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We often refer to bitcoin as “digital gold” because, like the metal, it is a potential store of value. To determine if bitcoin has value, it is important to start with an understanding of the two types of value:
If bitcoin is increasingly used as an asset with monetary value, what role might it play within an investment portfolio?
Bitcoin may potentially increase portfolio diversification because of its low correlation to traditional asset classes, including broad market equity indices, bonds and gold.
Source: Morningstar. Data as of 31 July 2019. U.S. Bonds is measured by the Bloomberg Barclays US Aggregate Index; Gold is measured by the S&P GSCI Gold Spot Index; U.S. Real Estate is measured by the MSCI US REIT Index; Oil is measured by the Brent Crude oil spot price, Emerging Market Currencies is measured by the Bloomberg Barclays EM Local Currency Government Index.
Despite the relevant market risk, liquidity risk and cybersecurity risk, an allocation to bitcoin may also enhance the risk and return reward profile of institutional investment portfolios. As seen in the chart below, a small allocation to bitcoin significantly enhanced the cumulative return of a 60% equity and 40% bonds portfolio allocation mix. However, its impact on the volatility of the portfolio should not be neglected, as bitcoin is still a nascent asset with wild price swings.
Source: Morningstar. Data as of 31/7/2019.
A look at the stock to flow ratio1 may also offer a view of bitcoin’s growth potential. The below stock to flow data suggests that bitcoin may have potential to grow, based on historical data and the scarcity characteristics of bitcoin, gold and silver.
Source: Medium, “Modeling Bitcoin’s Value with Scarcity,” 22 March 2019.
Furthermore, bitcoin has “halvings” programmed into it. A halving is defined as a 50% block reward cut to bitcoin production rate, and they occur roughly every four years, with the next halving expected in May 2020. Given the scarcity induced by halvings, the price of bitcoin has historically increased following halvings.
Bitcoin transactions have crossed 400,000 permission-less transactions per day, exhibiting significant network value.2 When looking at off-chain adoption and the number of applications being built on Bitcoin, we see a natural evolution taking place.
Sidechains (such as Liquid by BlockStream) may be the next step in boosting Bitcoin adoption as they allow for scalability and customizations while retaining many of Bitcoin’s security properties. Built on top of the Bitcoin-blockchain, we believe the Lightning Network pushes the boundaries of Bitcoin payment capabilities with lower costs and faster speeds. Taking advantage of Bitcoin’s trust-minimized features, Microsoft is building a decentralized identity platform on the Bitcoin-blockchain.
1 The stock to flow ratio is defined as the amount of an asset that is held in reserves divided by the amount of that asset produced for a selected time period.
2 Source: Blockchain.info. Data as of 13/7/2019.
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