Exchanging value today is an antiquated, cumbersome and costly process. Digital assets can revolutionize the status quo. Benefits include the reduction of transactional frictions, the ability to transact across borders, the elimination of counterparty risk assessment, regulatory and monetary policy freedom, access to money for the “unbanked,” user anonymity and ledger transparency.
Given the long list of benefits as well as the fact that a digital infrastructure is available to most of the modern world, there is a present and growing need for a digital medium of exchange. The future of money is digital – and bitcoin is the first early success of that broad, world-changing vision. The digital revolution, and the popularity of bitcoin, have made it clear that digital assets have become a noteworthy candidate for alternative asset investing.
First, over the past three years in particular, the bitcoin market has exhibited signs of market stabilization and other characteristics of more mature asset classes, including declining volatility (i.e., risk), increasing liquidity (i.e., the ability for a buyer to readily find a seller at a particular price, and vice versa), and informational efficiency (i.e., a standard feature of established markets, as indicated by independence of returns and its quick price reaction to new information). These favorable trends in fundamental market metrics stem from bitcoin’s increasing popularity and accessibility.
Second, bitcoin is attractive under modern portfolio theory (MPT) because it offers significant diversification benefits and potentially high returns. The key driver of diversification is low correlation with other portfolio components. Bitcoin has exceptionally low correlation with other traditional asset classes. In addition, bitcoin has established itself historically as a high-risk and high-reward asset, so its inclusion in a portfolio can serve to increase the portfolio’s potential returns (and its risk). In 2016, for example, the value of bitcoin increased 122%, from $432 to $960 per unit.
By comparison, for 2016, the S&P 500 total return was approximately 12%. Indeed, an allocation of bitcoin in a diversified portfolio can significantly improve the portfolio’s riskand-reward trade-off under MPT.
Third, recent economic evidence shows bitcoin may hold the potential to act as a hedge or “safe-haven” in certain investment strategies, as its price movement is positively correlated with the likelihood of uncertainty-inducing outcomes, including the Brexit referendum and the 2016 U.S. Presidential election. Results show that bitcoin’s price changed in near lock step with prediction market probability of outcomes that were expected to introduce great uncertainty to global financial markets – that is, a vote to leave the European Union and a Donald Trump presidency. The results suggest that, to some degree, bitcoin represents a hedge opportunity against global financial market uncertainty. Evaluating the still-nascent bitcoin currency from a financial market perspective provides a deeper understanding of the prominent digital asset and how market participants value and interact with it.
This evaluation allows one to put a finer point on the definition of this digital asset that isn’t quite like anything the world has ever seen. Only the future will tell of bitcoin’s ultimate success, but its relationship with the digital revolution and unique and stabilizing financial market performance signal that digital assets – bitcoin or otherwise – area noteworthy alternative investment option with great potential.
Furthermore, bitcoin’s stability and other investment-worthy qualities prove, along with its increasing user base, that digital assets backed by central banks are not only possible but inevitable.