoin went its own way.

From Sep 29 Meanwhile in Markets issue:

“In the past week, all major stock benchmarks were deep in the red. The S&P 500 cratered to 3,600 and hit the lowest level since Dec 2020. And both the Nasdaq and Dow were down some 5%.

Meanwhile, crypto has unexpectedly lunged in the opposite direction. In the same span, bitcoin jumped 6%, ethereum is up 4%, and many major altcoins scored near double-digit gains.

This decoupling came as a big surprise because for much of 2022 crypto moved in tandem with stocks.”

One plausible explanation is that bitcoin has gained a critical mass of HODLers who are ready to hold it no matter what. Such devotion is reminiscent of “gold bugs” for whom gold is more a political statement than an investment—which means bitcoin may indeed fulfill gold’s anti-establishment appeal.

From Sep 29 Meanwhile in Markets issue:

“In a recent note, Bitnex wrote that their data shows the “anomalous” rise of bitcoin HODLers despite the bear market: “​The number of HODLers in the top 5 categories (up to 0.1 BTC) has grown under bearish market conditions since April 2022, which is anomalous to previous bear market data. This is even more testament to retail investors and crypto adoption growing even when the macro conditions face headwinds.”

Glassnode’s on-chain analysis confirms that HODLing is at record levels and has a profound effect on bitcoin prices: “The cohort of investors with older coins remain steadfast, refusing to spend and exit their position at any meaningful scale… with mature spending severely muted, the degree of HODLing behavior is historically high.”

Of course, bitcoin’s decorrelation with stocks lasted for just a month and broke this week when bitcoin sank with stocks after hotter-than-expected inflation. So it’s way too early to jump to any conclusions.

Just out of curiosity, what would happen if bitcoin proved itself as a mainstream store of value?

It was estimated that private investments in gold (excluding central bank reserves) amounted to over $2.3 trillion last year. If bitcoin captured just half of this “store of value market,” it would alone quadruple its market cap.

That would send bitcoin to near a seven-figure mark, but then the question is…

Do we need bitcoin as a store of value?

If bitcoin doesn’t get much more than a store of value—that is, it doesn’t have much utility as a medium of exchange or any other application apart from storing value—it, in effect, invalidates its own digital superiority to gold.

In that case, does gold really need a replacement? A digital thing that sits “in a vault” anyway.

I’m not saying no, but it’d be interesting to take a pragmatic look at bitcoin and gold sheerly as stores of value from different points of view—including economics, sustainability, and ethics. But that’s for another day.

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