The Case Against Adding Bitcoin to Your Investment Portfolio
Bitcoin pyramid. (Source: licensed from Adobe Stock.)
It has been 16 years since the launch of bitcoin. And while bitcoin’s value has value has grown spectacularly since its launch, its real-world utility remains abysmal, and its prospects for solving problems for humans in the material world remain unclear. Without any near-term prospects for real-world relevance, including bitcoin in a traditional risk-managed investment portfolio seems both impulsive and imprudent given the many extraordinarily large investment risks that remain.
DISCLAIMER: This is article is for educational purposes only and is not investment advice. Bitcoin is a highly speculative investment, and there is a chance for a significant or total loss of your investment. You should work with a licensed financial professional before making any speculative investments in bitcoin or other cryptocurrencies.
One of the primary characteristics of a good investment is a concept known as intrinsic value, and most investments have one of three classes of intrinsic value:
Income. Many investments provide either a promised income stream (e.g, a bond or other interest-bearing instrument) or a share of profits in an enterprise that markets products or services (e.g., a share of stock) that hopefully will end up providing more money than the initial investment.
Unique items. A class of investments that are prized among certain people for their uniqueness. Think: a renowned piece of artwork or an antique car.
Real-world utility. A material thing that people and companies need on a regular basis and whose value may grow in time because the product will become more in demand or shorter in supply. Two major types of investments that fit into this category are commodities (such as grains and oil) and real estate (because people need homes in which to live and businesses need places in which to do commercial activity).
And that’s about it. Virtually all investments provide some sort of intrinsic value in one or more of these three categories.
Here’s the problem with bitcoin (and all other cryptocurrencies): after 16 years, bitcoin still has yet to demonstrate any intrinsic value for any lawful purposes. To put it bluntly, if you own bitcoin or some other cryptocurrency, how much do you or anyone else use bitcoin on a day-to-day basis for something actually useful? Your answer is probably: none.
Instead, if your own Bitcoin or are considering owning bitcoin, your only likely rationale for owning it is probably: people have made a lot of money in bitcoin, and I want to make a lot of money.
Unfortunately, thousands of years of investing history has demonstrated that this is a very dangerous investment thesis. From tulip mania to pyramid schemes, investing is an asset with no intrinsic value has often worked out poorly for people who were left holding the bag when the music stops. The question is: when is the music for bitcoin going to stop, if ever?
The purpose of this post is to describe:
My thinking on bitcoin’s investment thesis, such that it is
The payment technology shortcomings of bitcoin - and what problem is bitcoin really trying to solve that isn’t already provided by our existing payments system?
Why the “replace fiat currency” argument for cryptocurrency is bad (though it warms the hearts of conspiracy theorists and people who don’t trust government)
The one practical use for bitcoin today: enabling criminal activity (which isn’t a valid investment thesis)
My acknowledgement that while I think it will be very hard for bitcoin to provide practical value for society, there remains the possibility that it will do so (and therefore bitcoin has option value)
An under-acknowledged risk of bitcoin specifically: technology risk and potential growing competition from new and technically better cryptocurrencies
Why bitcoin becoming less valuable as a piece of an overall portfolio because of the growing correlation of returns between bitcoin and the stock market, especially when stock markets decline.
Concluding that without demonstrating a real-world use case, the only path for growing demand of bitcoin is simply convincing more people to buy bitcoin without a strong investment thesis, and that is usually a very dangerous investment thesis.
This post is for the most part focused on bitcoin, not cryptocurrencies in general. But many of the points made here apply to most cryptocurrencies. I am also not addressing stablecoins in this post - this is really a separate type of product that has its uses and challenges.
Bitcoin Does Not Currently Have a Great Investment Thesis
To re-iterate, a good investment almost invariably has one or more of the following characteristics: (i) it provides access to an income stream; (ii) it is an asset that people need to survive and/or thrive in the real world; and / or (iii) it has unique value.
Let’s start with some easy logic. Clearly, bitcoin does not provide any sort of guaranteed income stream, nor is it really an enterprise upon which it seeks profits (although there are companies in the Bitcoin ecosystem who depend on bitcoin’s survival for their profits!).
Also, bitcoin is not a unique item - not only can anyone go out and buy some bitcoin anytime they like, but there are thousands and thousands of other coins that you can fancy, hoping that the one you pick will become the next memecoin. Bitcoin is clearly a commodity, though the market for bitcoin has several interesting though counteracting features: (i) bitcoin itself has limited supply (by design); (ii) bitcoin is the best known of all cryptocurrencies; however (iii) there are many, many other cryptocurrencies out there that essentially provides similar features to bitcoin.
That combination makes it more interesting than other commodities, but it’s still a commodity. In other words, bitcoin is kind of like branded gold bars, but at the end of the day, it’s still just a gold bar, and even worse, companies can make some knock-off cryptocurrency that often does things better than bitcoin does. And just because something is of a limited quantity does not necessarily mean that it is precious, especially if that thing can be divided and split up in smaller and smaller portions. Fundamentally, those things ultimately must have real-world utility to have value.
So the question is whether bitcoin has the potential of having any real-world utility. One benefit of gold is that it does have real world utility. It has industrial uses, and of course it is used to make jewelry, which many people like.
So what what will be the utility of Bitcoin? Essentially, there are two inter-related arguments:
Bitcoin will eventually be accepted as a way to pay for things, and since there is a limited supply of bitcoin, that will make bitcoin valuable.
Bitcoin will become a trusted reserve currency, because nation-backed currencies (like the dollar) cannot be trusted since governments and central banks are inherently untrustworthy, and nations won’t be able to prevent bitcoin from being an accepted means of payment.
Let’s examine these arguments one at a time.
The Magic of the Modern Payments System - And Where Bitcoin Falls Short
We who live today (especially young people!) take for granted the convenience of our modern payments system. But it has actually involved decades of incremental work to get to where we are today.
So let’s start with a brief history of how human beings paid for things:
First, we bartered things. I have grain, you have meat - let’s swap, and we’re both better off.
Then, governments created coins, which eliminated the need for bartering. But you still had to pay with physical currency.
Then the banking system came along, and over a couple of centuries that enabled people to pay on credit and eventually to write checks that drew against their bank accounts. Of course, accepting paper checks entailed risk for the receiver of the check! In many cases, the seller didn’t know if the account tied to the check actually had the cash in the account (or maybe it was a counterfeit check or fake account!).
Then banks started issuing credit cards…the benefit of this approach from the seller’s perspective was that credit cards were much more likely to make payment to the seller. And the banks created payment networks to minimize costs and centralize processing (the biggest payment networks in the United States eventually became Visa and MasterCard). The downside to the seller of accepting credit cards was that the payment network charged the seller a fee of 2-3% of the transaction. This fee paid for the cost of processing the charge and insurance against fake charges for both sellers and users of credit cards.
In the 1970s and 1980s, the way you charged something was that a paper form was filled out in duplicate and the vendor took your credit card number via a credit card imprinter. That’s why old credit cards had their numbers embossed on the card. (Kids these days probably don’t remember these embossed credit cards since everything is electronic these days.)
However, over the last 30 years (and especially since the dawn of the Internet), payment vendors built electronic networks to validate payment. And over time, the efficiency and speed of these networks has vastly increased through ongoing incremental investments.
And during this time, debit cards were also incorporated into the payment networks, enabling people to draw money from their checking accounts to pay for things in addition to charging their credit cards.
And recently, we have seen the adoption of contactless payments and phone-based payments, which further improve convenience and security.
As a result of these decades of investment in payment infrastructure, we now have an amazing payments ecosystem that enables us to pay for anything in about three seconds. No cash, no swiping of a credit card machine, no signing of a payment slip. And the vendor receives their money in 2-3 days. And while there are still obviously lots of fraudulent charges in the system, net-net the system works, and practically every vendor willingly pays the payment processing fee (and in practice, the vendor increases the prices it charges to consumers to pay for the fee).
So can bitcoin duplicate that? Well, the answer is no and yes.
Let’s start with the core bitcoin payments system. Yes, the core bitcoin technology infrastructure does include technology to transfer bitcoin from one party to another party. But the core infrastructure is not an ideal payment system for three reasons.
Owners of bitcoin can easily lose access to their bitcoin if they aren’t careful. When you purchase bitcoin, you receive a private key that provides access to your bitcoin. If you lose the private key, you lose access to the bitcoin associated with that private key forever. (But solutions to this have been and continue to be developed, especially crypto-wallets). In fact, it is estimated that somewhere around 10-20% of all bitcoin has been irretrievably lost…simply because owners lost the private key associated with their bitcoin.
Transactions are irreversible. Once a bitcoin transaction goes through the ledger, it is irreversible. This is unlike a credit card processing company where transactions are reversed all the time, especially for fraudulent charges.
Payments are slow. The way that the bitcoin system was built resulted in a system where executing and clearing a payment can take a long time. Like many minutes. Can you imagine going to Starbucks and waiting for 10 minutes for your bitcoin payment to clear? Neither can I. (But solutions to this are being developed - see below.)
Fortunately, many companies have emerged to address the above and other challenges that prevent bitcoin from being a convenient payments mechanism. Essentially, what these companies are doing is building an ecosystem of technologies that replicates the existing “dollar-based” payment system, making it faster and providing modern features that make payment more convenient.
Now of course, this additional technology will not be free…eventually consumers and vendors using bitcoin payment systems would need to pay for the privilege of a faster, more secure and more convenient bitcoin payment system. And that fee will probably be something like the 2-3% that Visa and Mastercard currently charge.
But you have to stop and ask yourself: wait, why are we replicating a payment system that is generally working pretty well? Who is this benefiting? And the answer isn’t clear.
In particular, Visa, Mastercard, and their ecosystem of financial institutions and technology vendors essentially have a 30-year head start on Bitcoin in creating a fast, secure payments network. Why would any consumer or vendor opt to use bitcoin to pay for things given the convenience of the current system?
In my view, the Bitcoin enthusiasts don’t really have an answer for this. And that’s when many Bitcoin enthusiasts retreat to their fallback argument, which is that fiat currencies such as the dollar can’t be trusted. Let’s tackle this issue.
Governments Will Ruthlessly Defend Their Sovereign Currencies…And Are Right to Do So!
For this section, the crux of my argument is:
Governments have a legitimate and vested interest in maintaining a sovereign currency; and
Governments have powerful statutory tools that makes it very hard for cryptocurrencies to compete with sovereign currencies in the real world.
Let’s start with the rationale for governments to maintain a sovereign currency, which requires a bit of economic history.
During the 1800s and early 1900s, the United States and many other Western countries operated under either a silver standard or gold standard. What that meant was that the dollar or another sovereign currency could in theory be exchanged at a fixed rate by a nation’s central bank for specie, or precious metal currency.
The challenge is that is also provided zero flexibility for managing a national economy in unusual situations. And two major world events caused most governments to abandon this approach. Those events were World War I and the Great Depression. The reason is because of the concept of money supply.
Money supply can be thought of at a very high level as the total amount of money outstanding in an economy, but how to measure that in a world with a modern banking system is very, very difficult, because money can be generated simply from more activity in the economy because of the banking system. There is a very easy way to describe this concept:
Let’s say that there are $2 in an economy, and I own that money, and that money is sitting at a bank.
Now let’s say that the bank lends $1 of it to someone else (because that is what banks do…they take in savings and lend out much of it to borrowers).
That borrower takes that money and then deposits the $1 and deposits it in another bank.
So therefore there are now $3 in the economy.
In other words, the banking system creates money out of thin air!
As you can imagine, this activity is going on at an unimaginable scale in today’s economy. Money is constantly going in and out of the banking system, so how much money there is in an economy can change over time.
One of the things that most economists generally do agree on is the importance of keeping money supply relatively stable relative to the overall size of the economy. If the money supply grows too fast, then the economy will likely experience inflation (in fact, we saw this in 2021 and 2022 when the government plowed trillions of dollars of money into the economy to maintain growth…but it boosted the money supply so much that it caused inflation). But if the money supply shrinks, then there is a risk of recession, because the economy has too little money to support economic activity.
Absent the intervention of a central bank, economies can by themselves grow and shrink the money supply very quickly, and it follows a boom-and-bust cycle. During the boom years, banks are lending out lots of money, and the money supply grows quickly. But then, almost inevitably in any boom cycle, too much lending happens, some of those loans go bad, and a bad loan is essentially the disappearance of money. And because of those bad loans, banks restrict lending, the money supply shrinks, and the economy goes into a recession or a depression.
That boom-and-bust cycle is pretty much what happened over and over again in the late 19th century and early 20th century, ending of course with the Great Depression. During the Great Depression in the 1930s, national governments didn’t have as much flexibility to manage the money supply, in part because there was a gold standard. Governments needed to increase money supply to boost the economy, but they were unable to do so, because if they issued a lot of new money, they might have to reduce the fixed exchange price into gold, which would lead to a crisis in the currency.
Fortunately, today’s modern central banks have some powerful tools for managing the money supply in the economy.
Since the Depression and World War II, governments, central banks and economists have generally come to agreement that a better approach in today’s global economy is to move away from gold standards and fixed exchange rates and instead provide central banks powerful tools to flexibly manage the money supply.
And this is not a tool that governments are going to be willing to give up, because if the economy is facing a recession or has significant inflation, democratic governments will want to use all tools necessary to remediate the problem because voters tend to hate recessions and inflation.
So that’s the argument for governments being able to control a currency. And quite frankly, cryptocurrency enthusiasts don’t have a lot of great arguments that most macro-economists accept about why a cryptocurrency-driven economy would be better for most human beings, because losing key macroeconomic tools would simply bring back boom-and-bust cycles.
But ironically, that is also an insidious argument to sow distrust in governments and currencies - macro-economists acknowledge that governments (especially central banks) are indeed manipulating the currency! There are many people who are open to accepting such arguments. The reality is that distrust of government institutions is one of the primary drivers of the adoption of bitcoin.
So if some people will potentially distrust governments no matter what and want bitcoin to be widely adopted and used, is there anything practically speaking that governments can do to prevent bitcoin from being a de facto currency? The answer is: you bet there is.
Let’s start with the most powerful way that governments can maintain control of the currency, which is determining the way that people and institutions pay taxes. In particular, the U.S. government can and does say that tax payments must be paid in U.S. dollars.
And that creates a problem for people who accept and pay money in bitcoin, because it exposes them to currency exchange risk. For instance, let’s say in January of a tax year that you accept payment of 1 bitcoin when bitcoin is worth $100,000 per bitcoin, and that income is taxable. You will have to report that $100,000 of taxable income on your tax return.
But let’s say you held on to that bitcoin and next month, one bitcoin is worth $30,000. Oops…now you have a problem. Because even though your Bitcoin is now worth $30,000, you still owe tax on $100,000. (And by the way, you can recognize a capital loss on your Bitcoin by selling it, but under U.S. tax law that loss largely won’t offset taxable earnings income, so you still owe the tax on most of the $100,000 of income.)
Could you hedge your risk through cryptocurrency futures or some other mechanism? Sure. But the easiest way to hedge currency risk is simply accepting payments in dollars and paying for things in dollars. And in fact, that’s what everyone does. A big reason everyone uses dollars is because we have to pay taxes in dollars.
The government and the Federal Reserve have other cudgels. The government issues Treasury bonds in dollars, and Treasury bonds are essentially the motor oil of the financial system. The Federal Reserve also has significant influence on the payment systems in the country, so it also has an interest will be that the dollar remains the primary means of payment in the US.
Net-net, I’m pessimistic that bitcoin is going to replace the dollar, and quite frankly in my view, bitcoin should not replace the dollar or become a meaningful part of how we pay for things.
The Current Practical Value of Bitcoin: Payments for Criminals
The one thing that bitcoin is very good at providing is a semi-pseudonymous payments system. In most circumstances, people don’t want payments with counter-parties with pseudonyms. Both buyers and sellers want to have a record of who paid the money and who received the money. When you buy something with your credit card, you want to see a record of it on your credit card statement. And sellers need records for their accounting and tax records. And the payment system itself wants records of the buyers or sellers in case something goes wrong or if there is fraud.
But there is one set of individuals who DON’T want records of transactions: criminals. For centuries criminals have looked for means of paying for illicit goods or services and of turning “dirty money” into “clean money”, aka money laundering. Traditionally, the way to do this money laundering is through “legitimate” businesses that deal with a lot of cash, such as, stereotypically, casinos or laundromats. But as the cash economy has declined with the growth of the electronic payments system, this has gotten harder.
Fortunately for criminals, they have a new way to move money: cryptocurrencies. And while the bitcoin system is not completely anonymous, sophisticated criminals often have the means to make payments virtually untraceable, especially if they are overseas. This is why bitcoin and other cryptocurrencies have become the favored payment mechanism for ransomware incidents where criminals overseas hijack IT systems and request a ransom to release control of those systems back to their owners.
With that said, the percentage of bitcoin transactions associated illicit activity is relatively small. But that small amount of illicit activity can provide value as a payment mechanism. Is that enough to support a valuation of $115,000 per bitcoin, equating to a total worth of all bitcoin of $2.2 trillion? While there may be some disreputable value of owning bitcoin simply because it’s a means of enabling criminals to move money, a $2.2 trillion “market capitalization” of all bitcoin seems far-fetched if its sole use is to support criminal activity.
Moreover, “investing in an enterprise that enables criminal activity” is not something I would ever recommend, not just because it’s unlikely to work out well financially, but also because it’s just not morally right. It’s a poor and wrongheaded investment thesis.
The Value of Bitcoin As an Investment
Now an important point here: none of the above arguments necessarily means that bitcoin and other cryptocurrencies have no value. A thing that has no value today but could theoretically have value in the future does in fact have value. This is called option value.
And in fact, we know that people perceive this value - that is why one bitcoin is worth a lot of money. The perceived value is likely based on the two somewhat widespread beliefs owners of bitcoin that I discussed above:
Many people view bitcoin as a potential future means of payment that has a limited supply. Although I think this is unlikely to come to fruition, it is still possible, and therefore, bitcoin has what is called “option value.” Unfortunately, that value is impossible to quantify, and because the value is immeasurable, the perceived value (aka, the market price of bitcoin) is likely to fluctuate dramatically over the coming years.
Many people view bitcoin as a safe harbor against the collapse of the dollar. Although I think this is unlikely to come to fruition, it is still possible, and therefore bitcoin has what is called “option value.” Unfortunately, that value is impossible to quantify, and because the value is immeasurable, the perceived value (aka, the market price of bitcoin) is likely to fluctuate dramatically over the coming years.
In other words, I can buy the argument that bitcoin has some theoretical value because of an unlikely scenario where bitcoin has value in the real economy. But I can’t measure that value, and NO ONE can measure that value. And because the value is immeasurable as of today, that means that the valuation is likely to fluctuate wildly.
Bitcoin Risk Factors Are Many - Correlated Volatility, Natural Limits, Competition
Extreme Volatility with Declines in Price Increasingly Correlated with Stock Market Declines. The point above gets to the big problem with having bitcoin as a meaningful part of your investment portfolio. Almost all people hate investments whose value fluctuates wildly, and both professional and amateur investors expect that investments whose values have lots of risk (as measured by highly volatile values) should offer more rewards. To date, bitcoin has provided those rewards, but it has been a very rocky ride. In fact, it has been so volatile that if you asked most investors whether they would want an asset with such volatility, most would say, “No thanks.”
But volatility alone is not necessarily disqualifying from a prudent investor’s portfolio, because what also matters is correlation of an assets value with other assets. In fact, many bitcoin enthusiasts have talked about the fact that bitcoin is relatively uncorrelated with the stock market returns, and for that reason it deserves a place in investors’ portfolios.
Unfortunately, that argument has gotten a little deflated in the past few years. While bitcoin retains relatively low correlation with stock market returns, we have in fact seen higher correlations between bitcoin and the stock market during times when the stock market is crashing. During the stock market declines in 2020 and 2022, the correlation between bitcoin and stock market returns grew significantly, and bitcoin remained highly volatile, so as the stock market went down, bitcoin went down by a lot more on a percentage basis. This is exactly the opposite of what investors are looking for in a diversifying asset.
Bitcoin Bumping Up Against “Natural Limits.” There is a “macro” argument against continued meteoric growth of bitcoin (and other cryptocurrencies), which is that the total value of cryptocurrencies is beginning to become rather meaningful relative to two other measures: (i) the total value of all gold in the world and (ii) the total global money supply.
As of the date of this post, the total value of all all cryptocurrencies is approximately $3.8 trillion. The value of all gold is approximately $22 trillion. So for those who see bitcoin as a reserve alternative to gold, we may see start to see some substitution effects. But for many, gold is still a better reserve because (a) it has real-world utility and (b) gold has thousands of years of demonstrating value.
It’s hard to see the bitcoin price continuing to demonstrate exponential price growth based on reserve demand alone…unless national governments start to purchase bitcoin for reserves. That is why many view recent arguments by some people for the Federal Reserve to purchase bitcoin as a “strategic reserve” is really a bailout for bitcoin investors who don’t want to be stuck holding the bag if the price of bitcoin goes down (because many sophisticated bitcoin investors also potentially perceive these natural limits).
In addition, bitcoin has started to become a very small, but meaningful percentage of global money supply. Bitcoin is not money, but one can imagine that there is a practical limit of how large the global value of bitcoin can be relative to the supply of money.
It seems very unlikely that the price of bitcoin could grow another 3,000% over the next six years like it did over the previous six years simply because it is bumping up against these practical limits. Of course, if bitcoin became a primary method of payment, that would change the calculus, but that gets to the issue of bitcoin still having no viable path to real-world relevancy.
Competition. Finally, as part of the investment thesis discussion, there is one additional risk for bitcoin specifically, which is competition from within the crypto market. Although bitcoin is currently the most widely-owned cryptocurrency on a market value basis, bitcoin was designed to be a store of value, not a facilitator of payments. As a payment mechanism, the bitcoin ecosystem is slow, uses a ton of energy, and is cumbersome to manage and interface with. So called “Layer 2” technologies provide solutions to this, but this adds cost to the bitcoin payment ecosystem, and as I mentioned above, it’s not clear how this makes bitcoin payments superior to the way we currently do payments.
And that brings up the risk of competition. Because one thing I learned while I was a technology investment banker is how fragile technology industry leadership can be. I often tell the story of Nokia: back in 2007, 40% of all mobile phones sold were Nokia phones. Nokia looked like it would be a dominant high-end phone provider in a fast growing and important industry for years to come. But just a few years later, Nokia lost its leadership, and it was unable to match the features offered by Apple and Android phones. And by 2013, Nokia exited the mobile phone market by selling its mobile device business for a trifling amount. That’s how fast life can move in emerging technologies - you can go from industry giant to zero in five years.
Bitcoin feels to me like an industry leader whose foundational technology is woefully behind where it needs to be to get wider adoption. No one in the cryptocurrency industry raves about bitcoin’s technical strengths (besides its security). And that makes bitcoin potentially subject to fierce competition with other cryptocurrencies in the future. In fact, bitcoin is by no means the only crytocurrency out there, though as of the time of this article, it has about a 60% market share. But that means that there are other coins out there that could grab the momentum and future leadership.
So why does bitcoin’s value keep going up?
Simple: People have seen other people make money from bitcoin, and they want to make money, too. That’s it.
There has undoubtedly has been an steady increase in the demand for bitcoin over the last few years. And given that the supply of bitcoin is now growing very slowly year over year, this increase of demand has meant that the price has gone up. It’s Economics 101.
Of course, for the price to increase further, either more people will have to be interested in buying bitcoin or current bitcoin holders will need to increase their bitcoin holdings. It really is as simple as that.
There is a wide variation of estimates about what proportion of people own bitcoin. Estimates are that anywhere from 5-20% of Americans own bitcoin, but ownership among younger adults is likely to be higher than that.
But one can imagine that we’re getting close to a point of saturation of people who would be willing to adopt bitcoin without a meaningful real-world reason to do so. This point where an investment fad reaches maximum saturation and there becomes no more buyers of an asset is when things get dangerous. Because market psychology (especially for an asset that has little practical use) can be a very fickle thing. Bitcoin is essentially a tulip bulb that maybe one day might be more useful than a tulip bulb and closer to a gold bar (but probably never as good as a gold bar). But for now, bitcoin is closer to a tulip bulb in terms of practical applications.
In particular, the growing correlation between the price of bitcoin and stock market performance during stock market bear markets is especially concerning.
To Sum Up…
So here is the summary argument on Bitcoin:
Bitcoin doesn’t have any of the typical characteristics of an investment
It doesn't provide income and it is not a unique asset
It doesn’t currently have much real-world value as a commodity
Bitcoin’s has unfavorable prospects for having real-world value as a commodity in the future
Bitcoin currently has a very weak payments ecosystem, and the bitcoin ecosystem offers no viable vision forward for offering a payments ecosystem superior to the existing one
The US government and other major governments will vigorously defend the primacy of sovereign currencies, and they have the means to effectively do. So it is unlikely that bitcoin will supplant sovereign currencies as the primary means of payment.
But that doesn’t mean that there is zero chance that bitcoin has any practical value
We can’t rule out the possibility that bitcoin and other cryptocurrencies may have value in the future - this perceived “option value” is partly what is driving bitcoin’s price these days.
Bitcoin can best characterized today a highly volatile, fad investment with some limited option value
In practice, the real reason most people are buying bitcoin is because other people have made money buying bitcoin. But this is not a valid investment thesis. In fact, there is a long history of this being a very dangerous investment thesis.
Bitcoin has been an extremely volatile investment - most investors hate volatile investments, for good reason!
In addition, significant declines in stock markets have increasingly correlated with declines in the price of bitcoin, which limits bitcoin’s value as a diversifying asset.
However, because bitcoin has delivered spectacular returns over the last 15 years, old investors have largely stuck with it and new investors continue to pile in.
Nonetheless, there remains significant risk of a market collapse - bitcoin has all the hallmarks of a investment mania that could eventually lead to a crash.
In large part, continued growth in the price of bitcoin depends on more people and institutions getting swept up with bitcoin mania, because the more people buy, the more the price goes up. This is a classic sign of mania, and although bitcoin is not a Ponzi scheme, it does retain some characteristics of a Ponzi scheme.
That doesn’t necessarily mean a crash will happen…but it could. In particular, one can imagine that a prolonged, correlated stock market crash and crash in the value of bitcoin could permanently alter the psychology of many bitcoin investors.
And even if cryptocurrencies do take off as a viable real-world application, bitcoin may not necessarily be a long-term winner due to scaling challenges with its technical architecture.
When a technology hasn’t provided a compelling real-world use case in the 15 years since it was created and released into the world, that’s a sign of trouble. Think about all the amazing technologies we’ve seen introduced in the last 30 years, especially the internet and the world wide web, mobile phones, and social networks. We have seen both tremendous innovation AND tremendous user adoption, and these technologies have fundamentally changed society, and all of them demonstrated significant user uptake AND real-world utility in the first 15 years of deployment. I have little doubt that artificial intelligence-related tools and applications will be the next big technology that changes the world in the coming 15 years (though like with the aforementioned technologies, there will be years of slow progress followed by accelerating adoption and rapid technology improvement).
After 15 years, bitcoin hasn’t come close to achieving in real world impact what many other breakthrough technologies achieved. In everyday applications, bitcoin is still a curiosity more than a fundamental part of how we live.
And the next five years is probably when bitcoin has to demonstrate what it is possible of achieving. If the bitcoin ecosystem doesn’t demonstrate real-world utility in the next five years, it is unlikely to become more than a small piece of the overall financial ecosystem. Moreover, bitcoin potentially faces the risk of being overtaken by a more modern, better-featured cryptocurrency platforms.
For these reasons, bitcoin remains a speculative play at best, suitable more for gambling purposes than for investment purposes. And it has particularly little utility in a diversified portfolio, because bitcoin is increasingly correlated with the stock market returns when the stock market declines. And also for that same exact reason, it has decreasing value as a place to put reserves.
But despite all this, what I hear from many of my clients who have bought bitcoin on their own is, “I’m ok with losing most of my money on my bitcoin investment.”
Important: if this is how you think about your bitcoin “investment,” you need to realize you are in fact gambling, not investing. You should be self-aware about that and realize that bitcoin is not appropriate at this time as a serious part of your investment portfolio.
Further reading: