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Bitcoin: A digital store of value?

In 2009, a mysterious and anonymous whitepaper was published under the pseudonym Satoshi Nakamoto, which described the principle of a peer-to-peer and purely digital currency. It described advantages such as lower transaction fees than traditional online payment infrastructure and a shift to a decentralised authority, unlike government-issued currencies. Since Bitcoin emerged in 2009, manifold other digital-based currencies have since appeared, with each subtle variation of the concept providing a plethora of ways in which the electronic currencies can be used by both consumers and investors alike. As the most established and mature form, today we will focus on Bitcoin, and ask whether in much the same way that gold transitioned from a form of currency (as far back as 2000BC) into an effective store of value, if Bitcoin has the capacity and characteristics to follow suit.

Context

First, let me address why this is a pertinent question to be asking at this moment in time. 2020 and 2021 have seen policy makers scramble to maintain economic growth and inflation to offset the social and thus economic stagnation resulting from the COVID-19 restrictions. In doing so, much of the stimulus that has been used has, and will probably continue to, make cash and cash-like assets become less attractive. Since, under an inflationary backdrop, their purchasing power diminishes. This can be noted quite clearly in the fact that just over 30% of the global investment grade debt have shown negative yields in 2020 and 2021. Despite this, many central banks continue to print money, in order to fund the large fiscal packages required to offset the effects of the global pandemic. All of this, combined with the overwhelming sense of political, social and economic uncertainty has seen a surge into safe havens and stores of value over the last 12 months, as investors seek ways to protect the value of their portfolios against the prevailing storm. This increase in demand has seen the price of gold rise by ~20% in 2020, the classic example of a store of value and hedge against inflationary effects.

Following its conception in 2009, Bitcoin has undergone many surges and drops in value and popularity, culminating in a great surge in 2018, seeing the price of a single coin soar from $975.70 to $20,089 between March and December of that year. Now again, in 2021, the cryptocurrency has picked up in both popularity and price, most notably being openly endorsed by high-profile individuals such as Elon Musk and institutions such as PayPal and Paul Tudor Jones’ Tudor Investment Corporation. Its presence as a form of currency is now established, however, how does the asset perform as a potential store of value — something that investors are all too keen to determine under the current economic climate?

What makes a good store of value?

Before dialling into the properties of Bitcoin itself, first let’s outline what is required from an asset to qualify as a good store of value.

There are many definitions of what makes a good store of value, some developing a degree of complexity not required for the purpose of this article. Simply put, a good store of value is an asset that maintains its purchasing power over time. In order to demonstrate this, the asset should in turn, typically demonstrate low volatility, be a good diversifier and stable.

The gold standard

Let’s look at the properties of gold as an example. First, gold is a very good example of a store of value, and owes a lot of its properties to the fact that it is in finite supply on Earth. Our planet contains a set amount of the metal, and it can neither be created* (despite the best efforts of Ostanes and co) nor destroyed (at least, not easily, although Auric Goldfinger had a bold idea on how to do so in Ian Fleming’s eponymous novel). This means that the continuity of gold’s abundance is guaranteed. This is in contrast to currencies, with cash or more generally capital being the associate tangible asset, created (through printing) and destroyed (through repayment, in the case of capital), varying the relative abundance and purchasing power with great frequency.

Second, by often moving in a contrary motion to other assets, such as stocks, gold demonstrates the next characteristic of a good store of value — diversification. Typically, when the value of stocks and cash-like assets drop, gold, with its historical value and known supply, increases in popularity as an asset and therefore due to the increased demand, value, causing it to move in the opposite direction to the falling stocks. This provides a useful tool for investors, in providing diversity in their portfolios to preserve a certain baseline in value, even in times of economic downturn.

Finally, gold is, in the grand scheme of things, easy to transport and exchange. It can be purchased and sold anywhere in the world, physically, electronically or through a broker and therefore typically demonstrates sufficient liquidity to provide investors with confidence that they can adjust their positions when needed. Being physically manifest in tangible and manageable bars, it is easier to transport and handle than businesses or real estate, for example.

There are of course, many other reasons that make gold a popular store of value, not to mention its longstanding historical and emotional value. Looking dispassionately at the material and one sees a useful non-reactive metal, used in electronics and jewellery. However, having been the subject of fantasy, mythology and deity from practically the beginning of human history, it is hard to ignore the intangible provenance and value that the material holds. One that perhaps, will outlive any of its practical value.

How does Bitcoin compare?

First, the question of abundance and supply. It is a common misconception that the supply of Bitcoin is effectively infinite, with the image of enormous computers trying to mine more and more “blocks” of transactions. However, this is not the case. Although in theory, it is possible to “mine” an endless number of Bitcoin transactions, the number of the actual tokens or “coins”, if you would, is hard wired and limited to around 21 million. An initial number was released when the system went live in 2009 and the issuance rate (how many new coins that are released) halves each year, resulting in a finite number. This is in alignment with gold, and similarly, provides investors with some sense of security that Bitcoin can’t simply be created or destroyed at the request of policymakers or central banks.

With an increasing level of infrastructure in place, Bitcoin is also, like gold, easy to transport and exchange. For transport purposes, since it is purely digital, Bitcoin can be stored and carried on any digital device — memory sticks, hard drive, laptop, etc. For exchange, many mainstream brokerages now offer cryptocurrencies for trading, in addition to the emergence of brokerages specifically for the purchase and sale of cryptocurrencies. In addition to digital brokerage platforms, Bitcoin ATMs are beginning to pop up all over the globe, allowing consumers to exchange their traditional fiat currency for Bitcoins. These can then be transported around and used to purchase goods through a digital wallet.

However, this ends the similarities between the two assets, gold and Bitcoin. Unlike gold, bitcoin, to date, has been extremely volatile. In the years between its conception and today, the cryptocurrency has been 10x more volatile than any other currency against the US dollar. A combination of being very young and immature (compared to fiat currencies for example) and without the backing of central banks or governments, the cryptocurrency has been prone to extensive drops in value when sentiments turn negative and enormous gains of up to 3200% in just three months in 2011, when confidence and appetite return. This high volatility currently makes Bitcoin pretty unattractive for any long-term, store of value applications.

This volatility is in itself a manifestation of other underpinning characteristics of Bitcoin that currently render it a poor store of value. For example, being a young and relatively immature technology, it has not yet developed the trust of investors looking at its buying power longevity or reliability. Despite being “one hell of an invention” to quote Bridegwater’s Ray Dalio, and indeed it is a remarkable technology, there still exist concerns over its reliability and safety. With its young age also comes a lack of history and track record. We know, with a relatively high level of certainty, how gold will behave in various economic climates, because hundreds of years of data exist on its behaviour. However, Bitcoin lacks this, and investors basing their decisions, to some extent off previous trends and learned understanding, currently do not have this historical resource at their disposal. What little historical evidence that does exist for Bitcoin, sadly does not help its cause either. For example, in an economic drawdown, gold typically holds its value and will protect a portfolio against this. At least, it can be said based on clear historical evidence that it will be likely to do so, within certain confidence limits. Bitcoin on the other hand, for the limited number of economic drawdowns that it has lived through, has delivered no reliable response. Sometimes it has held value during drawdowns, sometimes it has gained in value (c.f. 2020/2021) and sometimes it has decreased significantly in value, in line with the prevailing economic climate.

A great deal of uncertainty also remains over the potential future regulation of cryptocurrencies, which is likely to vary considerably between the different types of cryptocurrency and largely between countries. For example, initial coin offerings (the process that creates a new digital currency) has already been banned in China. Instead, in order to provide greater control over cryptocurrencies, China is developing its own state-owned version — allowing consumers to continue enjoying the benefits and ease of digital currencies, but while being able to maintain state control. Having been adopted by malicious parties, cryptocurrencies have also provided a platform upon which illicit uses have been realised; for example, money laundering and funding of terrorist organisations. To date, the sparse regulation has focused predominantly on mitigating these uses, however in the near future, further regulation could hinder the relative freedom enjoyed by even non-illicit users of cryptocurrencies.

The liquidity of cryptocurrencies, at least at present, is also quite limiting. Although currently at an all-time high, Bitcoin only holds 10% of the market capacity relative to gold and is still only 50% that of iron ore (which in itself, is a pretty small market). Although this poses little problem to retail investors and traders, the current maximum trade size and overall liquidity could be a problem for institutional investors — again hindering the outlook for the currency as a store of value.

Summary

We have investigated the potential of the cryptocurrency, Bitcoin, as a store of value. By comparing the digital currency to gold, a popular store of value, we have noted the similarities between the two; including the fact that both are in finite supply and benefit from ease of exchange and transport. However, the number of discrepancies between the two engenders the manifold reasons as to why, as it stands, Bitcoin does not possess the properties of a good store of value. Despite being an impressive innovation that could indeed pave the way for the widespread adoption of digital currencies, due to its current levels of volatility, the uncertainty of its future with regards to regulation, underwhelming liquidity and lack of historical provenance, the electronic coin remains, at present, as a currency, a speculative investment opportunity and an embodiment of financial innovation — but not, a good store of value.

Sources:

https://bitcoin.org/bitcoin.pdf

https://www.bridgewater.com/research-and-insights/our-thoughts-on-bitcoin

https://www.bridgewater.com/research-and-insights/further-exploring-bitcoin-as-a-storehold-of-wealth

https://www.investopedia.com/articles/forex/121815/bitcoins-price-history.asp

https://www.investopedia.com/terms/s/storeofvalue.asp

https://www.ft.com/content/0a6507e9-d3f4-4319-bffb-eb915260e388

https://www.cnbc.com/2021/01/04/bitcoin-btc-rally-partly-driven-by-more-institutional-investors-pwc-says.html

https://www.forbes.com/sites/robertanzalone/2020/05/07/paul-tudor-jones-buys-bitcoin-as-a-hedge/?sh=7d6e925d199b

https://www.ft.com/content/bed3e1ed-1379-44f7-b216-f388a172f45b

https://www.ft.com/content/08b64235-ad46-4d78-ae29-1adaa3f02d94

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