Publications

Asset Management Research - Crypto Currencies

Bitcoin: A decentralised, finite option on the future

Digital assets still remain firmly in their infancy. Therefore, the hurdles for acceptance are high with regard to understanding its price and volatility as we have been able to witness in the past. But that is to be expected with such a vastly different concept. But should investors start allocating exposure to digital assets and specifically Bitcoin in the near future?


Digital Gold

Bitcoin is effectively digital gold. Its supply is finite (with a maximum of 21m coins to be mined), it is a privately held asset stored across a decentralised block chain, which is essentially global in nature. It is also, in its very nature, far more a store of value rather than a payment system. Although new methods of payment are being created across the network, the original design was aimed to be a stock of value, given the size of the blocks. Gold, as an asset class and despite its over 3000 year history, is under owned across a vast range of investors. The same will be true for Bitcoin, as the large majority will remain hugely under-appreciative of the future power of digital assets. And with US tech stocks rallying 50% per year, why be interested where else to allocate scarce already assets?

A short history

In October 2008, a paper was published titled “Bitcoin: A Peer-to-Peer Electronic Cash System” and four months later, the first Bitcoin was transacted between a handful of cryptographers. From there it increasingly gained traction to where we are today. Interestingly, Bitcoin was released after the Global Financial Crisis (GFC). However, we can only guess as to whether the GFC was any motivation for its creation. Also, the creator of Bitcoin, Satoshi Nakamoto, using a pseudonym, in fact has not been heard of since. His Genesis block of Bitcoin (block number 0) has not been touched since January 2009. At Bitcoin’s peak Nakamoto’s Genesis block was worth $19bn.

Since then, the Crypto market has ballooned, but it remains largely unregulated and at times, has exhibited classic signs of being a speculative bubble. The majority of coins have little utility or value and seemed to be powered more by greed than anything else. Bitcoin here is the clear exception.

What is the Blockchain?

A blockchain is not specific to Bitcoin. It is simply a database that is validated by the wider community rather than a central authority, which provides Bitcoins with a competitive advantage. It is truly decentralised, (even apolitical) and no Bank/Sovereign or any other agency has any power over it. Each block represents a number of transactions, with a chain linking them together. The chain is a public ledger which cannot be broken or altered without the permission of the whole community, especially not by one single authority. Indeed, the FBI have used the Bitcoin ledger to trace transactions and ensure convictions. The remark therefore, that Bitcoin is only used by drug dealers, is incorrect, as Bitcoin is in fact far more traceable than cash.

Investment case

Some of the clear arguments for Bitcoin have already been discussed. Additionally, Bitcoin has zero correlation with Stocks, Bonds, Oil, Real estate or EM currencies. Hence, it can clearly be of great benefit when added to an existing portfolio. However, Bitcoin is different. It is not regulated. If you lose your private keys, you get no second chance to retrieve them. It is therefore highly volatile and certainly not a „get rich quick“-scheme. As we stand today, Bitcoin cannot compete with Visa and Mastercard for the sheer number of transactions per second, but then again, Visa and Mastercard are centralised systems.

Conclusion

Bitcoin is a decentralised, finite option on the future. Indeed, ultimately, history will show, whether or not Bitcoin will trade near zero or as high as $15k or even $100k. Bitcoin and the technology behind that created it, are perhaps the foundation of a new financial system. Bitcoin has first mover advantage, but it also has a truly decentralised blockchain, which in turn, will likely prove rare. In a world where Central Banks are devaluing money, it could be of great importance to have a finite resource as a store of value. It is attractive, just like Gold. It is therefore a call option on the future.

February 20, 2020

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