Why should anyone own bitcoin?
Most folks are interested in bitcoin, quite frankly, because the price has risen so much. Strategists continue to produce papers that show – not surprisingly – that a 1% allocation to bitcoin over the past decade would have added about 2.5% per year to a diversified portfolio. After all, the price of bitcoin has risen 250% per year for the past 10 years, and one percent of 250% is 2.5%.
But there’s a reason to own bitcoin that has nothing to do with its price or investment return.
In his masterful book series, “Investing for Adults,” William Bernstein talks about “deep risk.” These are risks that don’t show up in standard market volatility measurements. These risks that once they arrive, it’s impossible not to think about anything else. These are risks that are real but are often dismissed with the comment, “If that happens, we’ll have more serious things to worry about.”
Bernstein calls these risks the “Four Horsemen of Economic Devastation,” listed below, with examples from recent history:
- Severe, prolonged hyperinflation (Brazil, 1990; Zimbabwe 2008, Venezuela 2019).
- Severe, prolonged economic recession (Japan, 1990-2015; Greece 2008-2018).
- Asset confiscation (Cyprus, 2013; post-revolution Russia/China).
- Devastation due to domestic strife or civil/international war (Lebanon, 1982-1990; Afghanistan 2002-2021).
These incidents devastated traditional portfolios in their native countries. When index providers like S&P or Barclay’s or Ibbotson provide long-term returns for the global capital markets, there’s a reason they often start with the postwar period. It’s quantitatively challenging to incorporate the 100% losses associated with war and devastation. And they don’t make for very good marketing blurbs, either. The CFA Institute and other investment-credentialing programs don’t ask test questions about dealing with hyperinflation or asset confiscation. They simply can’t be addressed with traditional mean-variance optimization.
But these risks, while unlikely, are not impossible. A significant proportion of the world’s population has experienced one or more of the “four horsemen.” And bitcoin seems uniquely suited to address them.
Consider: bitcoin is a cyber-currency. If you have to quickly pack up and move with just what you and your family can carry, any bitcoins you have stored in an online “wallet” will be available for you after you relocate. Bitcoin is a non-inflationary currency. So if your national currency experiences a hyperinflationary spiral your bitcoin holdings would be expected to hold their value. Since bitcoins are pseudonymous and the distributed blockchain network is global, it’s very hard for them to be confiscated, and you can always download them to a hardware wallet. And bitcoin would maintain its value even during an economic downturn, just as cash did during the Great Depression.
A bitcoin paper wallet with its address and key printed in a QR code. Source: Wikipedia.
Of course, bitcoin is new, and new institutions carry their own risks. They may fail for their own internal reason, or they may be superseded by something even more effective. But bitcoin has survived a lot in the ten years it’s been around: exchange hacks, being outlawed in major economies, unfavorable tax treatment, a programming “fork” that created a near-duplicate cryptocurrency (Bitcoin Cash). Any one of these could have destroyed bitcoin. While its market value typically fell about 50% after each of these crises, what didn’t kill bitcoin made it stronger. Now it’s the crypto asset that everyone else is chasing.
If we purchase homeowners insurance, we’re not upset when our house doesn’t burn down; we didn’t “waste” our insurance premium. Bitcoin as insurance serves a similar function: not as a source of portfolio return, but as a source of calm and confidence, a shelter from unexpected storms. Because, as the saying goes, when the barbarians are at the gates, it’s too late to prepare for a siege. The time to buy straw hats is in February.