For a short one For a moment, everyone who owned bitcoin had made money from it. On March 5, the crypto token rose to an all-time high of just above $69,000 – a level sure to please the meme-loving crypto crowd – before sliding back a bit. The new record capped a remarkable comeback after the dark days of November 2022, when interest rate rises crushed risk appetite and ftx, a major crypto exchange, had just gone bankrupt. At the time, buying bitcoin on such exchanges seemed like little more than a fun and novel way to get robbed.
Bitcoin is hardly rising in isolation: everything is going up. Stock markets around the world are near record highs. This also applies to gold prices. Even bond prices are rising after a miserable two-year period. The catalyst is a combination of hype around artificial intelligence, joy about the state of the global economy and expectations of looser monetary policy.
Yet bitcoin is outperforming most assets. On January 10, the Securities and Exchange Commission, a US regulator, approved applications from ten investment firms, including BlackRock and Fidelity, to create exchange-traded bitcoin funds.ETFS). These make it easier for ordinary investors to buy the cryptocurrency. Instead of creating an account at a specialized exchange, setting up a crypto wallet, making a bank transfer and ultimately buying bitcoin, people can now simply log into their investment accounts and buy an account. etc. Assets in the ten largest bitcoin etcThe amount now stands at approximately $50 billion. And the activity seems to be self-reinforcing: the more money flows in, the higher the price, the more people talk about bitcoin. etcThe more money flows in, and so on.
Bitcoin has been around for 14 years. The elegant mechanism by which it validates itself and grows its supply has never been hacked, meaning the token isn’t going anywhere. Yet it is now clear that it is of fairly limited use for payments, as it is limited by both the high costs and the slow speed of transactions. Those trying to build applications on top of blockchains are also not doing so using bitcoin. With the establishment of etcs it is now clear that bitcoin is an investment asset and nothing more. What will returns look like after this initial wave of interest?
It would be foolish to extrapolate Bitcoin’s entire history. Over the past 14 years, cryptocurrency has gone from a niche cyberpunk idea to something approaching a mainstream financial asset. However, the more recent price movements may provide some clues. There are two explanations for them. One is that purchases are essentially a broad bet on technological progress, with variations reflecting the prospects for crypto itself. For example, even as tech stocks soared in mid-2021, Bitcoin slumped after Elon Musk posted negative tweets about crypto payments. Prices were also under pressure at the end of 2022, even as equity markets recovered ftx‘s failure.
The other theory is that bitcoin is a kind of digital gold. After all, supply is inherently limited, just as the supply of gold is limited by the amount of metal in the ground. Neither asset pays a return or makes a profit. This theory fell out of favor in 2021 and 2022, as inflation soared and bitcoin collapsed, but last year the cryptocurrency moved back in line with gold.
Perhaps both theories contain elements of truth. And a hybrid tech-stock-crypto-vibes-gold-bet asset could be useful even in pedestrian portfolios, especially if it is only somewhat correlated with other assets an investor might hold. Diversification among uncorrelated assets is the fundamental principle of portfolio management. For example, reallocating 1% of a fund to bitcoin would be a low-stakes hedge.
If investors accept this argument, Bitcoin’s price will likely continue to rise for a while. What happens then when the cryptocurrency’s transition to a standard financial asset is complete? Suppose bitcoin has been added to most investor portfolios. Also assume that crypto technology doesn’t really catch on. In this world, Bitcoin’s returns are likely to resemble those of gold: there is a fixed supply of it, and its price would rise roughly in line with the money supply over the long term. That implies stable single-digit returns. The creation of a bitcoin etc may have created a wave of eye-popping profits, but the future it portends could be slower and steadier. ■