Boom or bubble?

It’s that point in the cycle where Bitcoin is once again dominating the news cycle, with daily headlines flaunting bitcoin’s record highs and limitless potential. And although Bitcoin is undoubtedly the most successful cryptocurrency, its chequered history of -75% drawdowns has hitherto rendered investment suitable for only the bravest speculators.

Source: Bloomberg

Bitcoin’s detractors rightly point to these frequent boom-to-bust cycles and see no place in a diversified portfolio for an asset commanding such extreme volatility. However, whilst Bitcoin has always garnered extreme views – both positive and negative – the discourse has recently become more nuanced. Notably, the prospect of institutional adoption has started creeping into the conversation and is partly responsible for the latest buying frenzy.

And yet still, to many, Bitcoin remains an enigma and is largely viewed as a gateway into the dark web to finance nefarious activities – so, what exactly is the history of Bitcoin?

Filthy fiat

Bitcoin emerged during the depths of the Global Financial Crisis to serve as an alternative to fiat money. At the time, there were significant concerns around the longevity of the global banking system, and Bitcoin offered a medium of exchange completely divorced from the vagaries of central bank money printing and currency devaluation.

Bitcoin acts as a deflationary hedge through having a fixed supply of 21 million coins which are produced by ‘miners’ solving sophisticated algorithms. Currently (as of May 2024), 19.7 million Bitcoins have been mined; however, the rate of growth is constantly decreasing, which means the 21 million cap won’t be reached until 2140.  

Bitcoin is ‘digital gold’

Because of this inherent scarcity, Bitcoin’s promoters draw parallels to gold as they both offer a finite supply. Further adding to Bitcoin’s mystique is the ‘halving’ event which occurs approximately every four years.

The abovementioned ‘miners’ are rewarded with bitcoins for validating transactions on the blockchain. Interestingly, each ‘halving’ event sees the rewards that these miners receive halved –most recently from 6.25 to 3.125 in April of this year.

Historically, this supply reduction has resulted in price increases due to the fundamental laws of supply and demand (i.e stable demand yet shrinking supply). This has likewise spurred increased interest against a backdrop of governments debasing fiat currencies through significant fiscal deficits and bond issuance.

Cruisin' for a Bruisin

Further stoking price gains was the SEC’s landmark regulatory approval for numerous Bitcoin ETFs in January of this year, all of which have since attracted significant inflows. The perception that this would presage institutional investor adoption has likewise resulted in material price gains.

Admittedly, there is some discussion on the fringes around institutional adoption of bitcoin, yet this hasn’t gained any meaningful traction. Supposedly, the limited supply of both gold and Bitcoin and the fact that both are unshackled from government control could make the two interchangeable.

We’re yet to be convinced of Bitcoin’s merits in usurping gold in portfolio construction, as we believe the two serve radically different purposes. For example, Bitcoin has extreme volatility and is purchased to generate capital growth. This differs markedly from gold which typically acts as a safe haven in times of market stress and provides a ballast to volatile equity markets.

For our client portfolios, we currently gain this exposure through both gold and goldminers as the latter can also pay dividends (and franking credits) and grow more aggressively through exploration success, increased production and operational efficiency improvements.

White knuckle ride

Despite growing interest in bitcoin, we don’t currently advocate for its use within our clients’ portfolios due to the amplified potential for capital losses. Additionally, unlike traditional assets like property, shares or fixed income, Bitcoin doesn’t generate any rent or earnings, and unlike commodities, it isn’t used to produce goods.

Bitcoin has also consistently demonstrated a high correlation to shares, which in our view, makes it a weak diversifier. This is best illustrated in the below chart which highlights the correlation shared with the NASDAQ which is a growth-oriented equity index.

Source: Bloomberg

We therefore struggle to articulate Bitcoin’s potential role in a client’s portfolio – other than it being an outlet for speculation. And given clients have entrusted us as responsible stewards of their savings, we’re uncomfortable exposing their portfolios to what is effectively a leveraged bet on equities.

In bitcoin we (dis)trust

Although we’re currently reluctant to invest in Bitcoin, we do think that the blockchain concept has a strong use case beyond Bitcoin, which we will continue to monitor. One innovative example includes utilising ‘smart contracts’ to streamline property transactions and automating the transfer of property titles. Like many innovations on the blockchain, this would eliminate the need for third-party providers.  

But for now, we remain comfortable with the range of flexible investment solutions that we have at our disposal, and don’t feel compelled to pick up coins in front of a steam roller. And for the time being we’re content with our currency of choice being the Australian dollar – or, as the crypto-bros would say, the ‘Pacific peso’.