Quiz!
What asset is bitcoin most similar to, and why?
- Dollars
- Bonds
- Gold
- Stocks
- Real estate
Do I Invest in Bitcoin?
Bitcoin was invented in 2009 as a digital currency, and exhibited phenomenal growth so far, raising the question: what growth can we expect moving forward? While it is easy to extrapolate recent growth into the future, it is not always correct. History is full of such examples. Below is an analysis of bitcoin as an investment.
Potential intrinsic long-term growth:
- Ongoing value creation: bitcoin doesn’t offer any product or service (unlike companies), or a place to live in (unlike real estate). It is tough to identify value creation in the long run.
- Ongoing value destruction: bitcoin cannot lose value through a sharp increase in supply, so not expected to lose value to inflation, unlike the dollar.
Conclusion: There is a potential for 0% very long-term growth beyond inflation.
Today’s pricing: 0% growth beyond inflation assumes that bitcoin is priced correctly today. While there are no useful measures to give it any specific value greater than $0 (it doesn’t produce anything), there is some useful information:
- Bitcoin is a software product, and its returns have been correlated with tech stocks (but more volatile). If this correlation sustains, we may be able to draw potential information about bitcoin’s pricing (valuations) using tech stocks.
- Bitcoin existed only during the current up-cycle of US tech stocks (since 2009, 15 years). This makes it risky to assume that its past returns will continue. US tech stocks have become extremely overpriced. They have extreme prices relative to intrinsic values (Price/Book). The S&P 500 developed an unusual concentration in tech stocks, as it did before prior crashes. Mid-last month, it reached record overpricing beyond the extreme of year 2000 (potentially, an all-time historic record overpricing). While tech stocks (as presented by the Nasdaq) declined by 78% after that peak, the excess volatility of bitcoin could imply a greater decline.
The future: One of the biggest stated appeals of bitcoin is the ability to avoid losing value to the high inflation created by governments, similar to the stated benefit of gold. Both aim to achieve this benefit through their limited supply (with a hard cap on the supply for bitcoin). This commonality allows us to put the benefit to the test of a very long history of gold.
- Recessions: History had more severe recessions under the gold standard, including The Great Depression. With inability to print more money easily, the Federal Reserve (the “Fed”) could not stimulate the economy. In contrast, without the gold standard, the Fed and government were able to stimulate the economy during recessions. As an extreme example, it helped prevent the 2008 recession from turning into a depression. Central bankers and economists are largely unanimous against the idea of returning to a gold standard. If bitcoin becomes too prevalent, the government could set regulations to make bitcoin uncompetitive, or even illegal (as China & Saudi Arabia did).
- Spreading recessions: The gold standard linked countries through fixed exchange rates. If a country struggled, people wanted to stop holding its currency. This would lead to a depleting stock of gold for the country. To prevent that, the country raised its interest rate, to make its currency more appealing to hold. Higher interest rates led to reduced economic activity, magnifying the country’s economic struggles.
More topics:
- Environmental Impact: Bitcoin mining uses an enormous amount of energy (over 100 terawatt hours last year). While it seeks to use energy at times of low demand, it is a true waste when compared to storage in batteries for later use. Until the world operates on 100% abundant renewable energy (we are far from that), bitcoin has a negative environmental impact.
- Limited supply is not a benefit: Bitcoin is designed to have limited supply. This does not imply any rate of growth, if it does not come along with an appeal. For example, if I can find a small rock of an uncommon shape or size, it won’t likely have much value, no matter how rare it is.
Summary: I don’t see bitcoin as an appealing investment in terms of expected returns (inflation + 0%) or risk-adjusted returns (extreme volatility, with very low expected returns). It doesn’t have theoretical reasoning as an investment – it doesn’t generate anything. It also doesn’t have a history of a full cycle, so past returns are still between irrelevant and offering a hint at a potential sharp reversal.
There are plenty of productive investments that generate value beyond inflation, including companies (stocks) & real estate. Their viability is rooted in basic human needs: the desire to get things done cheaply and efficiently (e.g. buying a car from a company instead of building it at home), and the need to have a place to live in (real estate). Of these assets, there are plenty that are priced very reasonably (including value & international stocks).
To answer the question of the title, I do not invest any of my money in bitcoin.
Quiz Answer:
What asset is bitcoin most similar to, and why?
- Dollars
- Bonds
- Gold [The Correct Answer]
- Stocks
- Real estate
Explanation:
- Both bitcoin and gold are used as an inflation hedge – the ability to store money without seeing it decline with inflation.
- Both don’t generate anything on an ongoing basis (though gold has intrinsic value, such as for jewelry, and bitcoin doesn’t).