Deutsche Bank has a new report out on digital payments, covering the long-term migration of payment mechanisms from cash to cryptocurrencies. The report is titled: The Future of Payments: Part I. Cash: the Dinosaur Will Survive … For Now.
Most of the report is fine. And yet, in an interesting way, they misunderstand the nature of Bitcoin entirely — and they also get wrong what “store of value” means.
Within the report, Deutsche Bank states the following: “Bitcoin is too volatile to be a reliable store of value.”
We could call that statement false, except false is not the right term. It is “not even wrong.”
“Not even wrong” is an offhand physics term. If an argument or statement is not even wrong, the underlying assumptions are so faulty the statement cannot be judged true or false.
Is Bitcoin highly volatile? Yes, certainly.
Should volatility disqualify an asset from serving as a store of value? Absolutely not — especially when the concept of volatility is relative.
Take gold, for example. Gold can go through low stretches for years at a time, with no explosive movements whatsoever. And then, at certain times, the gold price can go absolutely wild.
Except when gold goes volatility-wild, the driver is not gold itself. It’s the rest of the world going haywire.
We’re used to thinking of gold priced in dollars. But if people are losing faith in dollars, or central bankers, or the financial system entirely, it is the price of gold that will strengthen — typically in a volatile way — to compensate.
The point is that, if a safe-haven asset becomes more volatile because people are piling into it, that is a function of the world’s instability and volatility, not a critique of the asset itself.
As a side note, we saw evidence of such behavior with Bitcoin this week.
As the world experienced a twinge of panic over the worsening coronavirus outbreak, and equities registered the beginning of their first real correction in months, the Bitcoin price rose more than 5%.
Meanwhile, in countries like Iran where political and financial volatility is extreme, Bitcoin is something of a godsend. As hardship and uncertainty increase, the value of Bitcoin to Iranian savers increases.
And in fact, the more political and geopolitical instability we see spilling across borders, the more attractive Bitcoin will become as a means of sheltering capital and moving it out of harm’s way.
The ultimate definition of “safe-haven asset” might be the thing you buy when you genuinely fear jackbooted thugs are about to kick down your door. In many countries, that thing is Bitcoin (which is easier to conceal and transport than gold, and far harder to confiscate).
The basic point here is that, when the world explodes with volatility, safe-haven assets tend to absorb that volatility in the form of upward price movement. That is no reason to disqualify them as safe havens.
Then, too, a thought experiment: Let us say that, for whatever reason, the U.S. dollar is plummeting straight down. In a world where you own the right things, the value of your safe-haven assets — as priced in dollars — would be going straight up to counter that drop.
This also shows a flaw in how Wall Street judges volatility in the first place.
Popular measures like the Sharpe ratio reward smoothness and predictability — a lack of volatile movement in either direction. But if things are going to Hades in a handbasket, volatile movement in a compensating upward direction is exactly what you want.
In addition, thinking about Bitcoin as a digital payment mechanism is completely the wrong frame. That is another deeper-level mistake that Deutsche Bank makes: Wrongly assuming Bitcoin is meant to be a substitute for cash.
Too many people, including a great many financial experts, still judge Bitcoin on whether it is useful as a means of transaction payment, a kind of cash proxy you can use to buy a coffee or pay bills with.
This is the wrong way to think about Bitcoin. Throw away the mental frame. It isn’t helpful, and it’s not where Bitcoin is going.
Bitcoin is the hardest form of “hard money” that has ever existed. Once 21 million coins are mined, there won’t be any more. Miners will still be extracting gold from the ground 21 years from now, but the new supply rate of Bitcoin will be zero.
That means Bitcoin will be hoarded as the ultimate store of value, with its dominance rooted in global brand recognition, global technology infrastructure, and irreversible network effects.
Then, too, because the ultimate destination of all fiat currencies is zero, the ultimate value of Bitcoin — as an immutable sovereign counterpart to fiat — will gravitate higher and higher as time passes. Even gold will see a little bit of inflation (due to new supply) in future years. Bitcoin will have none.
This is the nature of an asset to hold (akin to digital gold in a vault) as opposed to an asset to transact with (akin to how you pay at Starbucks).
And this points to the real irony in Deutsche Bank’s anti-volatility assumption. To put it simply:
- Not only is Bitcoin a store of value, it is likely the ultimate store of value.
- As the ultimate store of value, Bitcoin is not suited to casual transactions.
- Bitcoin’s ultimate-store-of-value nature will contribute to upside volatility.
- Bitcoin will exhibit upside volatility because it is a safe haven, not in spite of it.
They (Deutsche Bank) get it so wrong, it is really kind of hilarious.
But that is not because they aren’t smart — it is because their initial assumptions were wrong: They assumed low volatility is a hallmark for store-of-value assets (it isn’t) and that Bitcoin’s success should be judged by transaction suitability (it should not).
If we understand that, over time, safe haven assets generally absorb the volatility of the world — in the sense of going up while the rest of the world is going down — we can reject the assumption “safe-haven assets should not be volatile.” Safe-haven assets should indeed be volatile — sometimes, for the right reasons, given the proper surrounding circumstances.
And if we understand that Bitcoin is the hardest form of hard money that has ever existed, making it the ultimate store of value, we can see why Bitcoin will be hoarded more than spent over time — and this is completely fine and desirable, because serving as an ultimate store of value is a far more compelling and critical use case than enabling a coffee purchase!
We can then add a reminder that, in order to reach full bloom, the total market cap of Bitcoin will have to expand by 10X to 100X or somewhere in between.
At its current market cap of $163 billion, all the world’s Bitcoin is worth less than a one-eighth share of one single company, Apple. As the Bitcoin value proposition deepens and expands — likely assisted by the next financial crisis — the total Bitcoin market cap should move into the trillions. There is no way to make that trip without substantial volatility!
“But big institutions don’t like to hold volatile assets,” someone will say.
That is true as far as it goes, but the statement requires context. Institutions don’t like volatile assets given the option of hitting investment-return targets with the help of non-volatile stuff and the assumption of a calm world — where non-volatile assets are rising steadily.
Those conditions are too “Pollyanna” and don’t always exist. We are used to them these days, but they go away for long periods, too, sometimes years or even decades at a time.
In a newly volatile and dangerous world, where things are going haywire and Bitcoin is one of the few things going up alongside gold, the big institutions are likely to change their tune: In such an environment, they would just allocate a percentage of assets to Bitcoin, buying and holding for the sake of their sanity.
TradeSmith Research Team