Original title: Bitcoin: A Unique Diversifier
Original author: Samara Cohen, Robert Mitchnick, Russell Brownback, Blackrock
Original translation: 1912212.eth, Foresight News
Bitcoin has experienced a turbulent journey in the 15 years since its birth, from obscurity at the beginning to becoming an asset held by more and more individuals and institutions in the world today.
We believe that as a global, decentralized, fixed-supply non-sovereign asset, Bitcoin's risk and return drivers are very different from traditional asset classes and are fundamentally unrelated in the long run. We maintain this belief even if short-term market trading behavior occasionally (and in some cases even profoundly) deviates from Bitcoin fundamentals.
On August 5, 2024, while the S&P 500 fell 3%, Bitcoin also experienced a 7% one-day drop as global markets experienced a sharp correction due to the unwinding of yen carry trades. This event coincided with a series of long-pending bankruptcy distributions and liquidations (e.g., Genesis, Mt. Gox) that had unfolded over the previous three days. This was then further exacerbated by the scramble for liquidity caused by the global market sell-off.
During these occasional periods of sharp short-term negative correlation with the stock market, the Bitcoin price typically rebounds and recovers to pre-sell-off levels within three days. We view this pattern as an example of fundamentals ultimately triumphing over short-term leveraged trading reactions. As Warren Buffett has said, the stock market is a vehicle for money to flow from the impatient to the patient. This insight has also tended to hold true throughout the history of the Bitcoin market.
Key Points
1. Given Bitcoin’s unique attributes and history, investors considering investing in Bitcoin are struggling to understand how it compares to traditional financial assets.
2. Bitcoin is clearly a high-risk asset due to its high volatility. However, most of the risks and potential return drivers faced by Bitcoin are fundamentally different from those of traditional high-risk assets, making it a poor fit for most traditional financial frameworks - including the risk-on asset vs. safe-haven asset framework used by some macro commentators.
3. Bitcoin’s status as a scarce, non-sovereign, decentralized global asset makes it a safe-haven option for some investors during market panics and certain geopolitical turmoil events.
4. Over the long term, Bitcoin’s adoption trajectory is likely to be driven by the intensity of concerns about global monetary stability, geopolitical stability, U.S. fiscal sustainability, and U.S. political stability. This is in contrast to the general relationship that traditional risk assets are subject to these forces.
Introduction
Is Bitcoin a risk-on asset or a safe haven? This is one of the most common questions our clients ask us when considering their first investment in Bitcoin. They want to know about Bitcoin’s long-term correlation with stocks and bonds and how it is affected by U.S. real interest rates or liquidity.
We believe the answer is that Bitcoin’s unique properties make it ill-suited to most other traditional financial frameworks, and that the drivers of Bitcoin’s long-term returns are fundamentally uncorrelated, and in some cases even opposite, to other sources of portfolio returns. Over the long term, we believe that the drivers of Bitcoin’s adoption are likely to be different from, or even opposite to, the global macro factors that drive most traditional financial assets. While Bitcoin is volatile and has experienced brief co-movements with stocks (particularly during periods of market volatility), in this paper we attempt to explain this dynamic.
Why Bitcoin is Important
First, we need to understand the fundamental reasons why Bitcoin is important. Since its creation in 2009, Bitcoin has become the first Internet-native monetary tool to gain widespread global adoption. Its technological innovation lies in creating a digitally native, globally universal, scarce, decentralized, and permissionless form of money. Due to these characteristics, Bitcoin has made significant breakthroughs in solving problems that have plagued other forms of money for centuries:
1) The supply of Bitcoin is limited to 21 million, which means it cannot be easily devalued.
2) Its global and digitally native nature means that it can be transferred around the world in near real time at near-zero cost, transcending the friction inherent in transferring value across political borders for a long time.
3) Its decentralized and permissionless nature makes it the world's first truly open-access monetary system.
While other crypto assets have emerged since Bitcoin’s original breakthrough, many in pursuit of broader use cases, Bitcoin has gained global recognition as the preeminent asset in the space. This places Bitcoin in a unique position in the crypto asset space as a global alternative to currency and an asset with credible scarcity.
Bitcoin’s Path to $1 Trillion Market Cap
Despite Bitcoin’s significant price appreciation and widespread global adoption, there is uncertainty about whether Bitcoin will ultimately develop into a widespread store of value and/or global payments asset, and Bitcoin’s changing market value reflects this uncertainty.
In seven of the past ten years, Bitcoin has outperformed all major asset classes, resulting in an annualized return of over 100%, an extraordinary performance. Although Bitcoin also had three of the worst years of the decade, and experienced four pullbacks of over 50%. However, through these historical cycles, Bitcoin has demonstrated the ability to recover from pullbacks and reach new highs, despite the longer duration of these bear market cycles.
These fluctuations in Bitcoin's price continue to reflect, to some extent, the evolving prospects of its widespread adoption as a global currency alternative over time.
"Macro-Uncorrelated" Assets
Bitcoin has little fundamental correlation with other macro variables, which is why its long-term average correlation with stocks and other risk assets is low. Although Bitcoin's correlation has risen sharply in the short term, especially during periods of sudden changes in US dollar real interest rates or liquidity, it is short-term in nature and has not produced a clear long-term statistically significant correlation link.
As the first decentralized, non-sovereign currency alternative to gain widespread global adoption, Bitcoin does not have traditional counterparty risk, is not dependent on any central system, and is not subject to the fate of any single country. These characteristics make Bitcoin fundamentally decoupled from certain key macro risk factors, including banking system crises, sovereign debt crises, currency devaluations, geopolitical turmoil, and other country-specific political and economic risks. In the long term, Bitcoin's adoption trajectory may be affected by rising or falling concerns about global monetary instability, geopolitical discord, U.S. fiscal sustainability, and U.S. political stability.
Due to these characteristics, Bitcoin has been viewed by some investors as a safe-haven asset during some of the most disruptive events in the world over the past five years. It is worth noting that during these events, Bitcoin sometimes experienced a short-lived negative reaction before rebounding. We believe these short-term trading reactions, which are difficult to explain with fundamentals, can be attributed to the following factors:
First, Bitcoin trades 24 hours a day and settles almost instantly into cash, making it a highly marketable asset during periods of tight liquidity in traditional markets, especially on weekends.
Second, the Bitcoin and crypto asset markets remain immature, and investors lack understanding of Bitcoin.
In most cases, including the recent global market sell-off on August 5, 2024, Bitcoin recovered to its prior levels within a few days or weeks, and in many cases rose further, as people began to realize that the positive impact of these disruptive events on Bitcoin's fundamentals dominated.
US debt dynamics back in focus
Based on this, growing concerns about the federal deficit and debt situation in the United States and abroad have increased the appeal of potential alternative reserve assets as a potential option to hedge against future events that may affect the dollar. This dynamic also seems to be happening in other countries with heavy debt accumulation. Based on our experience with clients so far, this explains much of the recent surge in institutional interest in Bitcoin.
Bitcoin Still a Risky Asset
None of the previous analysis negates the fact that Bitcoin itself is still a high-risk asset. It is an emerging technology that is still in the early stages of adoption on its path to becoming a global payment asset and store of value. Bitcoin has also been volatile and faces a number of risks including regulatory challenges, uncertainty about the path to adoption, and a still immature ecosystem.
The key point, however, is that these risks are unique to Bitcoin and are not shared by other traditional investment assets. Bitcoin is therefore a particularly strong case for why a simple risk-on vs. safe-haven framework may lack the nuance to apply broadly.
From a portfolio perspective, this is why holding a small position in Bitcoin can provide diversification, while at larger positions its standalone high volatility begins to have an outsized impact on increasing portfolio risk.
Conclusion
While Bitcoin can sometimes move in the same direction as stocks and other risky assets in the short term, over the long term its fundamental drivers are very different from, and in many cases the opposite of, those of most traditional investment assets.
As the global investment community faces rising geopolitical tensions, concerns about the U.S. debt and deficit situation, and increased political instability around the world, Bitcoin may be seen as an increasingly unique portfolio diversifier against the fiscal, monetary, and geopolitical risk factors that investors may face.
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