Bitcoin is dead – long live bitcoin

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It has been a while since the bitcoin community claimed that bitcoin was the one currency that would replace fiat currencies. For many people, the idea behind bitcoin was to decentralize the traditional financial system, favoring a fully decentralized one. However, it’s quickly became very unlikely that the world will ever switch from using government-issued money to using bitcoin.

The bitcoin community moved on and quickly saw a newfound interest in blockchain. Even though bitcoin is rarely referenced these days, it is still alive and well, but perhaps not the way the original bitcoin community envisioned it. Bitcoin shares many of the inherent traits of the gold standard, and just like we no longer use gold for our everyday transactions, bitcoin as common currency failed to gain mainstream appeal. Partly due to the fact that the majority of core use cases for bitcoin are still deeply connected to ransomware payments and other illegal activities. Asset security also became a big problem in 2014 when hackers stole $450m worth of bitcoins from the Tokyo-based Mt Gox exchange.

Despite this, bitcoin is now sharing another trait with gold as it is becoming an increasingly attractive asset class for investors.  Bitcoin has been the best performing currency in the world for 5 of the past 6 years. For the first half of 2016, bitcoin outperformed every other asset class, including currencies, securities and whole asset classes. The rapidly increasing value of the digital currency and its decentralized nature have led it to be considered as the global safe asset for investors and traders, and an increasing number of investors, particularly from China, have turned to Bitcoin as an investment tool to maintain their wealth. The Winklevoss twins has previously stated that bitcoin as ‘better than gold’ and  is hoping to launch a bitcoin ETF soon. Polychain capital, a hedge fund investing in digital assets has managed to raise 15 million USD from notable investors such as Andreesen Horowitz, Union Square Ventures as well as 30 smaller investors.

The defining moment for bitcoin as a potential asset class came from the report Bitcoin: Ringing the bell for a new asset class released earlier this year by Coinbase and ARK Invest, arguing that bitcoin should be considered the first in a new kind of asset class.  The report examines how bitcoin’s unique characteristics are breaking ground for an entirely new asset class: cryptocurrencies.

No asset has scaled from a theoretical concept to a market cap of more than 12 billion USD as fast as bitcoin. Bitcoin also displays a unique politico-economic profile. Its basis of value, governance, and use cases are clearly differentiated from other asset classes. This gives bitcoin as an asset class a unique price behavior with near zero correlation to other asset classes over the past five years.

In terms of liquidity, bitcoin has roughly the same liquidity of the largest gold ETF (GLD) and three times that of Vanguard’s REIT ETF (VNQ). The report also argues that liquidity is most likely to increase even more as bitcoin and cryptocurrencies get recognized as an asset class.

The risk-reward profile of bitcoin can also be determined by measuring risk (in the form of price volatility) vs. reward (in the form of absolute returns). This metric, known as the Sharpe Ratio, can be compared across asset classes, thus given bitcoin the necessary characteristics of being included in an investment portfolio of various, but comparable asset classes.

Volatility is also decreasing, giving bitcoin the necessary stability. Average daily volatility decreased from about 10% to about 4% compared to the previous year.

Ever since bitcoin emerged a couple of years ago, the pendulum has been swinging, gaining interest from various communities. The last two years has been all about the blockchain and distributed ledgers. It remains to see if this report manages to instigate renewed interest in cryptocurrencies by investors and asset managers. After all, the value of an asset is no more than the sum of a shared belief of its value. This acted as the fundamental principle behind the concept of money itself, and is also be applicable to cryptocurrency-backed securities.

One thought on “Bitcoin is dead – long live bitcoin

  • December 15, 2016 at 11:22 am
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    I have to correct a couple of statements in your blog post:

    1. Bitcoin is mainly used for illegal activities
    You write “..the fact that the majority of core use cases for bitcoin are still deeply connected to ransomware payments and other illegal activities..” and by that actively support this well-known myth. I advise you to read the paper “The Evolution of the Bitcoin Economy: Extracting and Analyzing the Nwtwork of Payment Relationships” where the authors firmly debunks this myth. According to the authors socalled “sin” enterprise (gambling, black markets ++) now accounts for appr. 5 % of all bitcoin transactions.

    2. Security
    You mention the Mt. Gox scandal, and I could add BitFinex and many more, and implicitly question the security of Bitcoin. Mt. Gox and other scandals have nothing to do with the security of Bitcoin, but have everything to do with unsecure and amateurish exchange businesses. Banks should see this as an opportunity. After all they are obesessed with security and have been to all times and would probably do a much better job at being crypto currency exchanges that today’ businesses.

    I also think it is too early to conclude that Bitcoin as a payment alternative is dead. There is a tremendous innovation pace in crypto currency and a lot of exciting ideas and initiatives. The potential for bitcoin (and possibly other CCs) in machine-to-machine payments and other fully automated and programmed payments is huge and work has barely started in this area.

    I agree with you conclusion and would like to add that after a couple of years with rejection of Bitcoin and other global CCs I think we see a turn these days where more and more people also in the financial sector see that the universal blockchain is the future and where the definite disruptiv potential is.

    Reply

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