Our Updated View on Bitcoin

January 22, 2021  | By Kevin Smith

We have been studying Bitcoin for a few years, trying to understand it from many angles to figure out why, how and when it might make sense to buy. ‘Because the price of Bitcoin has gone up dramatically’ is not a sufficient reason, and possibly a reason not to buy any particular asset.

Our position going into 2020 was something like…

The technology seems potentially very useful, but it has a long way to go to be actually useful. The utility of Bitcoin as a functional currency is not good: transactions are too slow, expensive, not accepted by most vendors, there is no credit market, and the price is too unstable. Bitcoin is very appealing as a possible exit from a hyperinflationary fiat currency, particularly in frontier economies, but also for those concerned about the future value of U.S. dollars. Another way to look at is from an investment perspective, separate from its utility as a currency. It’s price is driven only by supply and demand forces, and the supply side is essentially fixed! The software allows for the creation of only 21 million bitcoins. This is compelling because the value should increase with demand as new buyers bid up the price to convince current holders to sell.

The privacy features are interesting to those who care about privacy features, but they are under threat. The major risks seem to be potential regulation and susceptibility to hacking and theft. Did I mention it is really hard to figure out how to buy the stuff directly and maintain a 51 character private key? You can buy it on an exchange like Coinbase, but transaction costs are high and you don’t control your private key, which defeats many of the unique privacy benefits of Bitcoin.

We maintain that most of those points hold today, but some things changed that caused us to revise our views. The creation of $4 trillion in US dollars in a matter of months increased our concerns about potential inflation quite a bit, and neither political party has expressed much desire to limit this practice. Either we never need to have a recession again because we can print money endlessly, or this is only a patch and there will be consequences down the line. We expect there will be consequences in the form of inflation and higher taxes. This condition makes the scarcity of Bitcoin more appealing, meaning only a finite number of Bitcoin can be created. We can’t ‘print’ more Bitcoin like we do with dollars. If the dollar crumbles in value and inflation really takes off, traditional assets will suffer and it may be too late to buy inflation-friendly assets at a price that will preserve wealth.

The time to buy inflation fighting assets is before the inflation happens, but which ones and why? Stocks have some general resistance to bonds because companies can raise prices to offset higher costs, but traditional bonds have no such features. They are stuck paying the same interest on an amount of principal that becomes worth less with inflation. Other asset categories have done better during high inflation, such as real estate, inflation-protected bonds, high yield bonds, emerging market assets, and of course commodities, which are literally the price of the things going up in price with inflation. Gold is the fan favorite commodity when it comes to inflation because it is seen as harder currency than the dollar because of its natural scarcity and general acceptance as a store of value in the world. All of these tools are useful and we include them in many client portfolios, but what about bitcoin?

I think it is irrational to firmly believe bitcoin will become so widely adopted that it’s price is pushed up 1,000 times higher, and irrational to firmly believe it will disappear and have no place in the global economy. I can see a compelling case for much broader adoption, which is already happening with institutions openly entering the market. I can see a compelling case for government intervention because the ability to manipulate fiat currency is a tremendous power. We have seen recent movement in the direction of more regulation, and early indications from the Biden administration, Janet Yellen in particular, are not bitcoin-friendly.

These conditions are very different from traditional investments like Coca Cola, Apple, or Walmart. The demand for those companies is much easier to understand, we understand how we get paid as investors, and they are already regulated heavily and prepared to adapt to more. Bitcoin is a very different thing. The decision to buy or not to buy bitcoin remains very personal.

Why buy bitcoin? Everyone has their own answer; I think of it this way:

• Because the price went up a lot, you hope it will go up further and don’t want to miss out. (This is my least favorite reason.)
• It can free us from the devaluation of our assets by centralized institutions, shifting power to the individual. (This is my favorite reason.)
• It is part of the foundation of future technology development that is still in its infancy. (I don’t know enough about technology to understand this.)
• It will replace the dollar as a preferred medium of exchange, broadly adopted for all uses. (Hard to imagine, but lots of people are working on it.)

How to buy bitcoin? There are so many choices, and none of them are great. Here is a quick synopsis, and I am surely missing lots of options:

• Directly – this means buying directly from a bitcoin owner, called ‘peer to peer’. There are programs to help with this, but it remains very technical and apparently high risk.
• Exchanges – the exchange takes care of the technical transactions for you, but you don’t hold the bitcoin directly. They keep your private key, so you are totally dependent on the exchange. Common examples are Coinbase, Binance, Gemini, and Cash App. Transaction costs are high!
• Brokers – they function similar to an exchange, but the process for matching buyers and sellers is different. Robinhood is up and running and Fidelity is developing capabilities. Others are likely in the works. Brokers are regulated by the SEC, which may provide the sense of greater security.
• Funds – Grayscale is a massive trust that owns only bitcoin and shares of the trust are traded on public stock exchanges. They charge a 2% management fee and you probably pay zero transaction costs with your broker, but the share price is currently trading at a 30% premium to the underlying bitcoin value! There is a chance we will see a bitcoin ETF (exchange traded fund) in 2021, but that will depend on the regulatory environment.

So what is our stance? It’s not a simple answer. I personally own bitcoin as a small portion of my total portfolio through several of the methods listed above, for a combination of the reasons listed above. I am comfortable with the tremendous uncertainty about the future of bitcoin and believe I came to a rational conclusion for how and why I want to own it. I encourage anybody who is interested in bitcoin to go through a process of education and careful evaluation of their own situation. We welcome the conversation.