Bitcoin (BTC) is probably the most FOMO-inducing thing in the world. Investors always regret not doing something about it. First they regretted not buying bitcoin at all. Then they regretted not selling out at $16,000. Now they regret not buying enough at $20,000.
If you lay out predictions from the most credible investors, youâ€™ll get a scale that goes from â€œrat poison squaredâ€� to millions of dollars. So guessing Bitcoinâ€™s price, say, a year from now is no better than predicting the weather on January 7 next year. But to have at least an opinion about where Bitcoin could go, we first have to answer ourselves what Bitcoin is and what we might weigh it up against. After all, we canâ€™t value it as a currency (or a medium of exchange). There is very little we can buy with it without the involvement of a fiat currency like the dollar. Itâ€™s not an investment either. It doesnâ€™t generate earnings, nor does it pay a dividend.
What Bitcoin actually is at this pointâ€”or at least is attempting to becomeâ€”is a store of value. In other words, Bitcoin is not competing with paper money like the dollar or euro. Itâ€™s competing with â€œinsuranceâ€� against paper money.
And that’s where its biggest potential lies.
Governments are protecting their currencies like mama bears
A decentralized currency is a lovely democratic idea. And you can discuss its merits against fiat currencies day and night. But the thing is: no government will let a decentralized currency take away its powers. As legendary hedge fund manager Ray Dalio said: “If it [Bitcoin] becomes successful enough to compete and be threatening enough to currencies that governments control, the governments will outlaw it and make it too dangerous to use.”
You donâ€™t have to look far back to see what governments are capable of. Take gold, which has long been an alternative to paper money. After all, most major currencies were backed by it before the world wars. That meant you could walk into a bank and swap your dollars for physical gold based on a fixed exchange rate. And yet, any time gold threatened to strip the government of its power to control money, lawmakers quickly stepped in.
A good example is the U.S. during the Great Depression. In 1931, the nation was in the heat of the worst financial crisis in history. But unlike today, the Fedâ€™s hands were mostly tied. It couldnâ€™t print more dollars to prop up the economy because the currency was linked to gold. So Franklin Roosevelt passed Executive Order 6102, later dubbed the â€œGreat Confiscation.â€� In short, it forced Americans to turn in their gold and sell it to the government at well below market rates.
This allowed the Fed to print more dollars to support the economy and shore up the exchange rate. Later the dollar was re-pegged to gold at a ~50% higher price. And the U.S. is not alone. In the 50s and 60s, Australia and the UK carried out similar gold â€œconfiscationsâ€� to stop the decline in their currencies.
Banning Bitcoin at this point would be a political walk in the park compared to the Great Confiscation and other measures governments took in the past. So we have to get realistic here. Unless thereâ€™s some kind of political cataclysm that would shred the government as we know it to pieces, Bitcoinâ€™s chances as a currency are very slim. If it grows too big to compete with paper money, lawmakers will probably eat it alive.
But that doesnâ€™t mean Bitcoin is worthless.
Bitcoin doesnâ€™t compete with currencies. It competes with â€œinsuranceâ€� against paper money
From an investment and ideological standpoint, Bitcoin is actually more like a commodity. More precisely, one of the most expensive and â€œuselessâ€� commodities in the worldâ€”gold. Unlike other commodities like oil, gold has limited use. For example, ~3,000 tons of gold were dug up and sold last year. And of that amount, just 35% went into electronics and jewelry. The rest was melted into bars and coins and stowed away. Gold is not a medium of exchange either. You canâ€™t walk into Pizza Hut, drop a sliver of gold on the counter, and get a slice of pizza. At most, youâ€™ll get some strange looks.
And yet, central banks hold 34,000 tons of the shiny, yellow bullion bars in their reserves. Institutional and individual investors have sunk ~$2.7 trillion into gold. And every year, gold holdings keep growing and growing. Thatâ€™s because gold has just one job, and it does it very well. That is, sit tight in a vault and hold its value.In fact, gold has outlived each and every modern currency that has ever been created. And for thousands of years, it has successfully fought off inflation and even gone up in value.
(As a general rule, an ounce of gold has always been able to get you into a decent suitâ€”look it up for yourself.)
In other words, gold is the â€œinsuranceâ€� against anything that might go wrong with paper money. Inflation, devaluation, or any sort of crisis that could eat the purchasing power of government-issued currencies. Or as my ex-colleague Jared Dillian put it in a recent Bloomberg column: â€œGold is a hedge against bad government decisions”
If just 20% of private gold holdings moved to Bitcoin, the crypto would double or more
In form, Bitcoin is probably the furthest thing from gold you can think of. But as an investment, the two are very much alike. Like gold, Bitcoin has little utility. Its supply is limitedâ€”not by nature but by design. And its value largely depends on supply and demand rather than enforcement and monetary policy.
Can Bitcoin become a modern replacement to gold? Itâ€™s still hard to tell.
Its weak spot is that itâ€™s still on a roller coaster. And for a store of value, 12 years and one recession are just baby steps compared to goldâ€™s track record. At this point, itâ€™s hard to imagine a pension fund plowing a meaningful sum in Bitcoin. On the other hand, institutional investors are warming up to cryptos.
Just a few years ago, the whole of Wall Street laughed off Bitcoin as the biggest fad in history. But as central banks keep their print presses red hot, a number of big-name (and rather conservative hedge fund managers) have recently flipped to Bitcoin.
Last November, for example, Wall Street legend Stanley Druckenmiller made headlines after he said he â€œstrongly recommendsâ€� Bitcoin. He added: “Bitcoin could be an asset class that has a lot of attraction as a store of valueâ€�If (big emphasis on if) Bitcoin earns its name as a store of value on Wall Street, its future will change for good. In fact, trillions of dollars could flow into it.
For fun, letâ€™s do some back-of-the-envelope math real quick. As I write this, thereâ€™s $650 billion worth of Bitcoin out there. Meanwhile, investors hold at least $2.7 trillion in gold, according to World Gold Council. If, say, they moved just a bit more than 20% of their gold holdings to Bitcoin, the cryptocurrency could double or more.
Hereâ€™s what that would look like:
So the questions you should be asking yourself are these
Will investors buy Bitcoin as a legit store of value so early on? And will they move a meaningful chunk of their â€œgold insuranceâ€� to Bitcoin? Iâ€™m convinced these are the questions that will drive Bitcoinâ€™s price for now. Next week, weâ€™ll look at what institutional investors are doing to answer these questions. In fact, Iâ€™m in talks with the worldâ€™s largest crypto analytics firm to access their data on money flows in the crypto market. Subscribe below to get the next story straight in your inbox.
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