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For a brief moment, all Bitcoin owners had made money from it. On March 5, the crypto token rose to an all-time high of just over $69,000, a level that is sure to delight the meme-loving crypto crowd, before retreating a bit. The record capped a remarkable recovery from the dark days of November 2022, when interest rate hikes were crushing risk appetite and FTX, a crypto exchange, had just gone bankrupt. Buying Bitcoin on such exchanges seemed like little more than a fun and novel way to get robbed.
Bitcoin is hardly recovering in isolation: everything is going up. Stock markets around the world are near record levels. So are gold prices. Even bond prices are rising after a miserable two years. The catalyst is a combination of hype about artificial intelligence, joy about the state of the global economy and expectations of looser monetary policy in the future.
Still, Bitcoin is doing better than most assets. On January 10, the Securities and Exchange Commission, a US regulator, approved applications from 11 investment firms, including BlackRock and Fidelity, to create bitcoin exchange-traded funds (ETFs). This makes it easier for everyday investors to purchase the cryptocurrency. Instead of creating an account at a specialized exchange, creating a crypto wallet, making a bank transfer, and finally purchasing bitcoin, people can now simply log into their brokerage accounts and purchase an ETF. The assets of the ten largest bitcoin ETFs now amount to about $50 billion. And the activity seems to reinforce itself: the more money is invested, the more the price rises, the more people talk about bitcoin ETFs, the more money comes in, and so on.
Bitcoin has been around for 14 years. The elegant mechanism by which it validates itself and increases supply has never been hacked, meaning the token isn’t going anywhere. However, it is now obvious that its use for payments is quite limited, as it is restricted by both high costs and slow transaction speeds. Those who try to create applications on blockchains also do not do so using Bitcoin. With the creation of ETFs, the future of bitcoin appears to be an investment asset and nothing more. So after this initial surge of interest, what will your returns be like?
It would be foolish to extrapolate the entire history of Bitcoin. Over the past 14 years, cryptocurrency has gone from a niche cyberpunk idea to something resembling a mainstream financial asset. However, its most recent price movements could provide some clues. There are two explanations for them. One is that the purchases are basically a broad bet on technological progress, with variations that reflect the prospects of the cryptocurrencies themselves. For example, even as tech stocks soared in mid-2021, bitcoin plummeted after Elon Musk posted negative tweets about cryptocurrency payments. Prices also fell in late 2022, even as stock markets were rising due to the FTX bankruptcy.
The other theory is that Bitcoin is a kind of digital gold. After all, supply is inherently limited, just as the supply of gold is restricted by the amount of metal in the ground. None of the assets produce returns or generate profits. This theory fell out of favor in 2021 and 2022, when inflation soared and bitcoin crashed, but last year the cryptocurrency moved back in line with gold.
Perhaps both theories contain elements of truth. A hybrid asset of technology, stocks, cryptocurrencies and gold bets could be useful even in pedestrian portfolios, especially if it is only somewhat correlated with other assets an investor might hold. Diversification among uncorrelated assets is the fundamental principle of portfolio management. Reallocating, say, 1% of a fund to Bitcoin would be a low-risk hedge.
If investors believe this argument, the price of bitcoin will likely continue to rise for some time. What happens, then, when the transition from cryptocurrency to a standard financial asset is complete? Let’s assume that bitcoin has been added to most investors’ portfolios. Also, let’s assume that crypto technology doesn’t really catch on. In this world, bitcoin’s returns would likely come to resemble those of gold: there is a fixed amount, and its price would rise over the long term roughly in line with the amount of money. That implies steady single-digit returns. The creation of a Bitcoin ETF may have set off a frenzy of surprising profits, but the future it portends could be slower and more stable.
Correction (March 7, 2024): We wrongly stated that ten investment firms had bitcoin ETF applications approved by the SEC on January 10. The correct number is 11. Sorry.
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