Have I Missed the Bitcoin Bandwagon?
You can choose one of two paths. One path keeps you on the traditional financial path investing in stocks, bonds, real estate, precious metals, and maybe commodities. Now, this isn’t a bad path at all and can be an effective way to beat inflation on your earnings, but I challenge you to look at another path. The other path includes an asset class that is both nascent and volatile, yet, adding it to your traditional portfolio can increase portfolio efficiency while reducing risk.
That other path of course is to include digital assets like bitcoin and other cryptos in your total portfolio. I’m not talking a lot either as even 1% can improve returns and reduce risk due to its uncorrelated relationship with traditional finance products. Digital assets can create a perfect diversification scenario into an asset class that often lowers risk for at least the same amount of return.
How is this possible? Modern Portfolio Theory (MPT), introduced by Harry Markowitz in the 1950s, states, among other points, that by adding a risky asset to a portfolio can actually decrease the portfolio’s overall risk. The key however is correlation. If you own two positively correlated assets, you really are not diversified because as one goes up (or down), so does the other. You would be better off just owning one of them. But if you had negatively correlated assets, as one goes down the other goes up, your overall risk of a sharp loss is dramatically reduced. Now, adding a third asset that is riskier than the other two but NOT correlated with the other two in your portfolio, two things occur; you reduce the losses of the portfolio at any one time, but you also improve overall returns because the third, riskier asset, makes more return than the other two in your portfolio (Edelman, 2022).
According to Edelman, MPT creates a powerful investment thesis for adding digital assets to your portfolio, one which will increase portfolio efficiency while reducing risk. But the proof is in the pudding. Think of correlation from a scale of -1 to +1, where -1 is perfectly negative correlated, +1 is perfectly positively correlated, and anything in between is a weak or no correlation. Historically, these are the correlations between bitcoin and traditional financial assets (Edelman, 2022):
|Bitcoin’s HISTORIC Correlation to Other Asset Classes
-1.00 = Negative Correlation, 0.00 = No correlation, 1.00 = Positive Correlation
Correlation is further drilled down into four metrics commonly used by professionals: Sharpe Ratio, Sortino Ratio, Standard Deviation, and Max Drawdown (Edelman, 2022). We won’t go into detail about how each gets measured but find a nice high-level resolution for how Bitcoin affects the measures.
The Sharpe ratio helps reveal whether your returns are based on the lowest risk possible, or if you took unnecessary risk for the same return. The higher the Sharpe Ratio, the better the risk-adjusted performance of your portfolio, and portfolios with Bitcoin have higher Sharpe ratios than portfolios without Bitcoin.
The Sortino ratio looks towards volatility for its measure, and realizing that not all volatility is bad, strives to measure only the downside volatility since no one usually complains about the upside volatility. The higher the number the better, and portfolios with bitcoin have higher Sortino ratios than those portfolios without bitcoin.
An ideal portfolio would always generate similar returns and never deviate, but the only investment vehicles that can do this are savings accounts. Albeit safe, returns with savings accounts are very low. Stocks up the ante with higher returns, but those returns fluctuate all the time, and those fluctuations can be dramatic. If it is normal for an asset’s returns to deviate, then that deviation becomes standard (hence standard deviation). A savings account deviation is zero. The S&P500 is about 15% which means that returns in any one year can be +-15% than the average return. Consequently, the lower the standard deviation the better regarding risk. Portfolios with Bitcoin in them have standard deviations nearly identical to a portfolio made up of 60% stocks and 40% bonds (Edelman, 2022). Thus, risk is not increased even though you added a riskier asset like bitcoin.
Finally max drawdown reflects a portfolios maximum loss and is an indicator of downside risk over a given period. It measures the largest loss, not the frequency of losses, or how long a recovery took. Max drawdown simply answers, “how much can I lose?”. Investments that have similar Sharpe and Sortino ratios and standard deviation could have vastly different max drawdown numbers. Adding Bitcoin to a 60/40 stock/bond portfolio has little impact on this statistic (Edelman, 2022).
In conclusion, adding a risky asset like bitcoin to a portfolio will help to reduce the portfolio’s overall risk. It must be noted however that, in recent months, Bitcoin has fallen where the stock market has fallen. Suddenly, the correlation between bitcoin and stocks seems to be high. But will that last? Recently, we watched as the stock market recovered somewhat while Bitcoin maintained its “risk-off” standing and did not recover. Are we back to the days of non-correlation between Bitcoin and traditional assets? Only time will tell, and investors must watch this closely.
But Have I Missed the Bandwagon?
The simple answer, is an emphatic no. The long answer is built upon the adoption rates of institutions and retail investors. So, what do the institutional investors say about Bitcoin’s market cap? Here are some forecasts for 2030:
|By 2030 – Estimations of Bitcoin’s Market Cap|
|ARK Invest predicts:||$500,000|
|Fidelity Investments predicts:||$1 million|
Financial institutions account for an increasing amount of crypto ownership. This of course includes a lot of bitcoins. As of 2021, here is a list of the top 13 banks and their holdings (Mozee, 2021):
|Top 13 Banks and their Crypto Holdings as of 2021|
|Standard Chartered||$380 million and 6 investments|
|BNY Mellon||$321 million and 5 investments|
|Citibank||$279 million and 14 investments|
|UBS||$266 million and 5 investments|
|BNP Paribas||$236 million and 9 investments|
|Morgan Stanley||$234 million and 3 investments|
|JP Morgan Chase||$206 million and 8 investments|
|Goldman Sachs||$204 million and 8 investments|
|MUFG||$185 million and 6 investments|
|ING||$170 million and 6 investments|
|BBVA||$167 million and 5 investments|
|Nomura||$146 million and 5 investments|
|Barclays||$12 million and 22 investments|
Further forecasts for 2030 estimate that 90% of Americans will own Bitcoin. This is based on trend analysis from 2009 to 2021 of adoption rates and forecast out to 2030 (Pirus, 2020). This trend is determined by the S-Curve which depicts the speed and process of adoption for new technologies. Quoting Brian Estes, founder of Off the Chain Capital, “the amount of time it takes for new technology to go from 0% adoption to 10% adoption is the same amount of time it takes it to go from 10% adoption to 90% adoption.” (Pirus, 2020):
Source: Off the Chain Capital
Estes further states: “It took 10 years for Bitcoin to go from 0–10% adoption… According to S-curve analysis, BTC should reach 90% adoption over the current decade. Considering 15% of U.S. folks holding crypto in 2020, Estes said: “We’re right on track to hit 90% in the year 2029.” (Pirus, 2020)
But What Says I’m not too Late?
There will only ever be 21 million bitcoins minted when the final one is minted in the year 2140. And one does not have to own a whole bitcoin – one can own down to 8 decimal places of a bitcoin, or .00000001 bitcoins, known as a “Satoshi” or “sat”. In other words, there is plenty to go around.
Bitcoin is deflationary in that fewer and fewer bitcoins are created or “mined” over time until the last one is mined 2140. For reference, in 2009 the bitcoin mining award for miners who successfully mined the transaction block for the Bitcoin blockchain was 50 bitcoins roughly every 10 minutes. In 2012, that amount “halved” to 25 bitcoins. In 2016, it halved again to 12.5 bitcoins. In 2020, it halved again to 6.25 bitcoins. In 2024, there will be another “halving” and only 3.125 bitcoins will be awarded to miners. That deflating supply coupled with existing demand (or increasing demand) for the coin tends to increase the value of bitcoin over time.
At the time of writing, there are roughly 18 million mined bitcoins, but of those 18 million, roughly 4 million have been “lost” or “locked away” due to people losing their wallet access, leaving 14 million tradable bitcoins. That said, it would be physically impossible for everyone in the world, let alone every American citizen to own an entire bitcoin, hence the reason bitcoins can be broken down into 8 decimal places.
Consider that previously mentioned forecast of 90% of Americans owning Bitcoin by 2029, that would translate to a 330% increase in demand of a supply limited asset. And remember, this statistic is just for America. Imagine the demand for bitcoin when more and more people of the world adopt bitcoin as a useful financial tool.
The final thing to consider is the viewpoint that bitcoin is a store of value comparable to gold, in this case, “digital gold”. True, the Bitcoin whitepaper specifically described it as a peer-to-peer electronic cash system, but I would argue that bitcoin, being stored digital energy as money and deflationary as money, is really a store of value first, and an electronic cash system second.
As gold is considered money and a store of value due to its qualities, Bitcoin too follows closely the same qualities of gold. For example, the stock-to-flow of Bitcoin is very comparable to gold’s stock-to-flow model because more gold is always being mined just as there is always some amount of bitcoin being mined. The stock-to-flow value is the ratio of how much existing money there is versus the rate of how much new money is being produced or mined. With bitcoin, the stock-to-flow model is very high because again, bitcoin is deflationary money. Yes, there are bitcoins being “mined” until 2140, but for all intents and purposes, this number gets less every four years during each “halving”, thus, bitcoin will eventually have a higher stock-to-flow number than gold, therefore be scarcer, and therefore theoretically increase the value of bitcoin.
Finally, referring to the qualities of money, how does bitcoin stack up to gold? There are six qualities that money should have: 1) Fungibility, 2) Durability, 3) Divisibility, 4) Portability, 5) Identifiable, and 6) Scarcity. Let’s look at how bitcoin compares to gold in these attributes, and which one is best.
|Fungible||Yes. Gold can be interchangeable as coins and mutually substituted for other gold representing equal value.||Yes. Bitcoins are easily interchanged and substituted.|
|Durable||Yes. Gold is very durable.||Yes. Bitcoins are digital energy logged on a decentralized digital ledger and last forever.|
|Divisible||Yes. Gold can be divided into smaller units or coins.||Yes. Bitcoin can be divided down to eight decimal points; the smallest called a “Satoshi”.|
|Portable||Moderate. Gold is heavy and valuable compared to digital money, so to carry it around in your pockets or suitcase is somewhat difficult.||Yes. Bitcoins exist on the blockchain, and “keys” are stored on digital wallets to access those bitcoins. It can be transported as easily a USB drive, an online wallet, or paying someone for custody services that can be accessed by a smart phone.|
|Identifiable||Everyone knows what gold looks like, but is it really gold? What if its gold-plated, or painted lead? Gold really needs the trust mechanism of government minting and banks to be easily identifiable as real gold.||Yes.|
|Scarce||Yes and no. Yes, regarding the difficulty in mining the gold, but no in those miners always develop ever better ways to mine for gold thus increasing the supply over time. Just imagine how it will be when we begin mining gold on asteroids!||Yes. There will only be 21 million bitcoins ever minted, and the last one will be minted in 2140. Right now, there around 18 million in circulation with around 4 million “lost” in wallets owners can no longer access because they lost their keys.|
As can be seen, in all categories, bitcoin matches or completely exceeds gold. For that matter, the same comparisons can be made with paper money or digital money. The big thing that separates bitcoin from paper money or digital money is the scarcity factor – bitcoin is simply much scarcer. Bitcoin satisfies all qualities of money, and really outshines gold, paper, and digital money in the scarcity category.
So. Have you missed the bitcoin boat? Again, no you have not. A scarce money not requiring a centralized authority only currently used by 10% of the US population who’s demand theoretically increases every time the production of the money halves every four years, in a world where there is ever-increasing adoption of that money? A simple “do the math” answer is all that is needed here. You may have missed the boat in dry-dock 12 years ago, but bitcoin hasn’t even left for the open ocean yet. There is plenty of time to hop on the bandwagon.
Edelman, R. (2022). The Truth About Crypto. New York: Simon and Schuster.
Mozee, C. (2021, 8 15). These 13 banks have invested the most in crypto and blockchain to date. Retrieved from Markets Insider: https://markets.businessinsider.com/news/currencies/13-top-banks-investing-cryptocurrency-blockchain-technology-funding-blockdata-bitcoin-2021-8
Pirus, B. (2020). Retrieved from CoinTelegraph.com: https://cointelegraph.com/news/bitcoin-adoption-could-reach-90-by-2030-investment-firm-founder-claims