While the invention of Bitcoin intended to be digital cash, the real-world use of the currency has subsequently changed. Investors are more interested in purchasing this asset as a speculative investment rather than purchasing to hold it for the long term.
Bitcoin, like gold, is a non-sovereign store of value that people can use to store wealth that is not backed by the US dollar system. It’s “digital gold,” as its proponents call it, which is appealing given the public’s growing concern about inflation. Furthermore, as the market structure evolves, it has the potential to serve as digital cash both domestically and across borders.
“These are large markets, and you can almost get them as a free call option on the ‘digital gold’ thesis,” said Matt Hougan, chief investment officer at Bitwise Asset Management. It’s also an appealing asset for portfolio construction, he says, because it provides investors with high potential returns, low correlations to stocks and bonds, and liquidity in a single asset.
“When you look at the price trend, volume, and retail and institutional adoption, you can see the bull case,” said Max Schatzow, an attorney at Stark & Stark who advises investment advisers and broker-dealers on a variety of financial regulatory matters. “We have already seen prices north of $60,000, so based solely on historical prices, it appears that there is room for growth with current prices. If demand continues to rise, the price will most likely rise as well.”
According to Jason Pride, CIO of private wealth at Glenmede, bitcoin is high risk with potentially high reward or complete wipeouts that go to zero. As a result, despite some of the market’s high returns, his firm does not recommend investors include it in their portfolio. Many people point to bitcoin as a diversifying non-correlated asset, but Pride points out that with every equity decline in the market, bitcoin has dropped dramatically in tandem.
“If the Fed were to reduce its stimulus, the majority of risk assets would fall,” he said. “If we had some extraordinary event, such as an economic downturn, bitcoin would most likely suffer alongside equities. It did so during the pandemic and the December 2018 correction, which was a liquidity event in the market.”
Furthermore, major exchanges and insurers may not have enough reserves to cover all of their cryptocurrency activity, according to Schatzow.
The greatest dangers
Volatility – Due to its speculative nature and developing market infrastructure, the price of Bitcoin fluctuates dramatically. While less volatility is required for it to establish itself as a more reliable asset, it will always be somewhat volatile due to its perfect inelasticity, which means that the quantity of bitcoin supply (which, once again, is set at 21 million) does not change in response to a change in bitcoin price. However, as the market structure improves and matures, price volatility should subside.
“Investors should consider bitcoin as a long-term buy-and-hold investment,” Hougan said. “Those who try to speculate on bitcoin’s short-term price movements are likely to be disappointed.”
Lack of regulation – Because cryptocurrencies are still so new, regulators aren’t sure which agencies should regulate them or how, and crypto also doesn’t fit perfectly into existing frameworks. Bitcoin and other digital assets, for example, are not available on most custodial platforms because they are not securities. Custodians and other regulated financial firms will be unable to meet rising crypto demand until there is more regulatory clarity, which may slow industry growth. “More regulation will, to a point, significantly help boost bitcoin adoption,” Hougan said. “However, regulators may overreach or enact poorly designed regulations that harm growth, which is a risk worth monitoring.”
“The continued lack of regulation and enforcement of intermediaries, promoters, and institutional traders does bitcoin and its potential growth and acceptance a disservice,” Schatzow added. “Some people believe that regulation will harm its prospects, but the market is vulnerable to manipulation in the absence of a viable regulator of market participants.”
Additional digital assets – It may have taken bitcoin more than a decade to be taken seriously by established institutions, but as it gains traction, developers are hard at work developing cryptocurrencies we’ve never heard of that may become more dominant than bitcoin for various reasons. “Alternative digital assets, currencies, and technologies are being developed at breakneck speed,” Schatzow said. “No one knows whether Bitcoin will be the preferred digital currency or a store of value in the future. If people collectively decide that another digital currency or store of value is superior, bitcoin’s prospects may suffer. Given Bitcoin’s longevity, it appears remote now, but this is a nascent industry, and don’t forget what happened to AOL.”
According to experts, bitcoin should be viewed as a complementary asset rather than a competitor. Having a large position in bitcoin entails a number of risks, and investors must size their allocation accordingly. ”[Bitcoin] can drop by 50% in a very short period of time,” Hougan warned. “If you have 1% to 5% of your portfolio invested in bitcoin, that’s not too bad. However, if you have 50% of your portfolio invested in bitcoin, this can be extremely difficult. Position sizing is critical.”