This price rebound proves that even investors who are skeptical of cryptocurrencies should realize that it is a safer choice to allocate a small amount of Bitcoin in their portfolio than to ignore the asset completely.
This week, the price of Bitcoin exceeded $44,000, more than double the price on March 13. According to market analysis, the price performance of Bitcoin is not very surprising. Going back to 2014, Bitcoin has doubled every nine months and 21 days on average; but this time, it achieved this goal 28 days ahead of schedule.
However, it is a little surprising that during this doubling process, Bitcoin did not fall below the lowest point on March 13. Normally, between each doubling, the average drop in Bitcoin is 27% (for example, from $1,000 to $730, and then rise to more than $2,000), and the maximum drop can even reach 83% (that is, the price first fell to $170 and then rose to $2,000).
Still, Bitcoin’s roller-coaster price swings are a thing of the past. Since the peak of volatility during the COVID-19 pandemic, Bitcoin’s annualized volatility has stabilized at around 50%, on par with many large technology stocks. More importantly, Bitcoin has shown relative price stability amid a slew of cryptocurrency scandals, bankruptcies, lawsuits and regulatory disputes.
Does this mean that Bitcoin can be served up at this year’s holiday dinners and have its own place in standard investment portfolios?
For most investors, the answer is still “no.” Bitcoin has enough upside potential to attract investors, and its volatility no longer seems to be a daunting factor. Issues like security of custody, tax treatment, and legality seem mostly resolved. But Bitcoin’s erratic correlation with other major assets — especially stocks, currencies, and gold — makes it as difficult to fit into a portfolio as a left-handed dinner guest.
Back in 2011, I estimated that cryptocurrencies would account for 3% of the global economy. As an efficient market investor, I always invest 3% of my net worth in cryptocurrencies, regardless of market volatility or whether crypto prices soar or plummet. However, most investors prefer investments that have a certain degree of predictability in fundamental events and tend to hold for the long term rather than frequently trade in the short term. (Disclosure: The author of this article has venture capital and consulting relationships with cryptocurrency companies.)
Bitcoin was originally created as a transaction currency, which is also its original value proposition. Bitcoin is far more efficient than the traditional financial system in processing international transfers and serving the unbanked and oppressed populations.
Bitcoin also facilitates rarely prosecuted crimes such as recreational drug sales, prostitution and gambling. Although there is a common misconception that Bitcoin is often used for serious crimes such as terrorism or hired murder, this is not the case because Bitcoin transactions are public and cannot be altered. True, Bitcoin transactions are also anonymous, but investigators can usually easily track individuals through transaction pattern analysis. For serious criminals, they usually use assets such as government-issued cash, gold or diamonds, or adopt privacy-preserving cryptocurrencies such as Monero or ZCash to conceal their identity.
At a Senate Banking Committee hearing this week, Senator Elizabeth Warren, along with JPMorgan Chase CEO Jamie Dimon and other bankers, agreed that anti-money laundering controls should be imposed on cryptocurrencies. While laws can make it difficult to deposit and withdraw fiat currency associated with criminal activity, there is no way to prevent or track direct transfers between cryptocurrencies with privacy protections. And the financial repression system to combat money laundering is one of the reasons that people, both good and bad, use cryptocurrencies.
This is not important for Bitcoin, because its use case and value proposition as a transaction currency have long since collapsed. Fundamental improvements in traditional finance and government regulation and crackdown on the use of cryptocurrencies for criminal activities are factors that have led to Bitcoin no longer being positioned as a transaction and transfer tool. But in addition, the biggest reason for the collapse of Bitcoin's original transaction currency attributes is the emergence of innovative cryptocurrencies such as Ripple or Nano, which perform far better as transaction currencies than Bitcoin.
Around 2015 or so, Bitcoin’s value proposition shifted from “transaction currency” to “digital gold.” Bitcoin would become the anchor of value for cryptocurrencies, used to convert traditional currencies into and out of cryptocurrencies—just as gold had been the anchor of value for paper currencies for centuries, used to settle accounts between central banks.
From this perspective, the value of Bitcoin depends on three factors: the ultimate value of the crypto project, the amount of traditional money flowing in and out of cryptocurrencies, and whether the financial services of the crypto economy (i.e., an alternative to the traditional banking system) are superior.
The first factor, the ultimate value of crypto projects, is essentially a technology venture - on the one hand, many exciting ideas that could change the world and be worth trillions; but on the other hand, the actual revenue or profit of these projects is very little in terms of traditional currency.
The amount of traditional money flowing in and out of cryptocurrencies has always been subject to economic booms and busts, or in crypto parlance, summer and winter. In crypto summer, a lot of money flows in, but there are also a lot of crypto people cashing out some of their gains during this period. In addition, people use Bitcoin to switch from one crypto project to another. In crypto winter, there is little money flowing in both directions, so there is little demand for Bitcoin financial services in the industry.
The most stable factor is competition in the financial services sector. Bitcoin has rapidly strengthened its connection with trading open futures and options, efficient lending, safe custody, and other aspects of the modern financial system. If the US Securities and Exchange Commission approves the Bitcoin ETF in January as expected by the market, the entire Bitcoin financial services system will be further improved. People can conduct various trading activities such as investing, financing, hedging, speculation, exchange and holding on Bitcoin, which is similar to stocks and bonds, and Bitcoin ensures the efficiency of these operations. In addition, Bitcoin provides a convenient channel for people to quickly enter the entire crypto-economic system.
In comparison, stablecoins have only been successful in specific areas. Among other cryptocurrencies, only Ethereum has developed a native financial system, but it is still far behind Bitcoin. Traditional financial institutions have tried to use blockchain and other encryption technologies, and have also only succeeded in specific areas, but this has not posed a threat to Bitcoin's dominance. In addition, some companies have tried to integrate financial services directly into the cryptocurrency system, such as FTX and Celsius Network, but they collapsed in 2022, and these events have also had a negative impact on similar companies.
This three-step value proposition also explains Bitcoin’s volatile correlation with other traditional financial assets.
The market value of crypto projects depends on investors' enthusiasm for technology startups, which is highly correlated with technology stocks. But investors' enthusiasm for putting money into cryptocurrencies is often the opposite of that of technology stocks - disappointing returns of technology stocks have led optimists and risk lovers to turn to cryptocurrencies.
The latest doubling of Bitcoin’s price seems to be mainly related to growing regulatory clarity and tolerance, but this does not seem to apply to stablecoins or other cryptocurrencies. This not only improves the efficiency of the Bitcoin financial system, but also protects it from competitors. Typically, there is no clear correlation between regulatory attitudes and asset prices.
Under the current circumstances, there seems to be no specific factor that will affect the success of crypto projects or people's enthusiasm for crypto trading, so Bitcoin's near-term market outlook seems to rely mainly on regulatory dynamics, especially the approval of Bitcoin spot ETFs. In addition, the possibility of a market correction or a black swan always exists, especially when a new crypto scandal emerges.
Competition from stablecoins, traditional finance, and crypto-native institutions is virtually nonexistent, so any progress in these areas can only be negative for Bitcoin. My guess is that the next doubling of Bitcoin’s price could be driven by the long-awaited “killer app” in crypto that attracts millions of people to learn about and use cryptocurrencies, rather than just hold or trade them. Another possibility is that problems with the traditional financial system — crises, tighter regulations, inflation concerns, credit crunch, etc. — could make Bitcoin relatively more attractive.
We are gradually reaching a consensus that even traditional investors who are conservative about cryptocurrencies should realize that it is safer to allocate a small amount of Bitcoin in their portfolio than to ignore the asset completely. Although there is still a risk that cryptocurrencies will go to zero, their potential growth space is enough to make a portfolio that is isolated from this field seem unbalanced.
