Bitcoin: Is it an asset or just pure speculation?
- Bitcoin’s key attractions seem to be that it provides a vehicle for speculative trading and an alternative exchange mechanism to traditional currency
- We have doubts about its role in core investment portfolios given its price volatility, liquidity challenges and difficulties in assessing its intrinsic value
- Blockchain technology certainly has broader uses, as evidenced by its adoption in the mainstream economy
- The ongoing ‘mining’ of bitcoin generates huge electricity usage which is incompatible with the stance of responsible investors
Bitcoin has been grabbing headlines once again as several major companies have declared an interest in the cryptocurrency. Subsequently, some AXA IM clients have been asking for our view on this development; here is our take on the situation, as it currently stands.
In mid-February bitcoin’s value surpassed the $50,000 threshold for the first time as several corporations, including Mastercard and Tesla, voiced their support.[i]
The electric vehicle firm announced in a regulatory filing that it had bought $1.5 billion’s worth and said that it expected to begin accepting it as a payment method, albeit “initially on a limited basis”. Tesla stated that it had made the purchase for “more flexibility to further diversify and maximize returns on our cash”.[ii]
Economists and investors are at odds to decide whether bitcoin constitutes a currency, or an asset - or neither. It does not satisfy the typical criteria of a fiat currency and does not have any cash flows to support its valuation like a stock, bond or real estate asset. Its main attractions appear to be as a vehicle for speculative trading activity and an alternative payments mechanism to challenge the incumbent monetary system.
As such, its fundamental value is challenged, although its supporters argue that it can act as a store of value and a medium of exchange. Indeed, with distributed ledger technology like blockchain, bitcoin and other cryptocurrencies are used to buy and sell goods and services, as well as other 'currency'.
Of course, those holding bitcoin will undoubtedly have cheered its recent value surge, but anyone considering diversifying into the asset should tread very carefully. It is hugely volatile; in the 2017-2018 period bitcoin rocketed from $1,000 to $20,000, before swiftly falling back to $3,000.[iii]
What is bitcoin?
Bitcoin is essentially a digital currency.
It was created at the tail end of the 2000s, by pseudonymous individual – or individuals - Satoshi Nakamoto.
A computer database, or digitally secure ledger, holds a record of every virtual coin in circulation. This ledger is circulated via a so-called blockchain i.e. every bitcoin holder has a record of another individual’s block. Significantly crypto assets bypass the main financial middlemen – the banks.
Bitcoin isn’t minted – it is digitally mined, in other words highly tech-savvy individuals seek out new bitcoins online by solving intricate computer puzzles. The easier route is to buy some already in circulation via a specialist broker.
There are reportedly just 21 million bitcoins that can be mined and so far, some 18.6 million have been unearthed.[iv]
Writing for The Financial Times, Professor of Economics at the Stern School of Business, NYU, Nouriel Roubini said that “claims that bitcoin is the new ‘digital gold’ are feeding a new bubble in it and other cryptocurrencies”. He added that he does not see it as a hedge against tail risk or as a stable store of value, highlighting that even some crypto conferences don’t accept them as payment for attendance.[v]
European Central Bank governing council member Gabriel Makhlouf is also treating bitcoin with skepticism, comparing the world’s largest cryptocurrency to the 17th century Netherlands tulip craze - which ended in collapse.[vi]
There is also the environmental issue – bitcoin is anything but ‘green’. The carbon intensity of bitcoin mining – and therefore its effect on the environmental - is significant to say the least. Various studies have criticized the negative externalities of crypto-asset mining and questioned the sustainability of such practices.
Presently, some 900 new bitcoins are created every 24 hours. Because they are minted via computers, a huge amount of energy is required.[vii] According to research from Cambridge University, bitcoin uses more electricity every year than the whole of Argentina. Researchers found it eats up some 121.36 terawatt-hours (TWh) a year – the equivalent of powering all the kettles in the UK for 27 years. [viii]
Below, five AXA IM experts outline their opinions on the cryptocurrency…
Chief Investment Officer, Core Investments, Chris Iggo
I find it difficult to put bitcoin into a traditional investment framework. There is no model for its value as it generates no economic cash-flow. Unlike other traditional currencies, there is no link to national economic conditions or fiscal and monetary policies. It pays no yield or dividend and there are no mechanisms for hedging its value.
Flows into bitcoin are driven by speculation of future price gains or to satisfy some need to bypass the traditional institutions of the payments systems – perhaps in some cases for reasons that are not legal. Some of these flows are driven by a ‘political’ perspective around the sustainability of existing currencies and payments systems. My view would be to put more trust in a legally-governed monetary and banking system, which has been around for hundreds of years than in a recently created digital token that provides little in traditional insurance to the holder.
While the technology can confirm all transactions that take place on the blockchain, there is no legal basis for the coin, which would limit its use in traditional banking activities like borrowing and lending. With little guarantee of its future stability and given the environmental impact of its existence, in our view bitcoin does not fit the requirements of a responsible investor.
Chief Economist, AXA Group & Head of Research Gilles Moëc
Bitcoin is treated by the US Commodity Futures Trading Commission (CFTC) as a commodity, and indeed this is probably the right reference. Just like oil, or precious metals, the overall quantum of bitcoin is ultimately finite. This means that should demand stay unchanged, its price should continuously rise. But finite-supply commodities usually come with a non-financial use.
Gold can be used for jewellery, and oil is used to power vehicles which – if tastes and technology don’t change – provides a minimum demand for these products, meaning their price cannot fall to zero.
What use does bitcoin offer? Fundamentally, it is a payment system, competing with other such systems. There is no structural minimum demand for bitcoin. Its price can fall to zero. Gyrations in its price may reflect investors’ concerns with the quality of traditional currencies, if they are worried by excess monetary creation under unconventional monetary policy, or balk at the fact that some governments use their currency as a source of power e.g. via sanctions. But in my view, presenting bitcoin as a proper alternative currency is misleading.
There is at least one finite-supply commodity which has long been used as currency - gold (and silver for that matter). But the very reason why the world ultimately gave up on gold as the anchor of the monetary system is the same why bitcoin cannot be used safely as a reference currency. The gold standard system failed because gold-rich central banks were under no obligation to lend it to debtor countries.
The liquidity of the system was far too tight and contributed to massive financial crises. More recently, in March 2020 the world was reminded why central banks play a crucial role in times of massive uncertainty - they can create liquidity without limits. The problem with bitcoin is not so much that there is no central ‘generator’ which can regulate liquidity, it’s because it operates under programmed scarcity. By definition, liquidity will decline on trend.
Framlington Equities, Portfolio Manager - FinTech and Financials, Vincent Vinatier
We are not particularly keen on cryptocurrencies in general. From my perspective bitcoin is not an investable asset – there are no cashflows, no residual value, no usage value and it is way too volatile to be used as a means of payment. In our view it is a speculative asset that could be worth $10 or $10m. Fundamentally, we believe that a lot of the public interest in bitcoin is being driven by its recent performance and its adoption by some industrial players is speculative.
The idea that bitcoin is uncorrelated to other assets does not ring true, it is highly correlated with technology in particular. But when inflation starts to rise and interest rates pick up, investors will likely be able to pick up a decent yield from other assets and appetite for bitcoin and other cryptocurrencies will probably reduce.
However, where we are more positive, is on blockchain technology, as it has several promising applications such as forex trading. We also expect that ‘official’ digital currencies will materialize over the coming years; the European Central Bank, the Federal Reserve and the People’s Bank of China, among others, are looking into this. But these are so-called ‘stablecoins’, which are backed by hard assets and therefore a world away from bitcoin.
Global Head of AXA Fixed Income and Buy & Maintain, Christophe Herpet
There is a distinction between ‘money’, the asset that is being exchanged, and the ‘exchange mechanism’, the process through which an asset is transferred. Bitcoin is not a new class of money, it is a new type of exchange mechanism, that can support a variety of forms of money, as well as types of assets. The ability to make electronic exchanges without a trusted party - a defining characteristic of bitcoin - is radically new.
Unlike traditional currencies where monetary aggregates are growing exponentially - thanks to central bank policy - bitcoin is limited to 21 million units. This makes it a stock of value versus major currencies, that are worth less and less in real terms because of monetary policies. In my opinion, the price of this cryptocurrency will be less volatile the closer we get to the maximum.
But before then, its moves may well be impressive, as the value of this exchange mechanism is not known. Tesla founder Elon Musk foresees accepting the currency as a payment for Tesla cars and analysts reckon this represents a large shift, as some companies and investment houses follow small traders into bitcoin.
Global Head of Rosenberg Equities, Paul Flavier
One would legitimately favour a currency that is stable, safe and liquid to serve as a reserve of value and a means of payment - two of the main attributes of a currency. Although this could change, bitcoin in its early years seemed to suffer from numerous issues, chiefly - aside from the lack of liquidity factor - instability.
It has made some investors very rich, but its extremely volatile nature is the opposite of what you expect – or want - from a currency. In general, it is interesting to see the digital economy’s empathy with speculative behaviours condemned in the old world. The second issue is about the lack of safety - hackers and the opacity of exchange platforms make the risk of losing it all real – not exactly Federal Deposit Insurance Corporation-insured, while in terms of anti-money laundering the traceability of bitcoin is a real lost opportunity.
Could bitcoin be a future asset class?
Bitcoin may possibly develop some characteristics of a traditional currency or asset in the future. However, even with greater financial institution interest in the cryptocurrency, its price volatility, its existence beyond traditional legal arrangements – as well as its lack of grounding in any fundamental economic activity - this could be a long, uncertain and arduous journey. Perhaps the greatest concern for long-term responsible investors is the indirect environmental impact. As the investment community strives to decarbonise investment portfolios, can we be sure that the future supply and trading of crypto tokens will be able to contribute to net zero carbon targets? As the environment currently stands, we are far from convinced.
[vi] Bloomberg 16 February 2021
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