1. A payment network
2. A currency
3. A store of value.
So far I have focused on 1 & 2. In this post, I am focused on 3.
Call it a currency or call it a commodity (as the IRS does), the store of value question is simply “will I get a better risk-adjusted total return than other alternatives?”
Let’s parse that question for Bitcoin:
- “Total return”. This means capital appreciation PLUS Interest (Bonds) and Dividends (Equity). You receive no Interest or Dividends if you hold Bitcoin. Indeed the cost of Cold Storage makes it a cost to own Bitcoin.
- “risk-adjusted”. Bitcoin is more like Gold, which also pays no Interest or Dividend and you pay to store it in a vault. Gold has thousands of years of price history, Bitcoin about 5. It is inconceivable that Gold value will decline to zero. It is possible that Bitcoin will decline to zero; unlikely but possible.
- It is inconceivable to forecast a 10x or 100x return for Gold but one can paint many scenarios in which the price of Bitcoin will be 10x more than it is today (which makes it a 100x return for early speculators and miners).
- So, you might lose everything or you might get a 10x or 100x return. Does that sound familiar? Or course it does, this is like investing in tech startups.
- If this is like investing in startups, what stage is the deal? Is this Seed or Series A or B or C or is it IPO stage? I don’t think it is Seed stage. That was investing in Bitcoin in 2010. Today it is more like a Series A deal. You probably won’t lose everything at a Series A stage (a lot of the risk has been taken out by the time a venture gets to Series A). So the upside is also more constrained. Some ventures do get a 100x return from Series A valuation but 10x is a more reasonable expectation.
It is easy to paint the scenario in which Bitcoin declines to zero. Merchant adoption stalls and a better cyber currency emerges to replace Bitcoin. To paint the 10x or more picture, we have to imagine things like:
- People in a significant sized economy with a failing currency (think Argentina, more than Zimbabwe which is too small an economy to make a difference) decide to use Bitcoin rather than US$. This sounds plausible enough until you try to imagine the actual scene where the black market guys exchange tourist dollars for Bitcoins and then the tourist offers Bitcoins to the vendor.
- Rich people worried about taxation, store their money offshore in Bitcoin rather than in US$. Again this sounds plausible, except for one inconvenient fact, which is that this is viewed as money laundering in most jurisdictions i.e. illegal. If somebody does this illegally, they won’t want to keep it in Bitcoin, they will want to turn it back to Fiat and get Interest and Dividends.
- Gold bugs become Bitcoin hoarders. Despite a libertarian bent to both communities, I see this as unlikely. Gold bugs love the fact that it is physical and has thousands of years of history.
If any of the above scenarios pans out, fast money such as Hedge Funds and retail currency speculators will pile into Bitcoin and then there will be “meltup” in price. That will lead to more hoarding and so more price rises.
What I find hard to see is what sort of investor will feel drawn to this type of risk/return. If you like 10x or 100X upside with the possibility of 100% loss, you will be drawn to investing in startups.
If Bitcoin succeeds as a payment network, it won’t have much impact on the price, it will just be an enabler for lower cost payments. For bitcoin to succeed as a currency it needs to become boring and non-volatile, floating up a down compared to Fiat currencies like USD floats up and down compared to EUR. Speculators will find something else to play with.
For Wall Street to get really comfortable with investing in bitcoin, they will want an ability to short bitcoin. That of course will help to stabilize the price and ensure that it is less volatile, which will make it less attractive to speculators.
Of course, the reality is that Wall Street does not need to get comfortable with investing in Bitcoin, they just need others to get comfortable. If Wall Street firms can earn fees and commissions from selling Bitcoin, they will do so and many will become rich from doing this even if investors actually lose money (“where are the customer’s yachts?”). These periods of irrational investing last longer than a rational person might expect, but they do eventually implode.
Personally, I prefer the risk/reward of tech startups and I think that Bitcoin the payment network and bitcoin the currency is fundamentally at odds with the volatility that speculators love. If Bitcoin does become a viable currency, it can be traded just like any other currency and will have similar levels of volatility, which still leaves plenty of room for intra day trading to make money.