BlackRock on Bitcoin: Risk and Return Drivers Are Completely Different from Traditional Assets

Original authors: Samara Cohen, Robert Mitchnick, Russell Brownback, Blackrock

Original compilation: 1912212.eth, Foresight News

Bitcoin has undergone a tumultuous journey over the past 15 years since its inception, from being relatively unknown to becoming an asset increasingly held by individuals and institutions worldwide.

We believe that Bitcoin, as a global, decentralized, and fixed-supply non-sovereign asset, has risk and return drivers that are fundamentally different from traditional asset classes and are fundamentally uncorrelated in the long term. Even when short-term market trading behavior occasionally (and in some cases profoundly) deviates from Bitcoin's fundamentals, we maintain this belief.

On August 5, 2024, while the S&P 500 index fell by 3%, Bitcoin also experienced a 7% single-day drop as global markets underwent a sharp correction due to yen carry trade unwinding. This event coincided with a series of long-pending bankruptcy distributions and liquidations (such as Genesis, Mt. Gox), which had unfolded in the previous three days. Subsequently, the liquidity scramble caused by the global market sell-off further exacerbated the situation.

During these occasional periods of short-term negative correlation with the stock market, Bitcoin's price typically rebounds and returns to pre-sell-off levels within three days. We view this pattern as an example of fundamentals ultimately prevailing over short-term leveraged trading reactions. As Warren Buffett said, the stock market is a mechanism for transferring money from the impatient to the patient. This insight often holds true throughout Bitcoin's entire history.

Key Points

1. Given Bitcoin's unique attributes and history, investors considering Bitcoin investments are striving to study how to compare and analyze it with traditional financial assets.

2. Bitcoin is clearly a high-risk asset due to its high volatility. However, most of the risks and potential return drivers that Bitcoin faces are fundamentally different from those of traditional high-risk assets, making it unsuitable for most traditional financial frameworks—including the risk asset versus safe-haven asset frameworks used by some macro commentators.

3. As a scarce, non-sovereign, decentralized global asset, Bitcoin is viewed by some investors as a safe-haven option during market panic and certain geopolitical turmoil events.

4. In the long term, Bitcoin's adoption trajectory may be driven by the intensity of concerns over global monetary stability, geopolitical stability, U.S. fiscal sustainability, and U.S. political stability. This contrasts with the general relationship that traditional risk assets have with these forces.

Introduction

Is Bitcoin a risk asset or a safe-haven asset? This is one of the most common questions our clients ask when considering their first investment in Bitcoin. They want to know the long-term correlation of Bitcoin with stocks and bonds, and how it is affected by U.S. real interest rates or liquidity.

We believe the answer lies in Bitcoin's unique nature, which makes it unsuitable for most other traditional financial frameworks. The long-term return drivers of Bitcoin are fundamentally uncorrelated with other sources of portfolio returns, and in some cases, even opposite. Over the long term, we believe that the drivers of Bitcoin's adoption may differ from, or even oppose, the global macro factors that drive most traditional financial assets. While Bitcoin is volatile and has had brief correlations with stocks (especially during periods of extreme market volatility), in this paper, we attempt to explain this dynamic.

Why Bitcoin Matters

First, we need to understand the fundamental reasons why Bitcoin is important. Since its inception in 2009, Bitcoin has become the first internet-native currency tool to achieve widespread global adoption. Its technological innovation lies in creating a digital-native, globally usable, scarce, decentralized, and permissionless form of currency. Due to these characteristics, Bitcoin has made significant breakthroughs in addressing issues that have long plagued other forms of currency for centuries:

1) Bitcoin's supply is capped at 21 million coins, meaning it cannot be easily devalued.

2) Its global and digital-native characteristics mean it can be transferred almost in real-time at near-zero cost globally, overcoming the friction inherent in transferring value across political boundaries for a long time.

3) Its decentralized and permissionless nature makes it the world's first truly open-access monetary system.

Despite the emergence of other cryptocurrencies since Bitcoin's original breakthrough, many of which pursue broader use cases, Bitcoin has established itself as the most prominent asset in the field, gaining recognition worldwide. This has given Bitcoin a unique position in the cryptocurrency space, becoming a global currency alternative and an asset with credible scarcity.

Path to Bitcoin's Market Cap Reaching $1 Trillion

Despite Bitcoin's significant price increase and widespread adoption globally, its ultimate development into a widely accepted store of value and/or global payment asset remains uncertain, and Bitcoin's ever-changing market value reflects this uncertainty.

Over the past decade, Bitcoin has outperformed all major asset classes for seven years, resulting in an annualized return exceeding 100%, which is remarkable. However, during this decade, Bitcoin also had three years of poor performance, experiencing four drawdowns of over 50%. Nevertheless, throughout these historical cycles, Bitcoin has demonstrated the ability to recover from drawdowns and reach new highs, even though these bear market cycles lasted longer.

These price fluctuations continue to reflect, to some extent, the evolving prospects of Bitcoin being widely adopted as a global currency alternative over time.

"Macro Variable Uncorrelated" Asset

Bitcoin has little fundamental correlation with other macro variables, which is why its long-term average correlation with stocks and other risk assets is low. While in the short term, Bitcoin's correlation can spike sharply, especially during periods of sudden changes in U.S. real interest rates or liquidity, this is essentially short-term and does not create a clear long-term statistically significant correlation.

As the first decentralized, non-sovereign currency alternative to achieve widespread global adoption, Bitcoin does not carry traditional counterparty risk, does not rely on any central system, and is not affected by the fate of any single country. These characteristics fundamentally decouple Bitcoin from certain key macro risk factors (including banking system crises, sovereign debt crises, currency devaluation, geopolitical turmoil, and other country-specific political and economic risks). Over the long term, Bitcoin's adoption trajectory may be influenced by the rising or falling concerns over global monetary instability, geopolitical discord, U.S. fiscal sustainability, and U.S. political stability.

Due to these characteristics, Bitcoin has been viewed by some investors as a safe-haven asset during some of the most disruptive events globally over the past five years. Notably, during these events, Bitcoin sometimes initially experiences a brief negative reaction before rebounding. We believe that these short-term trading reactions, which are difficult to explain by fundamentals, can be attributed to the following factors:

1. Bitcoin trades 24/7 and can be settled almost instantly for cash, making it a highly sellable asset during periods of liquidity stress in traditional markets, especially on weekends.

2. The Bitcoin and cryptocurrency markets are still immature, and investors have insufficient understanding of Bitcoin.

In most cases, including the recent global market sell-off event on August 5, 2024, Bitcoin has recovered to previous levels within days or weeks and, in many cases, has further increased as people begin to recognize that the positive impact of these disruptive events on Bitcoin's fundamentals has taken precedence.

U.S. Debt Dynamics Back in Focus

Based on this, growing concerns domestically and internationally regarding the federal deficit and debt situation have increased the appeal of potential alternative reserve assets as a hedge against future events that may impact the dollar. This dynamic seems to be occurring in other heavily indebted countries as well. Based on our experiences communicating with clients so far, this explains much of the recent surge in institutional interest in Bitcoin.

Bitcoin Remains a Risk Asset

The previous analysis does not negate the fact that Bitcoin itself remains a high-risk asset. It is an emerging technology that is still in the early adoption phase on its path to potentially becoming a global payment asset and store of value. Bitcoin has also remained volatile and faces numerous risks, including regulatory challenges, uncertainty in its adoption path, and an immature ecosystem.

However, the key point is that these risks are unique to Bitcoin and not shared by other traditional investment assets. Therefore, Bitcoin is a particularly strong case for why simple risk asset versus safe-haven asset frameworks may lack the nuanced consideration necessary for broad applicability.

From a portfolio perspective, this is why holding a certain position in Bitcoin can provide diversification benefits, while larger positions can begin to exert excessive influence on increasing portfolio risk due to its independent high volatility.

Conclusion

While Bitcoin may sometimes move in tandem with stocks and other risk assets in the short term, its fundamental drivers are fundamentally different from those of most traditional investment assets in the long term, and in many cases, even opposite.

As the global investment community faces increasing geopolitical tensions, concerns over U.S. debt and deficit situations, and rising political instability worldwide, Bitcoin may be viewed as an increasingly unique diversification investment to hedge against the fiscal, monetary, and geopolitical risk factors that investors may face.