- Investing in Bitcoin is risky for many reasons, but also it is a reasonable asset to include in certain investment portfolios.
- The reasons we believe have driven Bitcoin’s rising price, and might continue to do so, are the belief that it can be a reserve of value, its privacy advantages, lower transaction costs and barriers, the impulse of some investors to speculate, and the high level of brand awareness it has achieved.
Investing in bitcoin
High volatility, regulatory uncertainty, unsafe, unproven, complex. If all these things arguably have characterized the world of Bitcoin, why has its price skyrocketed?
Figure 1: Bitcoin price from 2015 to 2021
I believe five factors have driven bitcoin’s explosive price and could continue to do so in the future.
- The believe that it can be a reserve of value
- Its privacy advantages
- Lower transaction costs and barriers
- The impulse of some investors to speculate
- The high level of brand awareness it has achieved
The belief that it can be a reserve of value
The ability of an asset to preserve its value throughout time is key for its widespread use as money or as an investment. In other words, people prefer not to save or invest in assets that cannot sustain, or increase, their value with the past of time.
During the years that the gold standard was implemented, gold was the asset that backed the value of currencies. Then, during the years the Bretton Woods system was in use, the world lived in a period in which currencies were pegged to the value of the US dollar and the quantity of US dollars printed was determined by the amount of gold it held in order to maintain a stable exchange value USD/Gold. After US President Richard Nixon ended the convertibility of the US dollar to gold, the world has used fiat money whose value is based on the creditworthiness of the issuing government.
With rising levels of governments indebtedness (see figure 2) and fiscal deficits (see figure 3), the creditworthiness of many governments, including the USA, Japan, and the European Union has deteriorated.
Figure 2: General government debt total, % of Gross Domestic Product, 2020 or latest available
Figure 3: General government deficit total, % of Gross Domestic Product, 2005 – 2020
For years now, governments around the world have increased their fiscal spending well beyond what they can finance with tax revenue. That gap has been closed by selling debt. And at least since 2008 or so, a big chunk of that debt has been bought by their national central banks. In the long term, this is an unsustainable course of action. Hence, the fear of many, both individuals and companies, to hold money that will lose value in the future (through devaluations and/or higher inflation).
Consequently, investors have sought refuge in assets other than money, for example, in real estate and stocks.
Enters Bitcoin (BTC).
By design, bitcoin has a limited supply. Bitcoin supply currently is 18.77 million, or 89% of the 21 million cap. This limited supply gives investors certain peace of mind because they know no one could just decide to create bitcoins beyond the pre-defined cap. When combined with increasing demand a limited supply is a driver of rising prices.
Its privacy advantages
It’s not that it is not possible to know who owns bitcoin or who has transacted with it, it is just that getting the answers is hard. This hard-to-track feature of bitcoin is appealing to users who like to stay “out” of the banking system and/or “out” of the government’s eyes.
Who those users might be? Well, many groups of people. For example, people who mistrust governments (remember, not all governments in the world are equally transparent or serve equally well its people. Some governments actively look for ways to curtail the freedoms of their citizens). Other examples are tax evaders and criminals. No further explanations are needed.
Lower transaction costs and barriers
Despite the significant advances the financial system has made in the last decades, one thing that remains a major pain point for the users of the banking system is the cost of transferring money internationally. Transacting with bitcoins lowers that cost significantly because 1) the transaction per se is cheaper and 2) there is no need to make a conversion from one currency to another.
Also, Bitcoin allows people to circumvent capital controls in their countries. For example, say a company based in the United Kingdom needs to pay in pounds the fees of a freelancer who resides in Venezuela. Well, due to the severe capital controls that country has, it is extremely difficult to make the payment to a Venezuelan bank account. Bitcoin allows the company to make that payment without any barriers.
The impulse of some investors to speculate
Another reason why people buy bitcoin is that they are speculating in one of three ways:
- The strategic investment: These are people who place bets in uncertainty. They very well know there is a risk for significant losses, but also that there is a chance of astonishingly high returns. They don’t pretend they know what will happen. They fully recognize they do not know what will happen. Because of it, they place a bet that represents just a small part of their investment portfolio. If they lose the money, it won’t be much. If they win, it could be a lot. Generally, these people invest with a long-term horizon (> 10 years).
- The bet on hope: Did you know that poor people spend a greater proportion of their income on the lottery? And if their income declines their demand for lottery increases. From an expectations point of view, people in this group are like the ones in the strategic investment group. The difference is that people in this hopeful group have a much shorter time horizon (<1 year. Sometimes their horizon is measured in hours). In essence, these people are buying the right to hope for a little while.
- The FOMO group: When buying bitcoins, people in this FOMO (Fear of Missing Out) group are just hedging their regrets. They don’t like to feel they are the only dimwitted of their group that didn’t make a high return buying bitcoin. So, they prefer to invest and see the price of bitcoin decline than to not invest and see its price rise. They are making an emotional play.
This is an aspect of bitcoin that is not usually discussed. Nevertheless, it is an important characteristic. Why? Anyone who knows anything about marketing and sales knows that awareness is the first stage of the sales funnel. No one buys what they don’t even know exists. At this point, billions of people around the world have heard about bitcoin and millions have invested in it. I believe this is a competitive advantage that bitcoin has in comparison to other cryptocurrencies specifically and other investments more broadly.
Investing in bitcoin
I don’t think everyone should buy bitcoin. But I think some people should consider it.
Whether I believe you are in one group or the other mainly depends on three factors:
- Your Financial Strength Index: <299, 300-449, 450-579, 580-699, 700-800.
- Your investor risk profile: conservative, moderate, aggressive
- Your time horizon: short, medium, long
Below is an example from our platform (www.fivent.com) of the suggested allocation to invest in Bitcoin for a person with a Financial Strength Index between 580 and 699, an aggressive risk profile, and a long-term time horizon.
Figure 4: Example of a portfolio that holds Bitcoin.
Our subscribers can select different values on all three criteria to see examples of various allocations for a respective investment portfolio.
Make no mistakes, investing in Bitcoin is risky. If you decide to invest anyways keep in mind you need to learn to deal with high volatility, regulatory uncertainty, unsafety, an unproven and complex technology.
According to the Global Wealth Report from Credit Suisse, in 2020 there were about 56.1 million millionaires in the world (people with a net worth of at least $1 million). What would happen to Bitcoin’s price if each of them tries to include at least one Bitcoin in their portfolio? Remember, the supply of Bitcoin is limited to 21 million.
This article was written for educational purposes and does not provide investment recommendations specific to individual investors. As such, the financial instrument(s) discussed may not be suitable for all investors and investors must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of the financial instrument(s) listed in this newsletter should not be taken as an indication or guarantee of future results. The price, value of, and income from, any of the financial instruments shown in this article can rise as well as fall and may be affected by changes in economic, financial, and political factors. If a financial instrument is denominated in a currency other than the investor’s home currency, a change in exchange rates may adversely affect the price of, value of, or income derived from the financial instrument described in this report.