by Jurrien Timmer, Director of Global Macro, Fidelity Investments
- Increasingly, investors and portfolio managers see bitcoin as a legitimate and distinct asset class.
- Bitcoin has a unique supply-demand dynamic with supply finite and demand growing fast.
- Seen as "digital gold" by some, bitcoin may act as a store of value and potentially offer inflation protection.
- Bitcoin, however, continues to face considerable risks from volatility, competitors, substitutes, regulation, and other factors.
Bitcoin was the first digital currency to hit the world. Though it's inarguably the most successful cryptocurrency to date, it is relatively new and comes with considerable unknowns and risks. Jurrien Timmer, Fidelity's director of global macro strategy, shares his views.
What is bitcoin (BTC)?1 Is it an asset class? Is it digital gold—or digital tulip bulbs? Can it be considered a diversifying investment (and under what circumstances)? If so, what is bitcoin worth? For most investors, it comes down to these few questions.
Price resides at the intersection of supply and demand. As I see it, bitcoin has both a unique supply and a unique demand dimension that suggest it could be an alternative to gold.
Supply: Scarce by design
One of bitcoin's key features is a built-in scarcity factor: Total supply is limited to no more than 21 million bitcoins.
Today, about 18.6 million of the total 21 million bitcoins have been created, but it still will take many more years (120, give or take) before the mines are depleted.2 This declining supply-growth curve is what makes bitcoin a scarce asset—unlike, say, fiat money, which isn't under the same supply constraints.
Demand: Growing exponentially
Where is the demand side of this equation? Think back to 2017 when bitcoin first reached $20,000 only to collapse down to $3,000 before eventually crawling back. What happened? Again, price lies at the intersection of demand and supply, and without the demand side kicking in, it doesn't really matter how scarce the supply is.
Furthermore, for bitcoin an entire demand-side dynamic is at work—one described by Metcalfe's Law. In its simplest form, Metcalfe's Law holds that, as the number of its users grows exponentially, so does a network's value (or, by inference, the bitcoin price). In other words, bitcoin's utility (value) should grow much faster than does its network of buyers, sellers, exchanges. Consider the graph below which illustrates growth curves, also known as S-curves, for mobile phones and bitcoin: flatter at each end, steeper in the middle.
It appears to me that the bitcoin growth curve may still be in its exponential phase—and could remain so for a number of years. That suggests to me that the demand side of the equation also could continue to grow exponentially.
Thus the bullish case for bitcoin: Price is at the intersection of supply and demand, and demand is growing exponentially while supply approaches its limit.
Is bitcoin "digital gold?"
Since 1971, the US has been in a "fiat money" era, with gold reserves making up less and less of the world's monetary system.2 In 1970, the ratio of global reserve assets (money) to reserve gold stood at roughly 2-to-1; currently, the ratio is more like 10-to-1.
So in this fiat era we have less gold backing up the monetary system at a time when money is being printed at breathtaking speed. For some, this has made gold more appealing as an asset class, and lately bitcoin has joined the conversation as, potentially, a form of digital gold. Some investors use gold to hedge inflation or diversify a portfolio.
Bitcoin risks to consider
There are some risks to consider though. Like gold, bitcoin is scarce, but unlike gold, bitcoin cannot be touched, seen, or felt. Moreover, bitcoin is a brand-new asset that may be at risk of future regulation. Indeed, both the US Treasury and the IRS have been paying more attention lately.
Uncertainty regarding policy-driven restrictions could affect demand. And regulatory risk isn't the only pitfall; bitcoin also faces risks from volatility, competitors, substitutes, and other factors. Trusting that something conceptual and unproven can compete with a tangible rarity treasured for millennia takes somewhat of a leap of faith, in my view.
But bitcoin may have a unique advantage over gold: Bitcoin supply, by design, is finite. So bitcoin could eventually become scarcer than gold.
What is bitcoin worth?
This raises the issue of valuation. Neither gold nor bitcoin produces a yield, making them impossible to value via traditional discounted cash flow models.
Fortunately, global bond yields are close to zero. That means the opportunity cost of holding a zero-yielding asset is much lower now than when bond yields were positive.
My major takeaway: Gold and bitcoin are competitive with bonds at today's low interest rate levels. In a 60/40 stock/bond world, gold and bitcoin may be poised, in my view, as potential disruptors to the bond side of the allocation—but not so much to the equity side.
Still, bitcoin remains small in size relative to other asset classes. The market value of stocks and bonds is around $160 trillion (as of December 2020); the value of all above-ground gold bullion is estimated at $11 trillion; and the market value of bitcoin exceeds $800 billion (as of February 15, 2021). Although bitcoin is catching up fast, as of now it remains only a fraction of gold's value.
Also, so far, bitcoin has proven highly volatile. I expect the ride to be rather bumpy, even dismaying at times. Because of that it may not be a prudent portfolio diversifier.
So how should gold and bitcoin be valued relative to one another, and relative to financial assets in general? My sense is that no one knows with any certainty, but I think both the gold bulls and the bitcoin bulls would surely say, "More than it is now."
Only time will tell if cryptocurrency can provide an equivalent to gold and if bitcoin is the crypto to do it. For investors, it's important to keep risks in mind when considering new investments and bitcoin may have more than its share of risks due to the relative newness, uncertainty, regulation, and hyper-volatility, among other things.
Retail brokerage customers cannot buy or sell any cryptocurrencies at Fidelity. However, those who have a Coinbase digital currency account can arrange to view those balances on Fidelity.com. Although Bitcoin futures are now available for trading on the CBOE and CME, Fidelity does not currently have any plans to offer Bitcoin futures trading for its retail brokerage customers.
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
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