The popularity of bitcoin and other cryptocurrencies has surged with the conversation entering the mainstream, and investors and businesses are exploring uses for the technology. The scope of the cryptocurrency topic is broad and complex. We initiate the conversation in this article by exploring the merits of including bitcoin, today’s dominant cryptocurrency, as an asset class in portfolios that can help investors achieve their financial goals.
“Bitcoin’s value is driven by the technology underlying its network and the supply-demand dynamics associated with it in the marketplace.”
Bitcoin background
A payment system and an asset
Bitcoin’s origin and purpose are to function primarily as a digital currency alternative to fiat currencies (the U.S. dollar, euro, and yen for example) issued and backed by global economies and central banking systems like the Federal Reserve. Bitcoin’s value is driven by the technology underlying its network and the supply-demand dynamics associated with it in the marketplace. The decentralized nature of Bitcoin was designed as a means of facilitating direct payments from peer to peer bypassing a central banking system such as the Federal Reserve while maintaining a permanent and anonymous record of all transactions.
Bitcoin is the best-known application of highly complex blockchain technology. However, it is only a subset of broader blockchain technology applications being used successfully today in both the manufacturing and financial services sectors. This paper focuses solely on bitcoin’s evolving identity as a commodity, currency, or potential future asset class and its merits as an asset class in an investment portfolio.
With several thousand cryptocurrencies in existence today, bitcoin’s market capitalization is larger than all the rest combined. For context, at a current market capitalization of roughly $1 trillion, if bitcoin were a stock (which it is not) in the Standard & Poor’s 500 Index, it would rank as the 5th largest in market value between Google and Facebook.
What type of asset is bitcoin?
Bitcoin doesn’t check all the boxes to be neatly categorized as a commodity, currency, or asset class. Its construct and speculative nature are untethered to the fundamental economic factors that drive valuations for traditional financial assets. Bitcoin was designed with a supply constraint, limiting the amount of coins that could be produced to only 21 million. As a result, a primary value driver for bitcoin is the supply-demand dynamics among users and the proprietary applications of its blockchain technology. Its relationship with other assets is more coincidental than correlated at present.
Valuations for commodities such as energy, industrial metals, or precious metals are largely driven by their physical scarcity, abundance, or demand at a given point in an economic cycle. In this sense, perhaps bitcoin is almost like a commodity given the supply-demand nature of its value drivers. However, its weak relationship with normal economic cycles makes a more compelling case for classifying bitcoin as a speculative real asset.
Currencies typically must meet three qualifying criteria. They serve as a medium of exchange, a unit of account, and a store of value. Bitcoin is increasingly accepted as a means of exchange but is not yet a medium of exchange with a commonly accepted value. Though businesses accept bitcoin as a form of payment, broader mainstream acceptance is a higher bar to cross. As it stands, bitcoin’s network speed and capacity would be unlikely to handle everyday transactions globally. To illustrate, the average daily transaction volume for bitcoin hovers at around 400,000 transactions per day whereas daily credit card transactions settling through traditional banking channels exceed 1 billion per day.
A unit of an account implies a commonly valued standard by which any financial transaction is measured. Bitcoin does not yet fulfil this standard for global trade or financial acceptance but has gained momentum.
For a currency to serve as a time-tested store of value suggests a history of stability. Bitcoin has gone up or down by over 3% more than half of all trading days and by more than 5% for almost a third of all trading days in the last five years. During this period, bitcoin has endured ten 30% corrections lasting an average of 40 days. This does not yet satisfy the store of value yardstick in our view.
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The opinions expressed in this article are the opinions of Aevias Worths and should not be assumed they reflect Investment Advice or recommendation
