13-10-2021 · 5 年展望

What's so cryptic about cryptocurrencies?

Bitcoin could qualify as digital gold, and the blockchain technology behind it has enormous potential, say quant researcher Laurens Swinkels and strategist Peter van der Welle.


  • Laurens Swinkels - Head of Quant Strategy

    Laurens Swinkels

    Head of Quant Strategy

  • Peter van der Welle - Strategist Sustainable Multi Asset Solutions

    Peter van der Welle

    Strategist Sustainable Multi Asset Solutions

Bitcoin was the first cryptocurrency, and still represents half the value of the entire cryptocurrency market. The narrative of bitcoin being a store of value in the form of digital gold is increasingly gaining credence. Some bitcoin investors see it as ‘superior gold’, and even Fed Chairman Jerome Powell recently called bitcoin “essentially a substitute for gold rather than for the dollar.”

Just like gold, bitcoin is scarce, durable, portable, and easily transactable. What it lacks of course is a physical presence and that long history of consensus on it being a reliable store of value. As digital gold, bitcoin has monetary value. The discussion about bitcoin’s lack of intrinsic value is therefore less relevant, although this may render it worthless if confidence tanks.

As with diamonds, art, stamps, gold, and let’s not forget, the US dollar, bitcoin does not provide cash flows. Yet all these asset classes are considered a store of value, even if their prices are not perfectly correlated, and correlation with inflation is low and dependent on the investment horizon.

The chart below shows that gold’s real value has increased substantially since 1971 when the gold standard ended. The gold price fluctuates about as much as a stock market index. Therefore, it’s a risky short-term store of value, even though in the long run it has proven to keep its purchasing power.

The price of equities, gold, and bitcoin versus inflation from 1969 to 2019

The price of equities, gold, and bitcoin versus inflation from 1969 to 2019

Source: Robeco, Refinitiv

Measured in gold, a Roman soldier 2,000 years ago earned about the same wage as a US soldier today. Although bitcoin’s volatility is markedly higher, which in itself is undesirable, it is a mistake to think that a store of value ought to be riskless. The gold price went down from over USD 670 in September 1980 and rose back to that level in 2007, losing about 60% of purchasing power in the meantime.

And let’s not forget that cash dollars, another popular store of value, lost about 50% of real value between 1969 and 1979. If bitcoin were banned by governments, that would affect it as a store of value. Here, too, lie parallels with physical gold, after hoarding it was banned between 1934 and 1964 in the US.

Given these features, we conclude that bitcoin has the potential to become an established store of value like gold. So, let’s now look at its return characteristics.


Bitcoin’s return characteristics

Bitcoin’s realized return since it became a relatively easily tradable asset from 31 December 2013 until 30 June 2021 is an eye-popping 67% per year. This compares to 10.8% for the MSCI World Index. However, its average annualized realized volatility is a staggering 84%, more than five times as much as equities and gold. Bitcoin’s realized return is so extraordinary that it has a Sharpe ratio of 0.8 compared to 0.36 for the global market portfolio since 1960. But an investor does not need to be that optimistic about bitcoin’s future returns for it to improve portfolio efficiency.

Bitcoin’s correlation with other asset classes has been close to zero, so adding it to a portfolio would have clear diversification benefits. Bitcoin’s market cap is roughly USD 1 trillion, while the value of physical gold held for investment purposes is about USD 3 trillion, about the same as the global high yield bond market. This would imply an allocation of bitcoin to a global market portfolio of about 0.5%. A strategic allocation ranging between 0-2% would seem optimal from a portfolio risk perspective.

Massive energy consumption

But there are other factors at play of course. The first is how much energy is consumed to make cryptocurrencies, surpassing 151 terawatt hours in May 2021, up from 80 TWh a year earlier. This is the same amount of energy that a medium-sized country uses in a year. This is a clear disadvantage in the design of bitcoin, and it will become worse when its price increases.

Estimated bitcoin electricity consumption

Estimated bitcoin electricity consumption

Source: Cambridge Bitcoin Electricity Consumption Index, Robeco.

Another issue is how it facilitates criminality. Ransomware attacks often demand payment in cryptocurrencies, illustrating its usefulness to international cybercriminals seeking to extort large sums of money in an efficient and easily concealed manner.

The technology behind bitcoin

While bitcoin is increasingly considered as a store of value, many players are more enthusiastic about the distributed ledger technology – or blockchain – that lies behind it. Blockchain is a record of transactions that does not require an external authority to validate the authenticity of data. This is now used to create an ecosystem that can provide many types of financial services in a decentralized, non-governed way. This trend is typically referred to as ‘decentralized finance’, or DeFi.

DeFi applications are typically based on the blockchain technology of Ethereum, the world’s second largest cryptocurrency. It has the potential to disrupt the traditional bank lending business by using smart contracts and a decentralized system of processing and validation. Compound is currently the largest DeFi lending protocol through which lenders create a liquidity pool in which interest rates are determined by supply and demand.

Most cryptocurrency exchanges, such as Coinbase and Binance, are centralized just like existing stock exchanges. Transactions made through decentralized exchanges (DEXes) are administered via a blockchain. This essentially removes third parties, which saves time and costs. Uniswap, SushiSwap and Curve Finance are the most prominent DEXes currently in operation.

Anything can be tokenized

On a smart contract platform like Ethereum, anything can be tokenized, including company shares or residential properties, and it is not limited to assets; media content such as digital pictures has also been tokenized. The result is called an NFT, non-fungible token, which are ‘one-of-a-kind’ digital assets. These can be traded. NFTs will probably have huge, positive implications for intellectual property protection and royalty collection in the art and media segment. Another potential use of NFTs is for digital identity purposes: since NFTs are as unique as one’s identity, they can literally represent a person.

So in spite of the environmental challenges faced by bitcoin, we see a bright future for cryptocurrencies that consume less energy. They may well transform the financial industry into a more inclusive and efficient system, particularly for countries with less developed financial systems, unstable political situations, or central banks with low credibility. Democratizing finance with less or no need for financial intermediaries is still at the heart of cryptocurrencies, by employing transparent and verifiable processes thanks to the use of blockchain.

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