This is a question that comes up from time to time. Let’s look at Bitcoin from three ways: first as an investment. second as a way to generate speculative returns, and third as a hedge or option that will payoff if we end up with substantial inflation or dollar weakness. Think of the last category as a big financial disruption caused by excess US debt and central bank intervention. Hopefully, it is a very unlikely event.

Is Bitcoin a Good Investment?

First, let me present a few of the arguments against owning Bitcoin as an investment. Warren Buffet is on record say Cryptocurrencies ‘have no value and they don’t produce anything’. CNBC Interview here. Buffet said, ‘I don’t have any cryptocurrency and I never will’. In prior comments he has called them ‘a mirage’ and ‘not a currency’.

Buffet is using both valuation and currency metrics to evaluate cryptocurrencies. He has also said previously about gold that it also doesn’t produce anything. He is squarely focused on buying companies that produce goods and services at reasonable valuation. Bitcoin doesn’t fit the strategy.

In November, Jesse Felder, a former hedge fund manager, penned a post for why he believes Bitcoin is neither an investment nor a currency. He argued based on Ben Graham’s measure of an investment as being ‘safety of principle’ and ‘a source of return’. He argues that it doesn’t have a good track record as a digital currency as it has been hacked, it has been forked (more units were created) and it isn’t widely used as a medium of exchange. He argues that fiat currencies are backed by governments (and I would add with taxing authority) and since there is no such backing for Bitcoin any future technology improvement could replace it. All very powerful arguments.

This issue of technology is a vexing problem. In the late 90’s, when I was with Intel Capital, we were investing in early technologies to help accelerate adoption of internet based commerce (e-commerce). We invested in a range of companies developing platform security, public key infrastructure (PKI) and even early online currency. We invested in a company that went public in 1997 called CyberCash. The online wallet to enable credit cards online didn’t gain traction and the company went bankrupt in 2001. Arguably, Bitcoin has substantially larger acceptance, but Bitcoin is just 11 years old and is a very nascent technology. I have no doubt the technology will improve orders of magnitude from here, but which technology will win is by no means easy to predict.

Bitcoin for Speculative Return

Assume Bitcoin does not fit the definition of a traditional investment. Would it be possible to purchase Bitcoin and generate returns? Well, in a case like this we would have to assume someone will buy it from us later at a higher price. One argument for Bitcoin for it’s speculative return may sound like this, ‘the number of bitcoins is limited, more and more people are using it… demand would seem to be going up. Therefore, since it is a scare item with likely increasing demand, we may speculate the price will be higher tomorrow’.

Paul Tudor Jones, a billionaire Hedge Fund Manager, noted in a Yahoo! Interview in December:

“In a world where you’ve got $90 trillion worth of equity market cap and God knows how many trillions of fiat currency, etcetera…it’s the wrong market cap, for instance, relative to gold, which is $8 or $9 trillion,” Jones said in an exclusive interview.

“I’m going to assume that it’s the wrong price for the possibilities that it has. And I’m going to assume that the path forward from here is north,” he added.

This argument is one primarily focused on the speculative value of Bitcoin. Now to be fair, Tudor Jones has also said that he feels Bitcoin is becoming a store of wealth and may be thought of as an inflation hedge against monetary expansion and debut. So, his arguments include both speculative and hedging viewpoints.

Bitcoin as an Option in the Event of Major Financial Disruption

The final way to look at bitcoin would be as insurance against some significant financial disruption. In this camp we find people like Chamath Palihapitiya, former Facebook Executive, and more recently Ray Dalio, hedge fund manager.

Chamath has been talking about Bitcoin since 2013. In this recent interview, he talks about bitcoin going to $100,000 – $150,000 – $200,000.  He argues that bitcoin is ‘insurance’ against excess leverage and financial dislocation and could be a non-correlated hedge compared with other investments. He says everyone should invest 1% of their assets in Bitcoin.

Ray Dalio recently said, “Bitcoin looks like a long-duration option on a highly unknown future that I could put an amount of money in that I wouldn’t mind losing about 80% of.” Ray has recently been discussing alternatives to cash as a store of wealth. He has talked about the need to deal with the ‘devaluation of money and credit’.

We can stitch the two ideas of Chamath and Ray together. Here we have the potential for Bitcoin as a speculative insurance policy against some sort of largescale financial disruption in the US dollar or financial markets.

How would this look? Let’s say there is some 10% chance that within 20 years, the US debt results in either high inflation or a large drop in the US dollar or both. In this case, one might speculate that a cryptocurrency could provide ‘insurance’ for such a risk.

Normally, when we think of insurance, we think of a small premium that would protect us in an unlikely event. The idea here would be that you could take 1-2% of your wealth and insure against some major problem in the US dollar or the workings of the US government.

How Would This Work?

Say we want to protect a portfolio worth $1,000,000. We might buy 1% of that in Bitcoin or $10,000. Now, let’s say there are only two outcomes. Say there is a 90% chance Bitcoin fails to achieve long term success 20 years out and becomes worthless. Now say there is a 10% chance that the US dollar value drops 50% and massive amount of wealth floods into demand for Bitcoin. So, in 20 years in this scenario maybe Bitcoin goes to $1,000,000. That would be 20X from the current ~$50,000 price. In this scenario, purchasing Bitcoin is ‘insurance’ or a type of ‘put option’ in the event we get some kind of large financial disruption in the US. In this case, the $10,000 investment would be worth ~$200,000 and the remaining investments would be worth $500,000 (in the devalued dollar). At least in principle, this is how an option could work. To be clear, these numbers are completely hypothetical and extremely difficult to forecast. Consider this an illustrative example of how such a hedge would play out.

Conclusion

Based on the current volatility and short life of Bitcoin, I would say that it cannot be considered an investment. For the most part, even the ones advocating for Bitcoin are not arguing it is a good investment.

It certainly could be considered speculative purchase. For me personally, I just don’t put much focus on speculating. I find the economic rationale of owning a business (through stocks) to be a more compelling value proposition. For those with substantial wealth who could afford to lose their entire investment in Bitcoin but still live comfortably, a small purchase for enjoyment probably wouldn’t be catastrophic.

Finally, I think the idea of an insurance policy or ‘put’ against a major disruption to the dollar or high inflation is intriguing. For now, I just don’t see the insurance as being ‘safe’ insurance. The idea for insurance is that we have someone who will back the policy if the house burns down. In this case, we don’t know for sure which technology will win. The US banned owning gold for a period. It is very possible that the US could ban Bitcoin on the grounds of national security for tracking flow of funds and terrorists. So, in the end, I see the ‘put’ option not as safe insurance put highly speculative insurance that maybe pays off or maybe not.

For this reason, I don’t own Bitcoin today. Could circumstances change? Yes. Again, for those who have substantial wealth and are significantly concerned about the US government’s ability to back the US dollar, a small investment in cryptocurrency that doesn’t put retirement at risk wouldn’t be terrible. But think ahead. As new cryptocurrencies are developed what would you do then? Buy all? Pick one? Once you start down the path, where does it lead? It is interesting to point out that many of the ‘experts’ who are promoting Bitcoin are people with very substantial wealth. Most of them are billionaires. Wealth so large that losing $100 Million on Bitcoin will not hurt their retirement.