With its relative simplicity versus other “smart contract” based blockchains, its finite issuance, and its decentralized network, Bitcoin has already established itself as a financial ecosystem and a store of wealth in regions with poor property rights or high risk of sovereign default, currency devaluation, and government-based capital controls and repression. As an example, outside of China and the U.S., the next largest adopters of Bitcoin are Ukraine, Russia, Venezuela, Kenya, South Africa, Nigeria, Colombia and Vietnam.1 We believe the combination of market-capitalist foundations and socially beneficial utility support the case for Bitcoin’s long-term success as an asset.
Bitcoin and other digital assets still face challenges, from reducing their energy consumption and facing down their competitors, to regulatory uncertainty (as we described in the second of our series of articles). Yet, with technological advancements, increased understanding of digital assets and the overall maturation of the digital asset ecosystem, we believe that Bitcoin has cleared the hurdles to become an enduring feature of diversified investment portfolios—and consumers’ wallets. With its unique set of “digital risks” lending it low correlation with traditional assets, and an already relatively developed derivatives market, we believe Bitcoin’s success will likely manifest through several pathways:
- Offering a new, potentially durable store of wealth
- Facilitating global money transfers
- Potentially insulating against hyperinflation
- Providing a benchmark/reference for digital asset value
The Power of Consensus
What is it that gives Bitcoin value in the first place?
The fact that Bitcoins have no unique utility is often cited as a reason why they cannot serve as a long-term store of value. We disagree. There are family estates that have endured world wars, persisted for generations and outlasted government regimes. To do so, many have relied on stores of wealth that are less subject to governmental controls or to manipulation by central banks—but which often have no obvious utility beyond their beauty or the stories attached to them. For example, art, antiquities and jewelry have long been stores of significant wealth that have been hidden away, only to emerge for sale through prominent auction houses.
In June 2021, Stuart Weitzmann, a designer and, apparently, an astute collector, auctioned off what Sotheby’s marketed as the “Three Treasures,” for more than $30 million: the only legally available 1933 Double Eagle Gold Coin (face value $20); the Inverted Jenny Plate Block (a rare stamp-printing block); and the unique British Guiana One-Cent Stamp. The latter two are essentially useless; the first sold for many multiples of its value as gold. Their value appears to derive from the verifiability of their scarcity and the stories attached to them, and the faith and consensus among collectors that they act as stores of value. These are also the foundations of Bitcoin’s value: its built-in scarcity as an asset, and the verification process of the blockchain ledger. For artworks and antiques, we might think of respected auction houses such as Sotheby’s, Christie’s and Phillips as private blockchains that verify the authenticity of objects and transactions.
We are not arguing that Bitcoin will become a collector’s item. Rather, we wish to illustrate the power and durability of value assigned by consensus, without any need for specific utility. We also believe there is an important distinction between this type of consensus and traditional faith in governments and currencies backed by central banks—hence the commonness of Bitcoin in those countries, named above, where faith in the authorities is weak.
Solid Gold Versus Digital Gold
Many of the qualities we just described make us think of gold, whether in the form of jewelry, coins or bullion. Bitcoin’s explicit scarcity and digital “immutability” feed these comparisons, and the Commodity Futures Trading Commission (CFTC) has indeed classified it as a commodity—but its intangibility and lack of specific utility leave plenty of room for doubt.
Bitcoin’s decentralized blockchain technology, basically an open transaction platform with 24/7 trading, makes it seem less like gold and more like a modern global currency. Creating digital tokens, or “coins”, that create seigniorage independent of a government or central bank via a standardized process of digital “mining”—basically solving complicated cryptography equations—seems perfectly reasonable to us in the increasingly digitalized and globalized economy. Unlike gold, a billion dollars of Bitcoin could travel in someone’s pocket on a tiny storage device. Moving even a few hundred thousand dollars in gold is not a practical exercise for anyone, except perhaps comic book characters. Might this intangibility help facilitate an economy on Mars a hundred years from now? It could well be something for investors who prioritize environmental, social and governance (ESG) factors to consider: an intangible alternative to gold is potentially attractive, given that more than 55% of annual gold production ends up sitting in vaults so that investors can trade derivatives on it—as opposed to going into jewelry or technology.2
Of course, “independent of a government or central bank” is the issue here. The mere thought of such freedoms is what justifiably raises concerns with the authorities that seek to monitor and manage the flow of currencies around the world.
A less obvious way to label Bitcoin (or classify it for regulatory purposes) might be to recognize it as a kind of derivative, such as a future or perpetual option contract with an “underlying” exposure that would ultimately define how its price interacts with other assets. Some “stablecoins”, which are backed by other assets, have been labeled as swap contracts, for example.
Once again, this is apt to get us thinking about Bitcoin’s gold-like properties. Much like equity, securities can be considered perpetual call options on company profits, gold can behave like a long perpetual put option. Investors tend to hold gold without any form of guaranteed payments or assured compensation: they pay for storage and they pay the opportunity cost for not owning more productive assets, because they hope that the price of gold in terms of fiat currencies will appreciate rapidly during events such as high inflation or equity market selloffs. Basically, gold is regarded as a hedge with convexity for their portfolios, its optionality derived from the belief that the world could one day return to a gold standard, where fiat currencies have little or no value.
We do think that Bitcoin has the potential to provide attractive option characteristics like these. However, it will likely take many years for Bitcoin to earn the investor faith, the positive feedback loop, that gold has accrued over millennia.
A New Benchmark for a New Class of Assets
Let’s consider one final potential durable use case for Bitcoin.
Sometimes, a particular measure becomes so well established that it transforms into a shorthand for something much bigger and more complex than itself. The S&P 500 Index, or even the somewhat impractical Dow Jones Index, has come to stand for “the equity market”; the WTI crude oil price in U.S. dollars acts as shorthand for “commodities”. In 1993, Professor Robert Whaley created the S&P 500 Volatility Index (“VIX”) for the CBOE, a calculated value derived from the implied volatilities of listed S&P 500 Index options, which is today the standard measure of financial market risk and itself the underlying asset for billions of dollars in futures, swaps and options.
The fact that a standard of measure is scientifically derived doesn’t mean that it was not arbitrarily selected. Consider the history of the standard meter, which has evolved since its origins in 1793 in accordance with the world’s scientific community’s capacity for precise measurement. What began as the conveniently round number of one-ten-millionth of the distance from the equator to the North Pole, as estimated by 18th century researchers, is currently defined as the distance light travels in 1/299,793,458ths of a second.
If the Dow Jones Index and a seemingly random number can act as such important benchmarks, why shouldn’t the Bitcoin price become the standard measure of digital asset value and risk? Maybe all digital assets will one day be quoted in Bitcoin as proof of validity.
The “Everything Bagel” Is the Most Popular
After all these considerations, we arrive at a paradox about Bitcoin. We think its success and its durability will depend at once on its specificity and its flexibility.
Bitcoin has already attracted competition from other cryptocurrencies, such as Ethereum and Solana, that attempt to fix its “obvious” flaws. Yet, in doing so, as we argued in our first article in this series, we believe they are abandoning the foundational advantages of Bitcoin in favor of becoming all-purpose apps—open-source technology platforms that utilize smart contracts. Many wrap Bitcoin transactions themselves into smart contracts to speed the process up or augment payment terms. Overall, their innovations tend toward greater flexibility and unlimited capacity, rather than toward emerging as basic, immutable digital assets. Over time, we expect the fundamental differences between Bitcoin and other cryptocurrencies to continue to push their use cases further apart. Methodology upgrades and “forks”, such as Bitcoin’s Taproot and Ethereum’s Ether 2.0, will create new points of divergence.
Bitcoin may not be the only successful blockchain related security—innovations on blockchains such as Ethereum have undeniable utility. However, in our minds Bitcoin, by nature of its narrow focus and stable foundation, is clearly positioned to remain a “cornerstone” of the edifice of digital assets.
That’s the advantage of its specificity. What about its flexibility?
Without a clear-cut categorization of exactly what kind of asset Bitcoin is, it is possible that most investors could remain on the sidelines. Uncertainty around its viability and value—manifested as its price volatility—makes it difficult for investors to allocate meaningful capital to it. We therefore appreciate the temptation to put a convenient label on Bitcoin. It’s a temptation that we in the Option Group are familiar with, after being asked so many times to classify our own strategies according to the investment industry’s “asset-class boxes”.
But in our view, questions like these—Is Bitcoin a currency? Is it a commodity? A put option on the global fiat monetary system? A measure of the value of digital assets?—actually run contrary to the goal of widespread adoption by limiting its potential for evolution and varied utility. It has the potential to be all of those things and more, and that is its strength.
In 2019, order data from the food delivery service Grubhub indicated that the U.S. consumer’s favorite bagel flavor was “everything”—followed by sesame and then raisin. Human beings value optionality. They like a bit of everything. And that’s what Bitcoin is: the “everything bagel” (or the cheese pizza, as we put it in an earlier post, ready for any variety of toppings). But part of the power of the everything bagel or the cheese pizza is that it can be any flavor you like, without having to be any flavor at all.