The Crypto-Is-Gold Crowd Is Asking the Wrong Questions

(Bloomberg Opinion) -- The enduring debate in the cryptocurrency community is whether Bitcoin will outperform “altcoins,” which are generally defined as digital currencies other than Bitcoin, such as Ethereum, Solana, Cardano and Polkadot. The Bitcoin maximalists say that the only true store of value is Bitcoin, as it is perfectly decentralized and the number of coins that can be in existence is strictly limited. This is true. But the real question is whether crypto investors necessarily need a true store of value, or whether there is space for multiple blockchains that do different things.

Consider that 2,000 years ago the financial system consisted mainly of gold. There were no stocks, bonds or anything else in the way of financialization aside from informal loans. Not much changed for the next 1,400 years, until the first financial institutions sprang up and debt began to be treated as a financial asset. The first publicly-traded companies came about in the 1600s and financial markets in both equity and debt gradually developed from there. 

Finance has only become very complex relatively recently, with simple derivatives such as futures and options morphing into things like credit-default swaps, collateralized debt obligations and other mind-boggling ways to distribute risk. This trend is called financialization, and underscores how paper wealth has played a larger role in the economy while hard assets have played an increasingly smaller role.

Some people take a dim view of financialization because of the unpleasant experience with credit derivatives during the financial crisis. But the truth is that increasing financialization generally corresponds to a higher standard of living over time. Nobody wants to hear this, but financialization and complexity are a good thing.

Enter Bitcoin, which is essentially digital gold. The criticisms levied at gold apply to Bitcoin as well: It doesn’t do anything; it’s a pet rock; it pays no interest nor dividends; it doesn’t imitate the performance of any debt or equity security. It just sits there. But like gold, Bitcoin functions as an absolute store of value. There is a finite amount of gold in the earth’s crust, and it becomes progressively more difficult to mine over time, just like Bitcoin. Gold also serves as protection against the systematic abuse of fiat currencies by governments and central banks, which tend to create progressively more supply.

The crypto universe is just over 10 years old, and in the beginning there was very little besides Bitcoin. But what has happened since is financialization — you have more and more cryptocurrencies that do different things. Some of them, like Ethereum, have cash flows and can be valued on the basis of their cash flows. And the total market value of Bitcoin relative to the market value of all cryptocurrencies has been declining over time, and will continue to decline until one day it makes up less than 1% of the entire asset class — just like gold does today in the broader financial market.

This doesn’t mean that the price of Bitcoin necessarily goes down, but it does mean that the altcoins with utility will increase in value over time relative to Bitcoin. In other words, they are the stocks, bonds and derivatives of the young crypto world. Of course, issuers of stocks can always issue more stocks, and issuers of bonds can always issue more bonds, but this dilution doesn’t typically stop people from investing in stocks and bonds. It is simply a matter of choice: do you want hard assets or do you want financial assets?

I first bought Bitcoin in 2019 and owned it until January of this year. It was a pretty good time to own Bitcoin as a store of value. But this year I became interested in financialization, and bought a small portfolio of altcoins, each with different properties, as a bet on the asset class becoming increasingly complex. I also own gold. Sure, there are periods when financialization reverses and hard assets play a greater role, such as when high inflation kicks in and currencies are debased. But what gold and Bitcoin investors don’t seem to realize is that this is an implicit bet on human progress going in reverse, which doesn’t often happen.

It’s been a little bumpy lately, but digital currencies are here to stay, and their progress will roughly follow the history of financial assets, except in a very compressed time frame. 

More From Other Writers at Bloomberg Opinion:

• An ‘Omicron’ Crypto Is Surging Just Because: Mark Gongloff
• Fintech Flub Exposes Risk of Cryptocurrency Hype: Lionel Laurent
• Regulators Might Yet Head Off a Stablecoin Disaster: Editorial

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World." He may have a stake in the areas he writes about.

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