What Kind of Financial Asset is Bitcoin?

Is it money? Digital gold? A tech stock? Recent events shed some light on the question.

Noah Smith at his Substack Noahpinion: A lot of interesting things have been happening in crypto-world recently, mostly bad for crypto investors but interesting from a financial perspective. The whole asset class has fallen a lot recently, so that now all of crypto combined is estimated to be worth about $1.3 trillion, down from maybe $2 trillion a month ago. I’m going to write about things like stablecoins in a bit, and also about the possible effects of future crypto crashes on the real economy (this one shouldn’t be particularly dangerous, given the modest size of the paper wealth destruction, the lack of connection with the banking system, and the lack of debt backed by crypto assets.) But for today I want to talk about Bitcoin itself — the granddaddy of the cryptocurrencies. Bitcoin hasn’t fared as badly as some others, but it is down by more than half from its peak:

“Cryptocurrencies are to the real economy what fantasy sports are to the real sports. And NFTs are like penny stocks.” – @Hootsbuddy

So lots of people will be wondering whether now is a good time to get into Bitcoin, or whether it’s doomed and they should stay away. I can’t answer that question (for my part, I’m just holding on to the same amount of Bitcoin I bought years ago). But I thought it would be interesting to briefly go through the various theories that people have of Bitcoin as a financial asset. Which theory you believe will determine what you think Bitcoin’s price will do in the future.

Theory 1: Bitcoin as the future of money

This is the most common theory of Bitcoin, especially among the cryptocurrency’s supporters (the most avid of whom are called “maximalists”). In fact, this was the original idea of Bitcoin — it was supposed to replace fiat currencies like the U.S. dollar. Generally, money isn’t a very good investment. Even if money didn’t depreciate via inflation, it still wouldn’t go up in value very fast — even if there was steady deflation, the cash wouldn’t offer the returns of, say, the stock market, or a house. Those things are risky, and thus their returns will always be higher than that of cash. Instead, the case for really spectacular Bitcoin returns is that Bitcoin is not now money, but will eventually be money. If this is true, then demand for Bitcoin will eventually be much, much, much higher than it is now, since people will need it to buy everything. Higher demand will mean much higher prices.

More here.