Investment Thesis - Cryptocurrency

In times of high volatility or rising inflation, some people choose to invest in assets that are typically considered stores of value, such as gold and silver. More recently, investor shave also been using cryptocurrencies like Bitcoin as a hedge against currency depreciation and political instability. Here are some features that could make cryptos an interesting investment:

1. All units of Bitcoin, the most well-known cryptocurrency, have been and will be created according to a mathematically metered and predictable schedule. This makes it strictly scarce.

2. Cryptos are generally not issued by any central authority, which makes them somewhat protected from government manipulation or intervention. A sensible allocation to cryptocurrencies could serve as protection against asset seizure or rising inflation, for example.

3. The barriers to transacting cryptocurrencies are typically low - all you need is a private key that gives you access to your digital wallet. Moreover, cryptos are borderless and can be transacted regardless of your location.

4. Most cryptos are still too volatile for use at scale as a medium of exchange, but many of them have advantages regarding transparency and anonymity. it should also be noted that cryptocurrencies like Bitcoin have actually increased their purchasing power over time.

What are Cryptocurrencies?

Cryptocurrencies are virtual assets secured by cryptography, which makes them almost impossible to counterfeit or double-spend. Cryptos are generally associated with blockchain technology - distributed ledgers that run on decentralized networks of computers.

The decentralized nature of cryptocurrencies makes them more transparent than fiat currencies. For example, anyone on the Bitcoin network can validate transactions and audit Bitcoin supply because information on the blockchain is public.

Comparisons to Gold

Cryptos, particularly Bitcoin, have features that improve upon gold's limitations as a store of value. Unlike gold, cryptocurrencies can be transferred electronically and aren't subject to the same rehypothecation as gold, since they are strictly scarce and their availability is publicly auditable. Additionally, Bitcoin is "mined" just like gold. As explained by Investopedia:

"Bitcoin mining is performed by high-powered computers that solve complex computational math problems. The result of “bitcoin mining” is twofold. First, when computers solve these complex math problems on the Bitcoin network, they produce new bitcoin, not unlike when a mining operation extracts gold from the ground. And second, by solving computational math problems, bitcoin miners make the Bitcoin payment network trustworthy and secure, by verifying its transaction information".

Many investors are skeptical of cryptocurrencies as stores of value due to their considerable volatility, however it should be noted that cryptos like Bitcoin have actually reduced their volatility over time. As explained by renowned investment firm Ark Invest:

"Bitcoin’s volatility is diminishing over time, as shown below. As its adoption increases, the marginal demand for bitcoin should become a smaller percentage of its total network value, diminishing the magnitude of price swings. All else equal, for example, $1 billion in new demand on a $10 billion market capitalization, or network value, should impact bitcoin’s price more significantly than $1 billion in new demand on a $100 billion network value. Importantly, we believe volatility should not preclude bitcoin as a store of value, primarily because it typically has coincided with significant upward moves in its price".

Protection Utility

Since cryptos run on decentralized networks, they are often considered non-fiduciary, “trust-less” assets. Cryptos are generally not issued by any central authority, which makes them somewhat protected from government manipulation or intervention.

This protection is increased by the fact that cryptocurrencies can be stored in off-line, "cold" wallets such as Ledger or Trezor. You don't have to trust anyone with your cryptocurrencies - you can keep them safe on your own.

Moreover, all units of Bitcoin, the most well-known cryptocurrency, have been and will be created according to a mathematically metered, predictable and predefined schedule.

All this makes cryptos potentially interesting hedges against issues like inflation, political instability, or asset seizures. For these reasons, there is growing acceptance for the idea that crypto can be an interesting asset for diversification as a minor part of an overall portfolio.

Medium of Exchange

At the moment, cryptocurrencies face considerable regulatory scrutiny due to their ability to support anonymous transactions (transactions typically only require a wallet address) and most cryptos are still too volatile for use at scale. In short, cryptocurrencies are hard to spend.

Given this scenario, it seems cryptocurrencies still have a long way to go before becoming a widely used medium of exchange. However, as noted by Ark Invest, there are interesting aspects to crypto as a currency, such as Bitcoin's increasing purchasing power:

"Over long time horizons, bitcoin’s purchasing power has increased significantly. Since 2011, for example, the price of bitcoin has compounded at an annual rate of roughly 200%and, despite significant intra-year moves, it has appreciated on a year-over-year basis every year since 2014 as measured by its lowest value of the year".