The idea is that bitcoin is the new gold. It is secure and robust, with a fixed supply not dissimilar to gold.
Given enough time for it to catch on, it will surely supersede gold. Or will it? asks Charlie Morris, Founder and CIO, ByteTree Asset Management.
In terms of security and supply, gold and bitcoin are equals. But having followed the gold market for 23 years and bitcoin for 8, the differences become glaringly obvious. In terms of demand, their dynamics are poles apart.
When people think about bitcoin, their first thought is likely to be how risky it is. It is cyclical, high beta and volatile. This is true, but it surprises many that the volatility has been structurally falling despite recent events. This last price crash has seen 90-day volatility of 70%. In 2018 that was 90%, and in 2013, 150%. In crypto, we call that progress.
The reason for the volatility is the variable nature of demand. Much of it has been speculative, but over the years, bitcoin has started to witness a value buyer.
Alternative liquid markets
Gold has low volatility because it has many different value buyers with deep pockets. When the price falls, there is no shortage of interest from central banks, family offices, retail, industry, and jewellery. That limits gold price movements as there are many rational actors in this deeply liquid market that sees $145 bn change hand on a typical day.
Bitcoin has also been enjoying increased liquidity. My company, ByteTree, measures this on-chain traffic (the transactions are shared with all participants in the network and therefore transparent) and having analysed each of the circa 750 million transactions, the answer is approximately $8 bn per day. In addition, there are CME futures of around a $1bn per day, and crypto exchanges that typically see a staggering $30 bn per day.
With around $40bn of daily liquidity, bitcoin is the second most liquid alternative asset in the world (silver approx. $15bn).
Gold demand is based upon its monetary value. It behaves like a zero-coupon 20-year TIPS issued by God. That means it offers insulation from the financial system and inflation protection. But as with all assets, not at any price.
Inflation hedges, by definition, need to be cheap. You cannot expect the stock and bonds markets in 2022, to be inflation hedges when they are both trading at historically exorbitant valuations. Worse still, bonds and equities are falling at the same time, when they are supposed to be uncorrelated, precisely because they are simultaneously overvalued.
Investors should rationally assume that bonds will do well during periods of risk-off, while equities will perform best during risk-on. It is a failure of central banks to have created this double bubble.
Bitcoin was caught up in this liquidity splurge and had its own bubble last year, which has recently unwound with a thud. Yet that low, at $20,000 is four times the low in March 2020 at $5,000. What's more, this recent bitcoin crash is the first in history not to see the network traffic fall. In other words, the price has corrected, but the underlying transactional network has remained resilient.
Bitcoin is growing up
Bitcoin has a job to do, which is to transfer value. If everyone hung onto their coins, and did nothing with them, there would be no network and therefore no value. Bitcoin holders have a part share of a vibrant network.
Gold on the other hand, has done little since mid-2020, when it had its own bubble. At that time, the end of the economy as we know it seemed quite likely, and investors bought gold for financial certainty. That went too far, the economy recovered and, as a result, gold proved to be a poor inflation hedge the following year. Gold didn't fail as an inflation hedge; it was simply overpriced.
Equity and bond bubble markets
Today, equities and bonds are in a bubble at the same time, just as they were in 1972. Bitcoin and gold are alternative assets and will never be printed or bailed out. It is much harder to imagine them ever having a bubble at the same time, because they respond to different forces.
ByteTree created the BOLD Index which combines bitcoin and gold. The index his risk-weighted meaning approximately an 80% allocation to gold and a 20% allocation to bitcoin. It is rebalanced monthly according to the 360-day inverse volatility of each asset.
Since bitcoin are gold exist in freely traded and liquid markets, volatility is an effective measure of risk. If bitcoin were to have the same risk as gold, one day perhaps, then the BOLD would be 50/50.
Alternative to 60/40 diversification
The BOLD Index suffers the occasional painful bitcoin down-month, but you learn to embrace them as they provide the opportunity to rebalance. When bitcoin is down at the month end, you sell a little gold, and buy some bitcoin, until the weights are back in line with the BOLD strategy (and you do the same in reverse if gold has underperformed bitcoin).
The great thing about bitcoin collapses is they tend to happen relatively quickly, and so the odds of successive weak months is low. Besides, gold is normally resilient, and sometimes profitable, during risk-off periods.
You don't need much bitcoin to make money when things are going well, but you do need quite a lot of gold. Moreover, it is highly unlikely that gold and bitcoin will both be overvalued at the same time since they are naturally counter cyclical.
In conclusion, there is no need to choose between gold and bitcoin, but to combine them for their strengths and weaknesses. This combination, on a risk-weighted basis, is a powerful idea and is the liquid alternative to a 60/40 portfolio.
By Charlie Morris, Founder and CIO, ByteTree Asset Management
