We previously provided our thoughts on Bitcoin in 2017, but we’ve felt compelled to expand on those perspectives given the cryptocurrency’s recent buzz and eye-popping price appreciation.  We don’t have a horse in this race and aren’t incentivized to hold Bitcoin any more or less than we are to hold other investments/asset classes for our clients, but the principles underlying our investment decisions lead us to exclude the cryptocurrency from client portfolios.

We are certainly not economists, so this post will not be a commentary on the US money supply, inflation, or fiat currencies in general.  That said, it’s worth at least quickly addressing one of the leading pro-Bitcoin theses.  An oversimplified version of that thesis is that the money supply (particularly the US dollar supply) has grown faster than can be accommodated by normal economic activity, that “excess” money supply will lead to rampant inflation, that rampant inflation will lead fiat currency holders to prefer a government-agnostic digital currency with more certain/predictable supply growth, and that the digital currency of choice will be Bitcoin.  Bitcoin may very well continue its price appreciation and “take over the world,” but many events must go right for this to happen.  Put differently, rampant inflation is not only far from guaranteed, it is also far from sufficient to ensure Bitcoin’s long-term success.

A potentially helpful question to ask when deciding whether or not to own Bitcoin is: if you were going to buy a significant amount of Bitcoin, what asset on your personal balance sheet would you replace?  Here are the major categories of assets on our clients’ balance sheets and our thoughts on potentially replacing each with Bitcoin:

• Cash. When people (particularly those based in the US) replace their cash holdings with Bitcoin, it’s not clear what problem they are trying to solve. For the foreseeable future, most expenses and liabilities will be in dollars for US-based investors, so whenever they need to pay for something, they would have to swap their Bitcoins out for dollars (with rare but well-publicized exceptions), adding a layer of complexity/friction to their lives.  Bitcoin doesn’t yet benefit from broad acceptability, and this is unlikely to change significantly in the near-term.  One may be worried about inflation and decreases in purchasing power longer-term (i.e., the store of value argument), but for those with a thoughtful cash plan, all cash held should have a specific purpose, and any cash balances above those targets should be deployed for long-term investing.  That long-term investment portfolio, if constructed properly, should combat inflation quite well on its own, without the need for cryptocurrencies.
• Investment portfolio. Bitcoin doesn’t meet our criteria for inclusion in an investment portfolio because it doesn’t produce a future stream of cash flows. Equities, for instance, produce profits/dividends (or are eventually expected to), bonds earn interest, real estate generates rents, etc.  If an investor is placing Bitcoin in their portfolio, they have no expectation of receiving associated cash flows, and thus they are betting its price will appreciate – in other words, they are speculating.[1]  We recommend portfolios only include cash flow-producing investments that can be accessed in a diversified, low-cost manner.  A bit more on the specific roles equity and fixed income play in portfolios:
  • Equities (including equity mutual funds/ETFs). The purpose of the equity allocation in a portfolio is to provide long-term growth. The world economy innovates and produces productivity gains over time.  Because of innovation and productivity gains in the aggregate, investors can expect positive returns from the overall equity markets over time.  The same cannot be said of individual assets like Bitcoin.  Bitcoin-related innovations around the blockchain/distributed ledgers and the like are certainly important steps forward that will benefit society and equities broadly.  However, these benefits will not necessarily accrue to all companies or individual assets, and assuming the innovations will lead to the continued increase in the price of Bitcoin is a mere bet.
  • Fixed income (including bond mutual funds/ETFs). The purpose of fixed income in a portfolio is to serve as a “ballast” against overall portfolio volatility. We allocate a portion of client portfolios to very high-quality bonds, deliberately sacrificing some expected return in exchange for the bonds that do the best job of dampening volatility (i.e., those most likely to go up during stock market crashes).  Bitcoin is often celebrated as an “uncorrelated asset” and effective portfolio diversifier, but it failed the one true test it has yet taken in that regard, falling sharply during the “Coronavirus Crash” in spring 2020.
• Directly held real estate. Assuming you own real estate for your personal use, this obviously can’t be replaced by Bitcoin. If you own investment real estate, you would, again, be replacing a cash flow-producing asset with a speculation if you were to replace it with Bitcoin.

In sum, if you choose to allocate a material portion of your balance sheet to Bitcoin or other cryptocurrencies, we would encourage you to be thoughtful about what you are replacing and why.

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[1] For the same reason, gold does not meet our criteria for investing.  Nor do other precious metals, commodities, collectibles, or traditional currencies.  Notably, the arguments for Bitcoin are very similar to the arguments that “gold bugs” (those who are particularly bullish on gold and typically wary of inflation) have been making for decades.