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Wealth Management: Strategy blog – Bitcoin as an investment?

Strategy team: Kevin Gardiner

Bitcoin is surging again as some institutional investors add it to portfolios. It is said to be a plausible alternative to both conventional money and gold at a time when inflation risk may be rising: its origins date back to the global financial crisis and widespread distrust of the current banking system.

Bitcoin, gold and FAANGS stocks: indexed, log scale

Source: Bloomberg, Rothschild & Co

Inflation, gold, and ESG issues

The scale of any inflationary threat, however, is not yet clear. It may be incremental, rather than game-changing. It may not require a new asset to try to deal with it.

We think higher inflation may indeed follow the pandemic: the increase in conventional financial balance sheets in 2020 was big, and policy may stay loose even as economies recover more strongly. However, financial balance sheets were already large, and had been so for many years, without any obvious inflationary consequence: inflation has been historically low since 2008, and the break-even rates currently priced into bond markets are not much higher. Exchange rates have been relatively stable.

Parallels between bitcoin and gold may be overstated. Gold has intrinsic worth: it is tangible, useful and scarce. It did not become valuable because it was money: it became money because it was valuable. It has a track record extending over three millennia and many hyperinflations, independently of other monetary arrangements. But it is not a mechanical “hedge”: its real price is not fixed in either direction.

Bitcoin has no intrinsic worth: it is virtual, still has little practical use, and is one of many cryptocurrencies. It is said to be a more credible store of value than government-backed money or gold, but it is too soon to know if this is true. It has no track record during inflationary times, and during its short life it has been sensationally volatile, and not always in a helpfully uncorrelated way.

Bitcoin volatility in context

Source: Bloomberg, Rothschild & Co

Bitcoin: 52-week correlations

Source: Bloomberg, Rothschild & Co

Both bitcoin and gold score poorly in ESG (Environmental, Social, Governmental) terms. The “mining” of bitcoin is very energy-intensive, and its unregulated aspect is part of its appeal for money launderers and others seeking to transact incognito.

Bitcoin technology and transacting

The sophisticated distributed ledgers and blockchain technology used to create bitcoin’s public, permissionless network has been part of its allure, but can seem a rather cumbersome form of encryption. The transaction history of each bitcoin – but not its owners’ identities – is embedded across the net, and needs to be validated anew each time the coin is transferred. Transactions are significantly slower than on conventional payment networks.

The technology has not yet gained wider traction, in contrast to earlier claims. Its benefits may be delivered more efficiently in other ways. To this observer it looks like a complicated answer in search of a question.

If bitcoin were to be used more widely in place of money, its stand-alone status cuts both ways, and might not always be attractive. It will be independent of governments – but also of regulators and deposit insurance.

Bitcoin and portfolios

Nobody knows if bitcoin will last, let alone sustain its current value. Its price is rising because its price has risen – the hallmark of mania through the ages. An illiquid market has been swamped with buyers, including trend followers and other institutions. This will continue until it stops.

Estimated bitcoin market value recently is $0.6 trillion; the market value of gold might be $11 trillion (Apple’s capitalisation is $2 trillion; US M2 is $20 trillion). Some estimates of “fair value” for bitcoin are based on it becoming as large an asset as gold, in which case its price might rise a lot further. Other estimates see its value disappearing completely.

If we do not recommend bitcoin, but our competitors do, we risk looking conservative, and our clients’ portfolios may lag. There are however many things whose prices have risen, and/or which do not correlate with conventional assets, without us recommending them to clients as long-term wealth-preserving assets. We do not place great faith in benchmarking.

Nobody can know whether bitcoin will turn out to be a return asset; a diversifier; both; or neither. There may be an opportunity cost to waiting to find out, but we are happy to bear that.

Inflation risk is a concern, but probably a manageable one; meanwhile, the banking system currently seems to be weathering the pandemic (with that government assistance, of course). There is little sign of a widespread loss of confidence in today’s money. If there were, it is not clear that bitcoin would be a realistic alternative anyway.

Even in the UK in the 1970s – the most inflationary episode in any large economy in post-war times – the value of money was more stable than bitcoin.

Disclaimer

Past performance is not a guide to future performance and nothing in this blog constitutes advice. Although the information and data herein are obtained from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made and, save in the case of fraud, no responsibility or liability is or will be accepted by Rothschild & Co Wealth Management UK Limited as to or in relation to the fairness, accuracy or completeness of this blog or the information forming the basis of this blog or for any reliance placed on this blog by any person whatsoever. In particular, no representation or warranty is given as to the achievement or reasonableness of any future projections, targets, estimates or forecasts contained in this blog. Furthermore, all opinions and data used in this blog are subject to change without prior notice.

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