With this high volatility in mind, we believe that current Bitcoin investments should be largely viewed as speculative bets rather than growth assets. Cryptocurrencies are still a novel asset class, and a true understanding of their valuation and price movement is elusive compared with traditional asset classes within a well-diversified portfolio. It’s also important to remember that Bitcoin has only existed in a world of rising equity markets and low inflation. That said, it is still useful to think about the future trajectory of Bitcoin and assess the challenges that must be overcome for cryptocurrencies to emerge as a credible allocation for institutional investors.
Challenges Facing Bitcoin Investors
A variety of challenges need to be overcome in order for Bitcoin to be considered a defensible choice for institutional investors. These include valuation concerns, risks stemming from the complexities inherent to the asset, and the long-term sustainability of the Bitcoin market.
Valuation. The lack of a tangible backing, yield, or income makes assessing the value of Bitcoin a complicated process and partly explains its elevated volatility levels.
The challenges in determining the intrinsic value of an unbacked cryptocurrency such as Bitcoin are numerous and complex. Existing fiat currency valuations are determined partly via expected cashflows and valuation metrics that are ultimately tied to a country’s growth and inflation patterns. With Bitcoin, there are no expected future cash flows that can be discounted to the present. Valuation is therefore based solely on supply/demand factors and predicated on the hope that future investors will pay more for this intangible asset. As a result, the risk of Bitcoin losing almost all of its value is not negligible.
The wide dispersion of Bitcoin price targets among different market observers is one indicator of the difficulty in valuing cryptocurrencies. Some commentators believe that Bitcoin has the potential to displace gold as a primary alternative store of value in the form of “digital gold.” In this vein, based on an equalization with the US$2.7 trillion global private stock of gold, JP Morgan recently suggested a long-term target price for Bitcoin of US$146,000. In December, the CIO of Guggenheim Investments suggested a fair value of US$400,000. On the other hand, UBS recently expressed that they “are somewhat skeptical of any essential real-world use cases… [and]are cognizant of the real risk of losing one’s entire investment.”
Risks. The boundary between theory and practice is considerable in the case of cryptocurrencies – and even more so for institutional investors looking to gain exposure to them. Outside of valuation, the complexities of investing in Bitcoin are multifaceted and include a range of risks that few investors are equipped to manage. These risks include those posed by a lack of understanding of the technology underpinning the crypto; fragmented…