Investing In Bitcoin - Pros and Cons

With Bitcoin Halving just days away, it makes sense to revisit the case for investing in bitcoin.  Why should a long term investor hold any bitcoin at all in their portfolio?  One can certainly trade bitcoin without having any long term view on bitcoin as an investment, but this post is really about the long term view and the pros and the cons of investing in bitcoin.


Bitcoin As An Inflation Hedge and Store of Value

COVID-19 is causing an unprecedented recession with tens of millions of people losing their jobs.  This severe economic disruption is pushing the Federal Reserve towards unprecedented actions such as buying municipal and junk bonds and lending to companies.  These actions are necessary due to the severe liquidity crisis that would otherwise take place.  In addition, the Federal Government is borrowing trillions of dollars in order to provide support to companies and individuals.  All these actions may be necessary, but what is their long term impact on the value of the dollar?  In the long run, it is possible that this unprecedented expansion of the monetary base will result in additional inflation, reducing the value of the dollar. 

Bitcoin is an asset that has limited supply and the algorithm to mine bitcoins and verify transactions cannot be easily changed.  If there is indeed inflation, it is likely that Bitcoin will continue to rally along with other dollar denominated assets.  Note that bitcoin doesn't really need to serve as a dollar replacement for this case to be valid.  It simply needs to be more stable than lots of other currencies out there which are presently suffering from severe depreciation:

Currency  2014 Apr-20 % Depreciation
Ruble 34 75 -55%
Turkish Lira 2.3 6.46 -64%

Indeed, Paul Tudor Jones just expressed a similar rationale for why he is buying bitcoin, according to Bloomberg.

Bitcoin As a Distributed Consensus Based Settlement Layer

Bitcoin may be the only or one of the only ways to record small amounts of information securely without relying on any one entity to be responsible to maintain the information.  This makes bitcoin in theory an ideal vehicle for settlement of certain types of transactions.  The relationship from this settlement layer activity to a dollar price is not as clear as in the case of inflation based arguments - but at the same time, there is clearly value in such settlements and so some amount of non zero value in mining, owning and using bitcoin for this purpose.

In other words, this argument is for bitcoin to serve as sort of a low level protocol, which can be used to build various solutions for settlement.  OpenTimestamps is one simple example of such a solution.


Phasing Out Mining Rewards Creates Uncertainty

Bitcoin is designed with a fixed supply in mind.  This means that eventually, rewards for mining disappear.  Indeed, halving means that on May 11th, the reward for mining bitcoin gets cut in half.  Instead, as bitcoin usage grows, for example, as settlement layer, or some other way, the transaction fees are supposed to compensate miners for continuing to operate the network.

We can ask, is this actually happening? Do we see any evidence, that as mining rewards shrink, transaction fees are growing to make up for reduced profitability of mining?


We don't see a long term trend in growth in transaction fee revenue, based on this graph.  Of course, full phaseout of mining revenue is many years away, so this chart doesn't mean this growth will not happen.  But at some point, the uncertainty about whether or not it will happen, even many years from now, will weigh on the dollar based present value of bitcoin and low interest rates make events that are far in the future have more weight than they would otherwise in determining the price today.

Bitcoin is A Risk Asset, Not a Clear Hedge

In the COVID-19 based selloff, bitcoin sold off along with other risk assets, such as S&P 500.  It didn't act as a portfolio stabilizer.  It did not rally like Treasury Bonds did.  In theory, other things being equal, this makes the usefulness of bitcoin in portfolios less interesting than cashflow producing assets.


Bitcoin is a fascinating asset and an even more fascinating technology.  It has weathered various crises and price volatility reasonably well so far.  It may or may not have a long term role in portfolios and we tried to present a reasonable case both pro and con.  At Cove Markets, we do not take a view on the value of bitcoin, our mission is to reduce transaction costs to investors such that investors pay as little as physically possible to buy or sell bitcoin.

Cove Logo Get Started