Bloomberg column Bitcoin is winning a place in balanced investment portfolios.

Bloomberg's Column Shows Bitcoin's Increasing Role in Diversified Investment Portfolios

Source: Bloomberg

Author: Aaron Brown

Translation: LianGuaiBitpushNews Yanan

This rebound in cryptocurrency prices proves that even investors who are skeptical of cryptocurrencies should recognize that it is a more prudent choice to allocate a small amount of Bitcoin in their investment portfolios, rather than completely ignoring this asset.

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This week, the price of Bitcoin exceeded $44,000, more than doubling from March 13th. Based on market analysis, this price performance of Bitcoin is not very surprising. Since 2014, Bitcoin has doubled every nine months and twenty-one days on average; however, this time, it achieved this goal twenty-eight days ahead of schedule.

However, it is somewhat surprising that during this doubling process, Bitcoin did not fall below its lowest point on March 13th. Typically, between each doubling, Bitcoin experiences an average decline of 27% (for example, from $1,000 to $730 and then rising to over $2,000), and the maximum decline can even reach 83% (i.e., the price first falls to $170 and then rises to $2,000).

Nevertheless, the roller-coaster price fluctuations of Bitcoin are already old news. Since the peak volatility during the COVID-19 pandemic, Bitcoin’s annualized volatility has stabilized at around 50%, comparable to many large tech stocks. More importantly, despite numerous scandals, bankruptcies, legal lawsuits, and regulatory controversies in the cryptocurrency field, Bitcoin still demonstrates relatively stable price characteristics.

Does this mean that Bitcoin can grace the halls at this year’s holiday banquet and have its own place in a standard investment portfolio?

For most investors, the answer is still “no.” Bitcoin has enough appreciation potential to attract investors, and its volatility seems to no longer be a daunting factor. Issues like the security of asset custody, tax treatment, and legality appear to have mostly been addressed. However, the instability of the correlation between Bitcoin and other major assets, especially stocks, currencies, and gold, makes it difficult to integrate it into an investment portfolio, like a left-handed guest at a banquet struggling to adapt.

As early as 2011, I estimated that the market value of cryptocurrencies would account for 3% of the global economy. As an efficient market investor, regardless of market volatility or the soaring or plunging of cryptocurrency prices, I have always allocated 3% of my net worth to cryptocurrencies. However, most investors prefer investment categories with predictive fundamental events and tend to hold long-term rather than engage in frequent short-term trading. (Disclosure: The author of this article has risk investment and consultancy relationships with cryptocurrency companies.)

Bitcoin was initially created as a form of digital currency, and that was its original value proposition. Bitcoin is far more efficient than traditional financial systems when it comes to handling international transfers, serving the unbanked, and those oppressed by the financial system.

In addition, Bitcoin has also facilitated the ease of illegal activities such as the sale of recreational drugs, prostitution, and gambling, although there is a common misconception that Bitcoin is frequently used for malicious criminal activities such as terrorism or hired killings. The truth is that Bitcoin transactions are public and immutable. While Bitcoin transactions are anonymous, investigators can often track individuals through transaction pattern analysis. For malicious criminals, they usually prefer to use assets issued by governments, such as cash, gold, or diamonds, or privacy-oriented cryptocurrencies like Monero or ZCash to conceal their identities.

In this week’s Senate Banking Committee hearing, Senator Elizabeth Warren and JPMorgan Chase CEO Jamie Dimon, along with other bankers, unanimously agreed on the need to implement anti-money laundering controls for cryptocurrencies. While laws can make it difficult for fiat money associated with criminal activities to enter or exit the system, there is currently no way to prevent or trace direct transfers between privacy-oriented cryptocurrencies. This financial suppression system against money laundering is actually one of the reasons that incentivize people, both good and bad, to use cryptocurrencies.

However, these factors are not relevant to Bitcoin anymore because its use case as a transactional currency and its original value proposition have already diminished. The fundamental improvements in traditional finance and the regulatory and enforcement actions against the use of cryptocurrencies for criminal activities have contributed to shifting Bitcoin’s positioning away from being a transactional and transfer tool. Additionally, the main reason for the erosion of Bitcoin’s original value proposition as a transactional currency is the emergence of innovative cryptocurrencies like Ripple or Nano, which outperform Bitcoin in terms of transactional capabilities.

Around 2015, Bitcoin’s value proposition shifted from being a “transactional currency” to being “digital gold.” Bitcoin became the value anchor for cryptocurrencies, used for the conversion of traditional currencies into and out of cryptocurrencies, just as gold has been the value anchor for fiat currencies in the settlement of accounts between central banks for centuries.

From this perspective, Bitcoin’s value depends on three factors: the ultimate value of the crypto projects, the amount of traditional currencies flowing in and out of cryptocurrencies, and the superiority of the financial services in the crypto economy (alternatives to the traditional banking system).

The first factor, the ultimate value of crypto projects, is essentially a form of tech investment. On one hand, many exciting ideas have the potential to change the world and be worth trillions; on the other hand, their actual revenue or profits, when exchanged into traditional currencies, are often minimal.

The amount of traditional currency entering and exiting the world of cryptocurrencies has always been influenced by economic booms and recessions, or as we like to call it in crypto terms, the summer and winter. During the crypto summer, a significant amount of funds flow in, but many crypto enthusiasts also cash out their profits during this period. Additionally, people use Bitcoin to convert from one crypto project to another. In the crypto winter, there is minimal movement of funds in both directions, resulting in a low demand for Bitcoin financial services in the industry.

The most stable element lies in the competition within the financial services sector. Bitcoin has rapidly strengthened its ties to trading public futures and options, efficient lending, secure custody, and other aspects of modern financial systems. If, as the market expects, the US Securities and Exchange Commission approves a Bitcoin ETF in January, the entire Bitcoin financial services ecosystem will receive further improvements. People will be able to engage in various trading activities on Bitcoin, similar to stocks and bonds, such as investing, financing, hedging, speculating, exchanging, and holding, and Bitcoin ensures the efficiency of these operations. Furthermore, Bitcoin provides a convenient gateway for people to quickly enter the entire crypto economy.

In comparison, stablecoins have only achieved success in specific areas. Among other cryptocurrencies, only Ethereum has developed a native financial system, but it is still far behind Bitcoin. Traditional financial institutions attempting to leverage blockchain and other crypto technologies have also only succeeded in specific areas, but this does not pose a threat to Bitcoin’s dominant position. Additionally, some companies have attempted to directly integrate financial services into the crypto ecosystem, like FTX and Celsius Network, but they suffered setbacks and collapsed in 2022, which had negative implications for similar companies.

These three value propositions also explain the correlation between Bitcoin and the instability of other traditional financial assets.

The market value of crypto projects depends on investors’ enthusiasm for technological entrepreneurship, which is highly correlated with tech stocks. However, investors’ enthusiasm for investing in cryptocurrencies often differs from that of tech stocks. Disappointing returns from tech stocks have driven optimists and risk-takers towards cryptocurrencies.

The recent doubling of Bitcoin’s price seems to be primarily attributed to the increasing regulatory clarity and tolerance, but this does not seem to apply to stablecoins or other cryptocurrencies. This not only improves the efficiency of the Bitcoin financial system but also shields it from competitors’ influence. Typically, there is no apparent correlation between regulatory attitudes and asset prices.

In the current situation, it appears that there are no specific factors that will affect the success of crypto projects or people’s enthusiasm for crypto trading. Therefore, the near-term market outlook for Bitcoin seems to depend mainly on regulatory dynamics, especially the approval of a Bitcoin spot ETF. Additionally, the possibility of a market correction or black swan event always exists, particularly when new crypto scandals emerge.

The competition from stablecoins, traditional finance, and native crypto institutions is almost non-existent, so any progress in these areas will only have a negative impact on Bitcoin. I speculate that the next doubling in Bitcoin price may be driven by the long-awaited “killer apps” in the crypto space, which will attract millions of people to learn and use cryptocurrencies, rather than just holding or trading them. Another possibility is that problems in the traditional financial system, such as crises, stricter regulations, inflation concerns, or credit tightening, may make Bitcoin relatively more attractive.

We are gradually reaching a consensus that even traditional investors who are conservative towards cryptocurrencies should recognize that allocating a small amount of Bitcoin in their investment portfolios will be a more prudent choice compared to completely ignoring this asset. Despite the risk of cryptocurrencies going to zero, their potential for growth is enough to make portfolios insulated from this field appear unbalanced.

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