Since October 2020, Bitcoin has worked its way upward, almost invincibly, to new highs, a time when it seemed as if the Earth’s gravity had lost its grip on this asset and no other asset class had a price that could go as boldly as it did.
Along with the rise in bitcoin prices, there has been a steady stream of institutional investors entering to hold stocks, and traditional financial institutions are starting to take bitcoin-related businesses seriously, with some banks getting involved in bitcoin trading (such as DBS Bank in Singapore), some offering bitcoin trust custody (such as Bank of New York Mellon, or BNY Mellon), and some (in Hong Kong) offering virtual asset insurance.
It should be noted that BNY Mellon is the oldest bank in the country, and the fact that even such an old-fashioned bank is starting to take the need for bitcoin custody seriously shows how amazingly influential bitcoin is.
In Hong Kong, on December 15, 2020, OSL Digital Securities Limited (OSL), a subsidiary of BC Technology Group (00863.HK), was granted its first license by the Securities and Futures Commission of Hong Kong, China, to engage in licensed virtual asset trading platform business.
Of course, it is not simple to obtain OSL’s services, as the Hong Kong Securities and Futures Commission only allows the company to provide services to PI (Professional Investor). A so-called professional investor is someone who either needs to prove that he or she is an experienced investor with more than a million dollars, or a professional investment institution with large assets – both of which are out of reach for the average retail investor.
Interestingly, as recently as 2020, two of the world’s most dominant credit card companies, Visa and MasterCard, have also launched cryptocurrency-related businesses and continue to expand this massive market in 2021 by offering bitcoin-related products and services to their customers – although they can offer retail investors Bitcoin-related products and services, they do not need to obtain a license from the Hong Kong Securities and Futures Commission, as OSL does.
It can be expected that as more and more traditional financial powers participate in the cryptocurrency market, more and more institutional investors will accelerate their entry.
On February 13, 2021, Hong Kong-based Singularity Financial reported that Toronto-based Purpose Investments Inc. (PII) had received approval from Canadian securities regulators to issue a direct custody Bitcoin ETF, the world’s first Bitcoin product to be offered to retail investors (previous Bitcoin futures or bitcoin trust units have been for professional investors).
Previously, only the US-based Grayscale offered a bitcoin trust fund – but that fund was for professional investors only and had no redemption mechanism (i.e. it could only be bought and not exchanged for the underlying asset). In addition, investors must have a 1-year lock-in period if they want to sell their shares in the fund.
More products are expected to come out. That’s because as I write this, the dollar price of bitcoin has risen $20,942.17 or 72.47% since late last year so far, while the Hang Seng Index is up 7.7% and the S&P 500 is up an even more modest 2.58% over the same period. In the asset management industry, typically product managers push related thematic products when asset prices are rising, so I would expect that there is no reason why international custodians would not continue to ramp up their bitcoin products at this time.
Bitcoin is so bullish that when I recently attended a forum on alternative investments, a peer commented that Bitcoin would soon replace gold as the reserve currency of nations.
So the question is, while we all know bitcoin is bullish, will it be bullish enough to replace gold and become the next generation of reserve currency?
The possibility of Bitcoin nativity
There should be more than one person in the capital management industry who thinks like my peers. In the U.S., for example, some people are also becoming concerned about whether bitcoin will advance to become a reserve currency.
Right around the time Purpose launched an ETF for bitcoin, and also around February 13, Anthony Pompliano, co-founder of Morgan Creek in the US, tweeted asking Biden to put bitcoin in the Treasury – followed by Bitcoin Advisory, a US-based bitcoin advisory firm Founder Pierre Rochard showed a profile at the bottom of his tweet and replied, “The U.S. Treasury already holds 70,000 bitcoins, now the U.S. just needs Congress to pass a bill that would give consent for the Treasury to hold bitcoins.”
It’s hard to argue with the authenticity of the information Pierre Rochard showed, but one thing is true: Bitcoin will never return to the days when the foodie miner (Laszlo Hanyecz) traded his 10,000 count for two pizzas.
According to Anthony’s statistics at the time, as of February 14, 2021, Bitcoin’s return for the last 1 year was about 3.64x; for the last 2 years it was 12.33x, for the last 5 years it was 11,873% (118.73x); and for the last 10 years it was 4,486,540% (or 44,865.4x)!
But as an alternative investor, you can’t simply follow the trend of making bitcoin a treasure because its price has skyrocketed, even to the point of becoming a reserve “currency”; nor can you think it’s worth that much because it was traded by miners for only 2 pizzas for 10,000 pieces.
Let’s look at gold’s current status and see why some fund managers are listing bitcoin as a potential reserve currency.
Gold has been the reserve currency of the moment for a long period of time, a historical choice, and one that is the consensus of almost all civilized societies across humanity. It became a reserve currency because of its characteristics; and we can compare and contrast to see if Bitcoin has those same characteristics.
One is that it has a real use. There is no doubt that gold is a precious metal with real uses, widely used in industry and jewelry decoration, and also in demand by high-tech industries. More broadly, the World Gold Council (WGC) categorizes the demand side of gold as: investment (42%), jewelry (34%), central bank reserves (17%) and industrial technology (7%) demand.
In contrast, Bitcoin’s uses are tied to its underlying blockchain technology. Blockchain technology is now being applied to asset trading, the Internet of Things, archival storage, identity verification, and other areas, and this new technology will also become widespread in the future, proving the value of electronic money.
Nonetheless, there are few applications directly related to Bitcoin itself, and the user base is narrower and more focused on geeks and a very small number of alternative investors. In terms of usability, Bitcoin is not as useful as Ether with its smart contracts, which is why some are more bullish on Ether’s long-term value.
But bitcoin’s practical uses are trending upward, at least far beyond the days of pizza-for-pizza.
Bitcoin now clearly has investment properties and payment properties, although it has yet to be widely accepted as an investment asset class.
But this is probably more from national regulators – the cryptocurrency products they have granted so far are still only for professional investors, while its payment attributes remain practically inaccessible to the average retail investor due to the numerous technical issues and security concerns involved, and thus still rely heavily on the support of other third-party platforms to to be able to do so.
Of course, as more payment platforms such as PayPal, an online money transfer and payment platform, begin to trust cryptocurrencies, including Bitcoin, and more investors/consumers are allowed to begin exchanging or using them with physical currency, Bitcoin’s future growth in the payments space could be surprising.
Second, it needs to have a large market cap as a reserve currency. Here, let’s look at Bitcoin for a moment. As of the March 5, 2021 posting, the total global market cap of Bitcoin as shown on Coindesk is about $930.4 billion.
That’s a pedestrian-level asset for a reserve currency. Not to mention the fact that China’s foreign exchange reserves, as announced by the Chinese Foreign Affairs Bureau alone, reached $3,210.7 billion at the end of January 2021, the global bitcoin total doesn’t add up to a third of the size of China’s foreign reserves!
The gold market, on the other hand, is much larger, not to mention the gold reserves of various countries (about 40,000 tons), and not counting the gold reserves scattered among the people as jewelry, just counting the gold stock in the investment sector, it is hundreds of billions of dollars. According to the World Gold Council in January 2021, the AUM of gold currently distributed globally with data disclosed in the treasury sector alone is about 3,765 tons (3,915.8 tons at its peak in November 2020), or about $226 billion. At that rate, gold reserves in the hands of governments would be worth nearly $22 trillion!
To reach a market cap size similar to that of gold today, the price of bitcoin would have to be nearly 25 times higher than its current value – which, of course, is not out of the question given bitcoin’s past performance. In fact, Bitcoin’s performance over the last 5 years (11,873%) alone is well over 25x.
An important feature of Bitcoin is that it has a certain stockpile of no more than 21 million coins, and a large number of existing Bitcoins are permanently withdrawn from circulation each year due to lost passwords or damaged reserve settings, which invariably keeps the supply down, potentially pushing up the price of Bitcoin, all other factors being equal.
And the price of gold will fall as well, raising the chances of the two leveling off another step when the time comes.
That said, if Bitcoin’s price is to increase 25 times from its current position, it may depend on other factors, including the development of alternative cryptocurrencies, technological developments (whether or not Bitcoin’s blockchain encryption technology will gradually fail), and the extent to which countries will “close the water” after quantitative easing.
Third, the balance between security and convenience. In the cryptocurrency and chain world, many people only analyze the security of Bitcoin and other cryptocurrencies, but neglect to analyze the convenience of Bitcoin – in fact, I think you can’t have one without the other, and at this stage, Bitcoin’s price risk, transaction risk, compliance risk, and wallet security make it an unsuitable investment for the general public. investment for the masses. This will probably be the weakest link in its competition with gold.
Imagine if you stored a valuable piece of jewelry in a safe, but that safe required you to enter 100 passwords containing upper and lower case, letters and various characteristic symbols before you were allowed to unlock it. What’s worse, once you can’t remember the code, the safe locks up and can never be opened again.
Bitcoin is such a “jewel” that comes with its own safe. Since it is not even a physical object, but just a network address with two passwords, once the holder loses the key to open it, he or she loses the wealth forever with the current technology.
Obviously, this problem does not occur with gold. Moreover, there are far more people who know how to trade gold than there are internet users who can operate bitcoin wallets.
So, the two points of security and convenience should be looked at together. Bitcoin is definitely better than gold in terms of security. Because it is not a physical currency, there is no physical loss, forgery, counterfeiting, or physical theft. Bitcoin is essentially a decentralized, encrypted electronic ledger whose transaction information cannot be forged, cannot be tampered with, and cannot be seen outside of the Bitcoin network. Even on the Bitcoin network, bitcoins held by individuals are highly private.
However, bitcoin is still far inferior to gold in terms of transparency and convenience based on security. Most of the people who currently hold bitcoins are young people with some computer technology or Internet skills and are good at using IT devices. They have no problem at least reading this article by the author, and even find it child’s play, but for many traditional investors who lack this knowledge, even if they can afford to hold bitcoin, they are almost powerless when it comes to cybersecurity hazards.
Gold, by contrast, is much easier to understand and its means of trading, preservation and payment are transparent and sophisticated. In particular, the modern steps of gold trading and delivery have entered a globalized and systematic system that makes it very difficult to transfer counterfeit gold. Even the physical vault storage, transportation and security techniques are so mature that it is not easy to steal gold amidst heavy security.
Fourth, look at price volatility. For investors in any asset class, the price volatility of that asset class is closely related to risk. According to data provided by the WIND database, the average daily volatility of gold so far in February 2018 is about 1.14%, while the average daily volatility of bitcoin over the same period is 3.88%, which is 3.4 times higher than gold. This cumulative comparative value becomes apparent when weekly or monthly volatility is considered.
A report by the World Gold Council in January 2021 also compared market volatility metrics for bitcoin, gold, the S&P 500 and the Nasdaq, and the results were similar to the statistical analysis I conducted based on WIND data. Gold had the lowest volatility, the Nasdaq and S&P were next, and Bitcoin had the highest volatility, more than three times that of gold.
Looking at volatility alone may not be enough, the VaR value-at-risk model provided by the Gold Institute for the past two years on a weekly basis shows that bitcoin’s value-at-risk is five times higher than gold’s. That is, an investor who invested $10,000 in bitcoin over the past two years would likely have a 5% chance of losing at least $1,382 per week – compared to a loss of just $291 for investing in gold, $382 for investing in the Nasdaq, and $306 for investing in the S&P. Since VaR does not take tail risk into account, the odds are that bitcoin will be riskier than gold from a practical standpoint.
Fifth, look at market liquidity. There is no doubt that gold is far less concentrated in the market than bitcoin. If you take into account physical gold in the hands of retail investors, gold will be more widely distributed globally. In addition, the production and supply of gold is far more diversified than bitcoin.
Bitcoin can only be produced and supplied through “mining” at the moment, and there is a certain amount of concentration in the global mining scene that will further concentrate the supply of bitcoin. Alternative investors should be wary of this.
If the supply of bitcoin becomes increasingly concentrated in the hands of a few institutions, and the bitcoin in circulation becomes increasingly concentrated in the hands of some large institutions, this will pose a potential risk to bitcoin liquidity and cannot be ruled out as having a direct impact on the price.
From the comparison of the above indicators, Bitcoin has a long way to go before it can become a local “currency” at this stage.
The Value of Bitcoin as an Alternative Asset
Some readers may ask if Bitcoin is still worth paying attention to if it has such a high risk. As a sensible alternative investor, we can’t ask if it’s worth investing just because Bitcoin is wildly up, nor can we chicken out and retreat just because Bitcoin is so volatile.
Here we can still use some research data from WGC as a judgment. You can go to WGC’s official website to download the report for analysis for specific details. Here are just a few interesting and conclusive things.
First, bitcoin and gold are not substitutes. The correlation between gold and bitcoin is very low, between -0.5 and 0.5 most of the time. While it averaged positive in 2020, it is clear that the two cannot consistently show a positive correlation or a tendency to consistently have a negative correlation. This suggests that gold and bitcoin are not substitutes. The subtext of this conclusion can also be interpreted to mean that investing in both gold and bitcoin may also be a viable asset allocation option.
Secondly, Bitcoin’s “safe haven” function will be proven in the future, as WGC’s research found that gold has a certain “safe haven” function compared to other risky assets. In particular, gold tends to perform better during stock market crashes. This is because the trend between the stock market and the NASDAQ shows that gold tends to be negatively correlated with stocks during sharp stock market declines. This allows investors to achieve a better diversification of investment risk by adding to their gold positions when investing in stock indices like the S&P 500 or the Nasdaq Composite Index.
Looking at the current performance of Bitcoin, it seems difficult to say that it is a safe-haven asset. According to WIND data for the past 5 years ending January 2021, bitcoin has seen a spike up/down in the same direction when the NASDAQ has spiked up/down, and to a greater extent than the NASDAQ – in this sense, bitcoin has not proven to be an effective “hedge but more of a risk-enhancing asset class.
For example, in March 2020, Bitcoin fell more than 40% from peak to trough that month, eventually ending the month with a 25% drop. This behavior is more similar to U.S. tech stocks than to gold – which initially fell 8% from peak to trough in March 2020, but then rebounded quickly and was back to pre-decline levels by the end of the month, and then continued to rise as investors increased their hedging demand.
Third, appropriately added bitcoin can boost overall returns. the WGC study also found that adding an appropriate amount of bitcoin to a simulated portfolio does increase risk-adjusted returns. Looking at data from the past five years, allocating 1% to 5% of bitcoin to an overall portfolio boosts risk-adjusted returns.
However, WGC also notes that this improved return comes primarily from a rapid increase in bitcoin prices, not from a decrease in portfolio volatility – and that most investment managers in traditional capital management theory diversify their assets in large part to diversify risk.
WGC’s analytical perspective remains the classic, use the balance of return and risk to examine the allocation function of bitcoin and gold in a portfolio of assets, and for most investors, this is a very effective way to assemble a portfolio.
However, whether this approach from WGC is applicable to bitcoin, which is rising in price, may be a matter of opinion. From the author’s point of view, it is still a good choice if the addition of bitcoin boosts the Sharpe ratio (which represents how much extra return an investor can get for every additional unit of risk taken) of the entire portfolio. As for how to measure and improve the Sharpe ratio, that’s a separate topic that I won’t expand on here.
WGC believes that Bitcoin is not a liquid market. Bitcoin’s supply and demand, market liquidity, and the regulation it is subject to, are all evolving to date, and in this case, its price may largely need to respond to more than just one traditional factor, which causes its price drivers at this stage to differ from traditional investment analysis.
Since the WGC is an organization that represents gold investors, the above quote from the WGC should also be viewed dialectically.
Most alternative assets are less liquid than stocks and bonds, yet when the price of an alternative asset rises, it tends to attract more liquidity into the market – whether it’s real estate, jewelry, paintings, or currently bitcoin, all reflect this characteristic. Therefore, when the price of bitcoin rises to a certain point, this market is large enough to most likely trigger more liquidity to enter the market. Soros’ contrarian theory is actually a reflection of this very truth in a way. This is something that investment managers need to keep an eye on.