Breaking Tradition Newborn Bitcoin is winning a place in investment portfolios

Source: Bloomberg

Compiled by: LianGuaiBitpushNews Yanan

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

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

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

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

Does this mean that Bitcoin can now enter the mainstream and have its place in a standard investment portfolio at this year’s holiday dinner?

For the majority of investors, the answer is still “no.” Bitcoin has enough potential for appreciation to attract investors, and its volatility seems to no longer be a factor that scares people away. Issues such as asset custody security, tax handling, and legitimacy seem to have mostly been resolved. However, the unstable correlation between Bitcoin and other major assets – especially stocks, currencies, and gold – makes it difficult for Bitcoin to integrate into an investment portfolio, much like a left-handed guest at a dinner, struggling to fit in.

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 the size of market volatility or the skyrocketing or plummeting of cryptocurrency prices, I always invest 3% of my net assets in cryptocurrencies. However, most investors prefer investment categories with predictability in their fundamental events and tend to hold for the long term rather than engage in frequent short-term trading. (Disclosure: The author of this article has investment and consulting relationships with cryptocurrency companies.)

Bitcoin was initially created as a form of currency for transactions, which 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 provided convenience for rarely prosecuted criminal activities such as the sale of recreational drugs, prostitution, and gambling. Although there is a widespread misconception that Bitcoin is frequently used for malicious criminal activities such as terrorism or hired killings, the fact is that Bitcoin transactions are public and immutable. While Bitcoin transactions are indeed anonymous, investigators can often track individuals easily through transaction pattern analysis. Malicious criminals tend to use government-issued cash, gold, diamonds, or privacy-focused cryptocurrencies like Monero or ZCash to conceal their identities.

In a recent Senate Banking Committee hearing, Senator Elizabeth Warren, along with JPMorgan Chase CEO Jamie Dimon and other bankers, agreed that anti-money laundering controls should be implemented for cryptocurrencies. While laws can make it difficult for fiat currencies associated with criminal activities to be deposited or withdrawn, there is no way to stop or trace direct transfers between privacy-focused cryptocurrencies. The financial suppression system that combats money laundering is one of the reasons that people, both good and bad, use cryptocurrencies.

However, this is not important for Bitcoin anymore, as its use case and value proposition as a medium of exchange have already been undermined. Fundamental improvements in traditional finance, regulations, and crackdowns on cryptocurrency use for criminal activities are factors that have led Bitcoin to no longer be confined to being a tool for transactions and transfers. Moreover, the primary reason for the erosion of Bitcoin’s original function as a medium of exchange is the emergence of innovative cryptocurrencies such as Ripple or Nano, which outperform Bitcoin in terms of transaction capabilities.

Around 2015, Bitcoin’s value proposition shifted from “medium of exchange” to “digital gold.” Bitcoin became the value anchor for cryptocurrencies, used for the conversion of traditional currency into and out of cryptocurrencies (editor’s note: fiat deposits and withdrawals) – just like gold has been the value anchor for paper currency for centuries, used for interbank settlements.

From this perspective, the value of Bitcoin depends on three factors: the ultimate value of cryptographic projects, the volume of traditional currency entering and exiting cryptocurrencies, and the superiority of financial services in the crypto economy (i.e., alternative to traditional banking systems).

The first factor, the ultimate value of cryptographic projects, is essentially a technical risk investment – on one hand, many exciting ideas can potentially change the world and be worth trillions; on the other hand, the actual revenue or profit of these projects is often modest when calculated in traditional currency.

The amount of traditional currency entering and exiting cryptocurrency has always been influenced by economic booms and recessions, or as we say in crypto terms, summers and winters. In crypto summers, there is a large influx of funds, 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 crypto winters, there is very little movement of funds in both directions, resulting in a low demand for Bitcoin financial services.

The most stable element lies in the competition in the financial services sector. Bitcoin has quickly strengthened its connections with publicly traded futures and options, efficient lending, secure custody, and other aspects of modern financial systems. If, as expected by the market, the U.S. Securities and Exchange Commission approves a Bitcoin ETF in January, the entire Bitcoin financial services ecosystem will be further improved. People will be able to engage in various trading activities on Bitcoin similar to stocks and bonds, such as investment, financing, hedging, speculation, exchange, 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 still lags behind Bitcoin. Traditional financial institutions attempting to leverage blockchain and other cryptographic technologies have also achieved success only in specific areas, without posing a threat to Bitcoin’s dominant position. Additionally, some companies have tried to directly integrate financial services into the crypto ecosystem, such as FTX and Celsius Network, but they experienced collapses and negative impacts on similar enterprises in 2022.

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

The market value of crypto projects depends on investors’ enthusiasm for tech entrepreneurship, which has a high correlation with tech stocks. However, investors’ enthusiasm for investing in cryptocurrency often goes against tech stocks – disappointing returns from tech stocks have driven optimists and risk-takers towards cryptocurrency.

The recent doubling of Bitcoin’s price seems to be primarily related to 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 insulates it from competitors. Generally, there is no clear correlation between regulatory attitudes and asset prices.

In the current situation, there seems to be no specific factors that would affect the success of crypto projects or people’s enthusiasm for crypto transactions, so the recent market prospects of Bitcoin appear to largely depend on regulatory dynamics, particularly the approval of Bitcoin spot ETFs. In addition, the possibility of market corrections or black swan events always exists, especially when new crypto scandals emerge.

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

We are gradually reaching a consensus that even traditionally conservative investors of cryptocurrencies should recognize that allocating a small amount of Bitcoin in their investment portfolios would be a more prudent choice compared to completely ignoring this asset. Although cryptocurrencies still carry the risk of going to zero, their potential for growth is sufficient to make portfolios insulated from this field appear less balanced.

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