3/15/2021
The most prominent digital currency in the world right now is Bitcoin. The market capitalization for all Bitcoin just crossed over $1 Trillion U.S. Dollars. A single bitcoin can be bought for more than $55,000. Prominent business icons, like Musk, Dorsey and Tudor-Jones, have bought it aggressively, even replacing dignified U.S. Treasury Bonds in corporate treasury accounts with Bitcoin. Business channels have featured Bitcoin educational series. Acolytes have said that despite the recent quintupling of the price of Bitcoin, that it could still increase by magnitudes of 10s or hundreds.
Oh by the way, it’s completely worthless and its value is absolutely dependent on faith. That is not an opinion, but rather a truth of most forms of currency for the last 5,000 years, and especially true of Bitcoin.
What it is and what it is not.
Bitcoin is a store of value and an investment vehicle, but it is not a true currency. Bitcoin holds value the same way gold or diamonds do. Scarcity is its biggest ally. Only 21 million bitcoins will ever be created, currently about 18.7 million are floating in the open markets, and about 2.3 million have yet to be mined. It has been estimated that those last 2.3 million bitcoins will take 120 years to be mined, due to the halving of releasing blocks (a digression worth several paragraphs, but not taken here).
Bitcoin is an investment vehicle, like commodities, bonds, stocks, or real estate. There are buyers and sellers who meet at various fragmented clearing houses and agree on a price to transact at. That price has fluctuated wildly. In the dozen years that Bitcoin has been around, it has had six distinct price booms and five busts so far. Most of those cycles showed 400%+ gains during the booms, followed by 70%+ losses during the busts. The current boom is approaching three times the value of the last boom.
There is no implicit sovereign backing or precious metal collateralizing bitcoin’s base the way fiat currencies have. Like gold and diamonds, it has a negative carry and yields nothing. But unlike most sovereign currencies, it is limited in supply and cannot “print” a discretionary additional supply. It is this limited supply that has created such price volatility throughout its lifetime.
Bitcoin is also not a currency because it is not widely accepted as payment. Bitcoin can be divided into tiny fractions allowing for small dollar purchases, but the public concentrates on the price of one bitcoin, and this grates against the prospect of quick, accessible transactions. Proponents will point to anecdotal retailers accepting payment in Bitcoin, but these remain rare.
Although there are derivatives of Bitcoin that also use the blockchain technology like Bitcoin Cash, Bitcoin itself is not the transactional money it was born to be. While the blockchain allows digital breadcrumbs to expose every transaction committed with Bitcoin, a seemingly positive security measure that should prevent nefarious activities and Bitcoin theft, the opposite has been the norm. Bitcoin has been used by international drug dealers, corrupt dictators, and sanctioned nation-states because it is a bearer instrument outside the normal banking system. For these same reasons, it has been the target of countless digital thefts.
Bitcoin is an inflation hedge, and with the total global currencies increasing by about 10% in 2020 due to central bank money printing, inflation is coming. This bodes well for the price of Bitcoin. If the bond market continues to yield higher rates, Bitcoin will attract money flows that normally would go to bond allocations due to their perceived future underperformance. Gold has also seen a decline in money flows when Bitcoin surges. And if more like Elon Musk, Jack Dorsey, and Michael Saylor, CEOs of Tesla, Twitter and MicroStrategy respectively, foresee negative bond returns and ditch the conservative Treasury bonds from their eponymous treasury accounts in favor of Bitcoin, the price will rise.
Bitcoin is also maturing. The infrastructure for on-ramping and off-ramping from traditional currencies is being built out now. There are less institutional thefts because security protocols have improved for digital storage, including cold storage, insurance, and digital wallets. It is these security measures that create a negative carry for the asset but will also help to mainstream it.
The rise in the price of Bitcoin from here is predicated on mass adoption by individual and corporate investors needing exposure to a scarce asset. The price will go up 10 to 100-fold, so the pitch goes, when the whole world realizes they need a piece of this rare future money.
Should Bitcoin be part of my investment portfolio?
Diamonds have some industrial cutting uses, and they look pretty. Gold as well, has some uses in electronic conductors, and is nice looking. But if both were to lose their commercial uses, they could still fall back on their good looks, as rare beauties for jewelry. Bitcoin has no valuable attributes. If it loses public interest, if even acolytes are convinced of its folly, its price will fall to zero. There is no liquidation price, no price where it makes sense from a value stance. It is worthless.
If you examine the history of money from shells, beads, cattle, leather, silver, gold, and paper notes you will encounter mass faith in the value of mass faith. It is not the form of money that has value, often the form is worthless, it is the faith that society will continue to believe the story behind the form that holds the value.
If Bitcoin continues to attract attention for its rising price, then a positive feed-back loop will carry it higher. And even if only a small fraction of companies see Bitcoin as an appropriate investment for their treasury accounts, the small float of Bitcoin available will create an institutional stampede through a pinhole, pushing the price higher. Finally, if you hedge inflation, Bitcoin should see its way into your portfolio in a measured way. If you have a 5% allocation to gold, consider a 2% allocation to Bitcoin. Be price sensitive and recognize where the price of Bitcoin is in context with its historical pattern. Despite being worthless, it could be of considerable value if its story continues.
Justin Hudock
Starboard Wealth Management