Why bitcoin remains an investment risk and a currency puzzle
- With saving and investing, for most people, it’s best to stick to simple assets with easily understood characteristics. Bitcoin does not meet that test and there is also a regulatory risk
- Owning bitcoin is a bit like owning a lottery ticket: low odds but a potentially immense payoff. That is one scenario and probably argues for a small allocation. There are, however, other scenarios
Two perspectives are useful in thinking about bitcoin: within the sweep of history and as part of a portfolio. From either perspective, I am not attracted to it.
While most people find talking about the money supply boring, the question of how much currency to create is critical for social stability. If either too little or too much money is created, the economy and society become unstable. If the money supply grows at an appropriate rate, the consequent stability creates the requisite conditions for innovation, boosting the standard of living.
Throughout history, currencies have come in two forms, those whose supply is flexible and determined by committee, and those whose supply is constricted and determined by some non-human force, such as nature for gold or an algorithm for bitcoin.
A flexible system can reduce economic volatility by expanding and contracting the money supply as needed. A fixed system eliminates the risk of inflationary money printing.
In a portfolio, currencies play a specific role. Unlike stocks, bonds or real estate, currencies have no claim on an underlying cash flow and have zero expected return. Currencies rise and fall against each other, but they cannot rise in aggregate.
Adding a return stream to a portfolio that does not produce a return makes sense if it reduces risk. For bitcoin, that could occur in two ways. First, if the domestic currency is likely to rapidly lose value. Second, if this asset reliably rises in value when other assets fall in value, meaning that investing in bitcoin is diversifying.
As the Covid-19 pandemic recedes, money printing is likely to decline. This has already occurred in China. Moreover, I do not understand the technology that limits how much bitcoin can be produced and, as far as I can tell, most people do not. Bitcoin is less than 20 years old. What if something better comes along or technology shifts and the price plummets?
The correlation benefits of bitcoin are also uncertain. A good portfolio contains assets that rise in value over time, but rise at different points in time, thus dispersing the risk. With bitcoin, these relationships are less clear because the history is so short.
If global money printing produces global inflation, it seems logical that bitcoin would go up in value. Yet the big appreciation in bitcoin has come at a period of falling inflation. If inflation does come, would investors choose other assets instead, such as inflation-linked bonds, gold, other commodities or real estate? It is also true that ascertaining the correlations of any currency is fraught.
I welcome the evolution of financial systems and find bitcoin an interesting step in that process. However, when it comes to saving and investing, I am attracted to assets that are simple and whose characteristics are understood. For me, bitcoin does not meet that test, or it meets it in such a murky way that, at best, I could hold a very small allocation as a sort of experiment.
Paul Podolsky is an investor, author and podcast host, see: paulpodolsky.com. He spent over 20 years on Wall Street, most of that time with Bridgewater Associates
David Dodwell is away