It’s Time to Talk About Bitcoin (Again)

Lane Fraum

By Lane Fraum, Director and Head of Florida Office

Often the forgotten asset until it’s in the spotlight, Bitcoin is a polarizing topic in the investing world.

The cryptocurrency has nearly tripled from its cycle low of $16k in late 2022 due to speculation that the first spot Bitcoin ETF will soon be approved. Still, it remains nearly 39% off its cycle high of $68k. Is now a good time to look at it once again?

What is Bitcoin?

Bitcoin is an open-source (the code is public) computer program, run concurrently by individuals and entities globally. The program, launched in 2009, serves as a digital peer-to-peer money and banking system for over 100 million people worldwide, facilitating over $10B in transactions daily. Bitcoin uses blockchain technology to process and record transactions in its distributed, immutable database. As of December 11, 2023, the Bitcoin network represents $822B in value.

Bitcoin as Money

There are two kinds of money:

Fiat money (i.e., USD, EUR, JPY) derives value by government order. In the United States, legal tender refers to all coins and currency that may be accepted in a court of law as payment for monetary debt. It is said that the USD is backed by the “full faith and credit” of the US government.

Commodity money, also known as hard money, is money backed by a commodity such as gold. Commodity money is thought to be a sound form of money because it is backed by a physical commodity, making it a reliable and stable store of value.

Money serves as a medium of exchange, store of value, and unit of account. Money should be fungible, durable, divisible, portable, acceptable, and scarce. When we consider the use cases and properties required to classify assets as money, we can conclude that Bitcoin is money.

Evaluating Bitcoin

One of the criticisms of Bitcoin is that it does not have intrinsic value, or the measure of what an asset is worth by means of an objective calculation or financial model. One can easily determine the cash flows of a company or debt instrument. Commodities like Bitcoin, gold, art, and collectibles do not produce cash flows. Their value is determined by the free market – supply and demand determine the exchange price. But because Bitcoin has a deep and liquid market, its value is transparent and transactable with minimal slippage, its daily trading volume comparable to the most heavily traded large cap stocks.

Bitcoin’s role in a diversified portfolio

Bitcoin can provide portfolio diversification benefits. Historical correlations between Bitcoin and US equities are typically, but not always, low. For example, correlations increased during the Fed’s latest tightening cycle, with both asset classes underperforming. However, when Bitcoin wins, it tends to win big.

In May 2023, Coinbase Institutional and Two Sigma researchers asserted that adding 1-5% of Bitcoin can increase a portfolio’s Sharpe ratio by over 30%[i]. Portfolio volatility typically increases when adding Bitcoin, but so does a higher potential for return. Statistically, there is a “long right tail” in the distribution of Bitcoin returns.

Other studies demonstrate that a 10% Bitcoin allocation can be optimal in some cases[ii]. Portfolio construction can also impact the overall portfolio risk and return. For example, replacing a portion of equity exposure for Bitcoin can improve risk-adjusted returns and in some cases even lower overall portfolio volatility. Comparatively, reallocating to Bitcoin from a fixed-income bucket is more likely to increase overall portfolio volatility in pursuit of higher absolute returns. Ultimately, one’s risk tolerance should guide the size and location of a Bitcoin allocation.

The case for Bitcoin in 2024

As discussed in our October 10th webinar with Jason Trennert of Strategas, there is a non-zero chance that USD hegemony (status as primary world reserve currency) will come to an end in our children’s or grandchildren’s lifetimes.

The maximum supply of 21 million BTC is hard coded into the Bitcoin protocol. Bitcoin’s supply is known and predictable. In this time of increasing fiscal and geopolitical uncertainty, it is reasonable to assert that Bitcoin can continue to accrue value as a non-sovereign alternative form of money.

Given Bitcoin’s supply constraints, even marginal increases in demand could lead to significant price increases. Bitcoin’s inflation rate will be cut in half in 2024 and every 4 years thereafter until all BTC are mined, which is estimated to happen by the year 2140. Observing Bitcoin performance surrounding previous “halving” events of 2012, 2016 and 2020, the asset price set new all-time highs 12 to 18 months following each halving[iii].

Ways to get exposure to Bitcoin

Although not part of TAG’s formal asset allocation plan, for clients seeking exposure, TAG Associates’ digital asset advisory team can help devise a plan to navigate the Bitcoin ecosystem. Here are some ideas to get started:

Grayscale Bitcoin Trust (GBTC)

In lieu of a spot ETF, this is the easiest way for US investors to get exposure to BTC. GBTC trades on the OTC markets and is available to purchase in most brokerage accounts (i.e., Schwab). This vehicle functions like publicly traded gold trusts GLD and IAU. As of December 11, 2023, GBTC has an AUM of $27.54B and currently trades at a 10.72% discount to NAV[iv]. Interestingly, this vehicle used to trade at a double-digit premium to spot BTC. In 2021-2022, severe market dislocation exacerbated by a specific arbitrage trade caused the premium to flip to a deep discount, at one point close to 30%. Many expect the current discount will continue to narrow if the SEC approves a spot ETF. GBTC allows investors to get exposure but without the benefits of self-custody.

ProShares Bitcoin Strategy ETF (BITO)

The first Bitcoin-linked ETF available in the United States, BITO seeks to produce Bitcoin-like returns by investing in CME Bitcoin Futures contracts. This contrasts with GBTC, which holds “physical” Bitcoin. Launched in October 2021, BITO is available in most brokerage accounts and charges a management fee of 0.95%. As of December 11, 2023, BITO has an AUM of $1.109B[v]. This vehicle functions like United States Oil Fund (USO), which invests in near-term West Texas Intermediate oil futures contracts. Commodity futures prices can fluctuate above or below spot prices depending on specific futures market dynamics.

Spot BTC

Holding spot BTC is the “pure play” exposure to participate in the asset class. This requires technical savvy and comes with its own unique operational risks. TAG’s digital asset advisory team can help evaluate custody and liquidity solutions, assist with setup, and implement best practices.

Derivatives

For Eligible Contract Participants, derivatives such as options and futures are a way to get synthetic exposure to Bitcoin, without having to custody the “physical” asset. Derivatives can also be an effective way to hedge your existing Bitcoin and digital asset exposures. For example, one can buy put options to provide downside protection or sell covered call options to generate income.

 

[i] https://www.coinbase.com/institutional/research-insights/research/market-intelligence/cryptos-role-in-portfolio-diversification

[ii] https://www.galaxy.com/insights/research/bitcoin-in-a-portfolio-impact-and-opportunity/

[iii] https://www.fidelitydigitalassets.com/research-and-insights/understanding-bitcoin-halving

[iv] https://ycharts.com/companies/GBTC/discount_or_premium_to_nav

[v] https://www.proshares.com/globalassets/proshares/fact-sheet/ProSharesFactSheetBITO.pdf

 

Contact Information

Lane Fraum

Director, Portfolio Management and Digital Asset Advisory

Phone: (561) 249-8220

Email: lfraum@tagassoc.com

 

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