A Look at Three Bitcoin Myths

Bitcoin is front-page news again after topping its December 2017 record high and thereby unleashing an array of speculation about how far it could climb. But as with any hot-sounding, headline-grabbing investment, we suggest folks look past the hype over highs and coolly assess the common arguments people cite for owning bitcoin. Here is a breakdown of some, showing they are little more than myths—beware buying into bitcoin based on them alone.

Myth: Bitcoin is a safe haven asset.

In theory, a “safe haven” asset is one you buy when you want to shield it from severe problems in the stock market. The goal isn’t to own something that zooms when stocks sink, but rather, something stable—a fluffy cushion. It shouldn’t have high expected volatility, it definitely shouldn’t swing similarly to stocks, and generally the goal is for a cash-like return over a short period. US Treasury bonds, UK gilts and German bunds are classic examples of assets with this reputation. Ditto the Japanese yen and Swiss franc.

Based on popular definition, bitcoin doesn’t pass the safe haven test. We don’t have much history to test bitcoin’s safe haven efficacy considering it came online in 2009—and reliable price data go back to mid-2010. This year’s equity bear market was bitcoin’s first, and as global stocks fell -34.0%, bitcoin was down -32.7% over the same period.^[i] A 1.3 percentage point smaller drop doesn’t seem like a cushion to us. While we aren’t generally fans of the term “safe haven”—owning any asset comes with risk, including any of the aforementioned—bitcoin failed its first real-life trial.

Myth: Bitcoin is a stable store of value.

A stable store of value is supposed to be non-volatile and maintain its purchasing power—thereby offering a hedge against inflation. People see gold as fitting this description. Perhaps because it once backed the US dollar, many assume the precious yellow metal possesses “intrinsic value”—that is, it will allegedly maintain its worth regardless of economic environment. Yet this conventional wisdom ignores history, and not just because the dollar peg was a price control on gold. Gold prices are volatile and have fallen during periods of high and/or rising inflation—not what you should expect from an inflation hedge.

While we can’t test how bitcoin would have fared during the historically high inflation of the 1970s and 1980s, our limited dataset suggests bitcoin’s merits as an inflation hedge aren’t airtight. Inflation has been overall low this decade, but there have been spurts of mildly rising prices. In 2018, prices accelerated from 2.1% y/y in January to 2.9% in July.^[ii] Over the same period, bitcoin plunged -46.8% after its bubble popped in December 2017.^[iii] This is admittedly a small sample size, and we don’t recommend drawing too much from seven months of data. But an inflation hedge shouldn’t lose nearly half its value during a stretch of slow-but-accelerating rising prices.

Meanwhile, bitcoin’s inherent volatility cuts further against the notion of it being a store of value. Since July 2010, bitcoin’s median monthly percentage change (up or down) is 16.7%.^[iv] The S&P 500’s? 2.4%. Bitcoin’s standard deviation—a measure of volatility that represents the degree of fluctuations in historical returns—is 1541% (based on returns over 12-month rolling periods).^[v] In contrast, global stocks’ standard deviation is 10% over the same period.^[vi]

Myth: Bitcoin is a viable medium of exchange (i.e., money).

Some see bitcoin as the future of money—especially after a major online payments system announced users could buy, sell and hold certain cryptocurrencies. But to be widely used, money needs a stable, predictable value. Businesses and consumers must have faith that whatever they are paying with/receiving in exchange for goods and services today will maintain its worth tomorrow. Yet this stability means generating basically no return, gutting the thesis to own bitcoin for that reason.

Most people see bitcoin’s big swings and think of it in terms of a commodity/security. This is probably because if you think of bitcoin as a currency, you have to acknowledge that it resembles banana republics in crisis. In 2018, bitcoin plunged -74.5%, which we are sure anyone would agree is a massive devaluation.^[vii] It also dwarfs other recent currency crises. That same year, Emerging Markets Turkey and Argentina and Frontier Market Pakistan were all embroiled in domestic economic crises—and the latter two required IMF bailouts. For the year, the Turkish lira, Argentine peso and Pakistani rupee fell -28.7%, -50.0% and -20.5%, respectively, against the USD.^[viii]

This is a big reason few legitimate vendors price goods and services in bitcoin.^[ix] Most merchants that accept bitcoin convert them back to a major currency, which is part of the reason behind bitcoin’s high transaction fees. An actual digital currency—meaning, a viable medium of exchange—has to be more stable and predictable. That is the idea behind the cryptocurrency Tether, whose value is tied to the US dollar, Libra (Facebook’s cryptocurrency), and central banks’ research into digital payments systems (e.g., “Fedcoin”).   

As always, you can’t have it both ways. Either bitcoin is money and gives no return, making it a terrible investment, or it is a speculative commodity that you can’t use as money. So even if bitcoin eventually joins the ranks of the dollar, pound or euro as a global currency, that destroys the thesis to own it for price appreciation, in our view. Today’s hype strikes us as mostly heat chasing—an error for long-term investors to avoid.