Bitcoin on the brink: What investors need to know

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What is bitcoin and what is its role?

To understand bitcoin, it’s best to avoid conjuring up an image of today’s government-issued and backed (fiat) currencies like US dollars, pounds, euros, or yen. Many fiat currencies were once hard currencies, meaning they were backed by a commodity — generally gold — but governments abandoned the gold standard during the Great Depression. Throughout history, fiat currencies have suffered from periods of mismanagement or excessive money printing, leading to hyperinflation and a loss of purchasing power. Cases of this are particularly common today in developing countries or authoritarian regimes that implement capital controls or even confiscation. Even in the US, soaring government debt relative to GDP, increased money printing, and currency depreciation have become bigger risks.

Instead, thinking about the characteristics of hard currencies may be more helpful. Hard currencies were centrally issued and managed by governments; they were widely accepted means of payment; and importantly, they were scarce and difficult to produce, thus maintaining their purchasing power.

Bitcoin is considered to have many characteristics of hard currencies. Critically, it is scarce and difficult to produce. Unlike a fiat currency, the supply of bitcoin is capped — the preset limit of 21 million bitcoins is expected to be reached around the year 2140. Along with this supply limit, bitcoin’s intrinsic value comes from the security of the underlying blockchain technology (though importantly, cryptocurrencies are not backed by any government guarantee). Blockchain is a public, digital system that records all bitcoin transactions and holdings. So-called miners verify these transactions by solving complex mathematical problems and are rewarded for their work with new bitcoin. This incentivizes miners to maintain the network’s security, ensuring their bitcoins retain value.

A key difference from hard currency is that bitcoin is not centrally issued or managed by any single government or entity. Instead, it is a peer-to-peer decentralized digital asset, meaning that transactions occur directly over the internet between parties without a third party like a bank or other payment service. This is considered a positive as it reduces costs by eliminating intermediaries.

The primary use case for bitcoin is serving as a store of value (its role in paying for goods and services is secondary and inferior today to other forms of payment). It may have advantages over other assets in this respect, including better portability and liquidity than gold and less risk of debasement and inflation than traditional currency. There have been cases of bitcoin being used in the black market, with Silk Road being the most notorious example, but that underground market for illicit activities has been shut down and monitoring has improved.

Why is interest in bitcoin on the rise?

Adoption of bitcoin, generally considered the leading cryptocurrency in the market, has been rising in recent years as market participants have become increasingly confident in its underlying technology and its role as a store of value. Now, interest in bitcoin is getting a big boost from the political environment.

The Trump administration has voiced support for bitcoin and cryptocurrency in general. Investors have welcomed the change, given recent regulatory history in which the SEC and CFTC tussled over which crypto assets fall under their jurisdiction and crypto firms were frustrated as former SEC Chair Gary Gensler relied primarily on enforcement actions to regulate crypto retroactively, rather than proposing rules for comment.

Several policy ideas and initiatives that are on the table with the new administration could provide more support for bitcoin in coming years:

US leadership in bitcoin adoption — The US could take a leadership role in bitcoin adoption and regulation, positioning itself as the primary custodian of a global bitcoin infrastructure. This would allow the US to retain influence over a decentralized asset while supporting the diversification of global reserves in a way that benefits its interests. In an early indication of this leadership, Trump signed an executive order in March to establish a Strategic Bitcoin Reserve using bitcoin owned by the federal government that was seized through criminal or civil proceedings (the order also establishes a Digital Asset Stockpile consisting of digital assets other than bitcoin).

SEC task force — The SEC has formed a new task force “dedicated to developing a comprehensive and clear regulatory framework for crypto assets.” For bitcoin, the regulators are looking to define a market structure where brokers can freely engage and crypto assets can exist alongside digital securities. The SEC’s repeal of SAB 121 in late January, which restricted banks from custodying bitcoin, is an example of the changing landscape. Banks now want more clarity around the requirements for monitoring crypto asset transactions.

Energy sector support — Trump’s efforts to lower energy prices, if successful, should make bitcoin mining more profitable, as electricity is one of the largest operational costs in that process. This could attract more miners to states with excess capacity, further utilizing the available energy and potentially providing economic benefits to those states. There are also state-level initiatives aimed at addressing the energy-intensive nature of bitcoin. In states like Texas, for example, miners can help stabilize the grid by using less energy during peak demand and more energy when demand slumps. In addition, bitcoin mining is being used as a buyer of last resort to make renewable energy production profitable. 

With these policy tailwinds, several US states have proposed legislation to create state-level bitcoin reserves, with some also considering other digital assets. As of this writing, 23 US states have introduced bills supporting the creation of a bitcoin reserve and 18 of them have been passed into law. Retirement systems in Wisconsin and Michigan have also allocated a small percentage of their defined benefit pension plans to bitcoin via ETFs.

What are the potential investment benefits and risks?

For investors thinking about an allocation to bitcoin, it's important to consider both “sides of the coin”:

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Diversification — Bitcoin has had low correlations with traditional assets like stocks and bonds over the long term (Figure 4). Over the last 10 years, for example, it has had an average correlation of 0.14 to the S&P 500 and 0.13 to high-yield bonds. This means that adding bitcoin to a portfolio may help diversify risk and reduce portfolio volatility. That said, correlations can be driven by particular regimes. For example, correlations have increased somewhat recently, likely a result of the introduction of bitcoin ETFs, which have attracted equity investors to the space. We expect greater positive correlations in the near term as bitcoin’s growing adoption attracts risk takers, but we still believe the cryptocurrency will offer diversification potential over the long term.

Inflation hedge — Increased government spending, protectionist policies, a shrinking labor force, and a weaker US dollar are all potential drivers of higher inflation, which can erode equity and bond returns. As discussed earlier, unlike traditional fiat currencies, bitcoin supply is strictly limited, which could make it an attractive store of value in times of rising inflation. It should be noted that bitcoin performed poorly during the 2022 rise in inflation as interest-rate hikes by the Federal Reserve led to risk-off sentiment among investors and the FTX cryptocurrency exchange collapsed in November of that year.

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What are the options for investing in bitcoin?

For asset owners who want to invest in bitcoin or blockchain technology, we think it can help to think in terms of the trends shaping the cryptocurrency space or the specific investment objective:

• Broader adoption of bitcoin: This could be implemented directly via outright bitcoin purchases or bitcoin ETFs, or indirectly via exchanges, payment providers, bitcoin mining companies, or other financial service players.
• Clarity on the regulatory front: For example, once the SEC has issued a market structure framework, large banks may benefit and create investment opportunities.
• Continued innovation in the crypto space: Decentralized finance (DeFi) companies in the private and public space that develop platforms and applications to promote financial services using blockchain technology may be attractive.
• A long-term hedge against currency debasement or fiscal irresponsibility: Similar to gold, direct bitcoin purchases or bitcoin ETFs may play a role.
• Exposure to companies that hold bitcoin as a treasury reserve asset: These companies’ investments in bitcoin are typically based on the belief that bitcoin is a superior store of value compared to fiat currency. In some cases, companies issue debt and equity to finance bitcoin purchases and thus have substantial leverage to the performance of bitcoin.

The bottom line

With clearer and more supportive regulation and a more rules-based framework, we expect bitcoin to become more widely accepted by investors. Bitcoin may have several portfolio merits, including its low correlation to traditional assets, its potential role as a store of value in a period of reckless monetary policy, and its intrinsic value owing to its limited supply, unique technology, and decentralized nature. While bitcoin has withstood several major drawdowns, allocators should still consider that, over the short term, its speculative nature may drive results more than its longer-term features (e.g., store of value and low correlation to risk assets).

¹As of 31 December 2024. US stocks based on S&P 500. PAST INDEX OR THIRD-PARTY PERFORMANCE DOES NOT PREDICT FUTURE RETURNS.