Recently, friends keep asking me why I don't invest in encrypted assets. I'm actually interested in Bitcoin and have worked in the industry for a while, however, I'm not sure what I'm going to do as a full-time crypto investor. Currencies may be an entry point, so unless you think bitcoin is going to crash, the correct trade for a crypto fund is to be long bitcoin, at which point the trade manager needs to answer two questions:

1. How to hold it?

2. How long do you hold it for?

I hold bitcoin in a personal account and consider it a highly speculative option. At the same time, it is also a special asset. For a typical asset allocator, the correct cryptocurrency allocation is close to zero, but not zero.

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1 Bitcoin risk and reliability

Bitcoin is a store of value.

There are many theories about money, but the most comprehensive one is that money is the Schelling point: You see money as money because other people see it as money. Schelling point is the tendency of people to choose without communication in game theory.

Precious metals have been ideal Schelling points for money for most of history. Both gold and silver are difficult to find in large quantities, but when we started finding these metals, we found great ways to measure their mass. The nice thing about precious metals is that everyone knows they have value, but no one has the ability to make more. The problem with that is that if wealth grows faster than the money supply, you have deflation, ie: you can't mint money fast enough to reflect the abundance of goods and services available, and borrowers are at a disadvantage.

If you're worried about market overruns, the traditional hedges are vaults and gold. U.S. Treasuries have outperformed the broader market as a deflationary hedge, and they trade inversely with stocks when inflation is low. Gold outperforms the broader market during periods of high inflation (because it's hard to make more gold) and during deflation (because yields on other assets are crushed and the opportunity cost of owning gold is low).

In the short term, Bitcoin will fit within the framework of gold. Its supply is limited by design; it doesn't generate returns, so its opportunity cost is low when interest rates are low, but the lack of additional supply can cause it to outperform if inflation picks up.

If you were to judge by your history of buying safe-haven assets, you would view gold as the safest safe haven. If you purchased the discussion"Why Gold is a Safe Haven Asset"If you read a theoretical book, you will realize that although Bitcoin is more risky, it is more reliable. Because of the regulatory risk, Bitcoin could be confiscated, but Bitcoin was created with this risk in mind.

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2  Bitcoin valuation and comparison

Bitcoin has many stories, and we only need to focus on its success story without comparisons with other cryptocurrencies and unprofitable tech deals. The benchmarks for Bitcoin should be gold and the U.S. dollar. This may sound like a crazy idea, but in reality the value of Bitcoin is approximately equal to (Gold + USD) * (Odds of Bitcoin becoming the default global savings instrument). The second term in that equation is a small and volatile number, but we ultimately adjust valuations accordingly.

The world's current gold reserves are about 190,000 metric tons at $1,470 per ounce, and the value of gold is about $9 trillion. You could use the Swiss franc or the US dollar as other benchmarks - in one sense the Swiss franc is more comparable because more people are holding it purely, so what they own goes up when everything else goes down. From another perspective, the U.S. dollar is more comparable, because any transaction we make is ultimately settled in U.S. dollars.

But when it comes to the transfer of gold, the comparison becomes more complicated. Because we rarely borrow money in gold these days (although it used to be common; when JPMorgan bought Carnegie Steel, he paid with gold bonds; France issued Guiscard bonds; Turkey issued some bonds too) . It is useful for central banks to hold dollars in response to a shortage of government or corporate borrowers. So it can be said that the dollar is a hedge against certain problems. Gold is a hedge against the unknown.

If it were the norm for companies and countries to lend and borrow bitcoin, then bitcoin would be equivalent to the dollar. But that's just what speculators are doing at this stage, so it's not worth considering. There is a very small possibility that there will be lending based on gold, and then things will be so different that it is not worth speculating about it today.

So, therefore, gold makes sense as an asset that is both similar to bitcoin (little intrinsic use, scarce, relatively easy to transfer) and can be used for what bitcoin does (hedge against extreme changes in asset prices).

In this framework, valuing Bitcoin is straightforward. Not easy, but simple: If you have the desired rate of return, the date you expect Bitcoin to replace gold, and an estimate of the likelihood of that happening, you can easily extrapolate present value. For example, if you consider Bitcoin to have a 1% chance of displacing gold in ten years, its expected future value in 2029 is $90 billion. If you want Bitcoin to have the same historical Sharpe ratio as stocks, and you want stocks to offer returns that are 3% above the risk-free rate (lower than the historical average, but we're being cautious here). Bitcoin’s annual volatility is 50% compared to the S&P’s 10% volatility, so Bitcoin’s annual return needs to be around 18%.

Assuming that the discount rate is 18%, the term is ten years, and the future value is US$90bn, then the current fair value is the fair value of US$17bn. But this result does not take inflation into account. Bitcoin's inflation is fixed, but not zero. Over the next ten years, the outstanding Bitcoin supply will grow by about 16%, so that number shrinks to $15bn. The $15bn price target is a mismatch relative to Bitcoin's current market cap of $1,570bn.

But don't despair!

There are three main levers we can leverage:

1. Maybe the probability of Bitcoin replacing gold is greater than 1%.

2. Maybe our expected return is too high. The 18% expected return is based on the assumption that Bitcoin will remain as volatile over the next ten years as it is now, but highly volatile assets are not compatible with reserve assets. If Bitcoin becomes more of a reserve asset, there will be more buyers and price movements will be more difficult.

3. We will set the minimum bid based on the stock price, but in the long run, Bitcoin will not become the same as the stock. It would be more like an out-of-the-money option on gold.

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3  How Bitcoin Fits in a Portfolio

There is an old cliché - the market has climbed the "wall of worry", which meansWhen everyone is terrified that something bad is going to happen, stockholders are not getting paid every day.

Bitcoin is different: it keeps going up and down the "wall". No one really knows what's going on, everyone is peddling something. People try to value it, but the result is either zero or infinity. Bitcoin is either a Ponzi scheme, a Dunning-Kruggerand, a purely speculative instrument that doesn't even have the luster of gold - or it's gold, only easier to hide, easier to trade and therefore more valuable.

Even in a bull market there are contradictions. There was talk of the progress of Bitcoin development, elegant solutions to long-standing CS problems, the brilliant minds of Satoshi Nakamoto and the core developers. Others speak of it as a high-volatility store of value that you buy when you think the price of everything other than the money supply is falling.

So, is this part of the Transhuman stock, or is it the Swiss franc? There is a difference between them.

Specifically, there is a difference between being an ultra-optimistic technical instrument versus a bearish emergency asset in the context of a portfolio. If you hold too much risk capital,So which Bitcoin position offsets this risk – long or short?

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4 Why It’s Difficult To Decide Whether Bitcoin Is A Risk Or A Safe Haven

First, let's take a step back: what do we mean by risk aversion and risk appetite? After the financial crisis, I started hearing this term a lot. If you look at the 10-year chart of the S&P, you see a steady progression with some volatility, but in the first few years after the crisis, each volatility was enough to be scary.

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Source: Business Insider, The Scariest Jobs Chart Ever

We've also had ongoing balance sheet impacts, particularly in Europe. "Black swan" insurance is painfully expensive. As Mike Green said in an interview not too long ago:

So, in the post-crisis period, the only question that matters is: Has this bottomed out? If we bottom out, buy anything that is good for the global economic recovery: cheap EM stocks, high yield bonds, Aussie, copper, oil. It makes sense to sell any risky hedging asset, such as T-bonds, yen, dollars, Swiss francs, or gold.

This is somewhat ironic, as "risky" trade assumes the world has recoupled, and the crisis is an accidental event in this long-term trend. In boom times, when rich world valuations are stretched, investors look to riskier venues and asset classes. When the results aren't great, they go back to investing in what they know; German banks bought a lot of sub-CDOs in the mid-2000s, learned their lesson, bought Bunds again, and invested in small and medium-sized Business lending.

In a world of healthy competition and risk-taking, disputes are mediated through markets.China competes with Europe and the United States for raw materials through competitive bidding. Risk-off moves often involve higher price correlations, to the extent that owners of leveraged assets must sell everything at once. But in a real world of adventure, the underlying relevance changes: Japan is an ally of the US, while Switzerland is basically a giant mountain city with a high rate of gun ownership. But the yen and Swiss franc both rose 1 percent amid falling U.S. unemployment.

The risk assets are all the same, but the properties of the safe assets differ because their characteristic properties depend on their idiosyncrasies. There are two types of assets:

1. Assets that vary to accommodate broad risk appetites. Because leveraged investors are either borrowing or shorting: dollars, yen, treasuries (if you own risky debt and want to hedge your interest rate risk, you will be shorting them directly or indirectly).

2. These assets perform better in certain catastrophic situations, such as financial crises, major wars, epidemics, major trade disruptions, or oil crises. Crucially, backtesting of these assets ignores important distribution components. Something like gold or bitcoin would be worth a lot if fiat currencies collapsed (although if the crash severely disrupted the internet, bitcoin would also be worth significantly less). A recession triggered by an oil shortage would have made the dollar an extreme risk asset ten years ago, as the US was a major importer of oil; today, it would be a safe haven asset, and today, the dollar is a safe haven assets, because the United States is not dependent on oil and has a relatively diversified economy with a large number of internal sources of demand. China may have made a similar shift: a decade ago, a global crisis would have been an opportunity for them to expand their sphere of influence and win concessions from their neighbors; today, China is highly leveraged, has risky demographics, and is highly dependent on trade.

If you asked to run a simple optimization algorithm based on historical returns and the volatility of your portfolio, the algorithm would favor very risky assets and very low risk assets as a portfolio, with less money allocated to other assets rare. In practice, portfolio managers separate high-risk and low-risk categories, but end up following essentially the same design. In an economy where the flow of goods and money is globalized, such a portfolio would have different outcomes during economic booms and economic downturns.

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5 Bitcoin vs. other risky assets

To more accurately classify Bitcoin as a risk-on or safe-haven asset, I compared it to a handful of other assets. In a basket of risky assets, major indices include (S&P 500, Nasdaq 100, Shanghai Composite, Nikkei) as well as other assets that track macroeconomic performance (AUD, USD, oil).

When we traced the rolling 30-day correlation between Bitcoin and risk assets, we found no connection…

In the safe-haven asset analogy, we used the same approach.

The correlation is also zero.

There are several angles to look at this problem:

1. The price of Bitcoin is completely random and has nothing to do with hedging; it is pure gambling.

2. Bitcoin returns are driven by factors that do not directly affect other instruments, such as the need for money laundering. I tested this a while ago by looking at other ways of laundering money, but didn't find anything meaningful - Bitcoin price didn't correlate to either Macau gaming revenue or Vancouver housing prices.

3. Bitcoin is not correlated with trading in either high-risk or safe-haven assets because it embodies the nature of both.In this model, it should trade like a small mining company: a highly variable bet whose payoff is an exceptionally stable asset.

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6 The Future Direction of Bitcoin

The way bitcoin works is this: asset allocators buy small amounts of bitcoin when they think it's a safe asset. This has three effects: it raises the price significantly; it reduces volatility as asset allocators rebalance their holdings, which means they are shorting the market; and it makes Bitcoin more likely to be a safe-haven assets.

this happened againSchelling point. If every major asset allocator believes that 0.1% is the ideal weight for Bitcoin, then the ideal weight must be higher than 0.1%, so they will gradually increase and continue until they reach equilibrium. As Bitcoin’s probability of acceptance as a reserve asset increases, its volatility also decreases.

You can plot Bitcoin's hypothetical valuation like this:

I've shown many possibilities, but I've highlighted the only reasonable way:certainly,

certainly,Regulatory risk increases as Bitcoin value rises. Most governments like to have monetary sovereignty. If they want to change it, it's because they want more. Therefore, the higher the price of Bitcoin, the greater the government's concern may be.

When the government bans it, it's because they realize it's a problem, but it's an unregulated network, and it's growing a lot faster than the government. If they banned bitcoin because it was used for drugs and child pornography (and it still is!), it would probably kill bitcoin, but its main use right now is speculation, so the only reason why governments are gradually supporting banning bitcoin is, Bitcoin seems likely to succeed.

But if investors truly believe that Bitcoin is a good asset, then a ban will be unsustainable, and any government that issues a ban is implicitly saying that in a world where Bitcoin is commonly used, its national currency is worse assets. Even the most powerful U.S. government in history could only ban gold for more than one era, and it was relatively easy to confiscate.

We can consider a series of overlapping curves: the probability that the smartest minds think bitcoin will displace gold, the probability that asset allocators think this event is, and the probability that the government thinks this event is.

In each case, the expected probability is based on the price of Bitcoin, but as long as your model accepts that the government is not wise, you can buy safely in the face of ban. (At least, it's not a ban that affects only you personally.)

It's a nerve-wracking approach, but it's a useful framework:When Bitcoin’s price is trending up and its volatility is trending down, its intrinsic value goes up.

Note: PayPal has been authorized by the author to translate, and the article and title have been slightly changed.

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