Gadfly

What Leonardo Tells You About Bitcoin

You could easily add another $400 billion to the current $300 billion cryptocurrencies market cap.
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Photographer: antoniokhr/Getty Images

How high can bitcoin go?

Since the digital currency cleared $7,000 earlier this month, an asset known for its wild swings has gone ballistic. On Monday morning, just over a week after it smashed through the $8,000 barrier, it surged past $9,000. As this column was published, Bitcoin was only $300 short of $10,000.

Such behavior seems deeply irrational -- but those inclined to dismiss it and bet on an inevitable decline must contend with the fact that human beings are deeply irrational.

Take the $450 million paid for Leonardo da Vinci's Salvator Mundi earlier this month. The best explanation for that record-busting price -- enough to buy a gallery-full of Velasquez paintings -- is to look at it as a function of scarcity value. Only two or three paintings generally accepted to be by the Italian Renaissance master are in private hands. With about $45 billion a year being spent on art worldwide in 2016, it's not inconceivable such a unique piece might swallow up one percent of the market.

In asking how high digital currencies could go, it's worth thinking about them in similar terms. Even after its extraordinary growth, the market for bitcoin and its ilk is minute. As a result, relatively small net flows of funds away from conventional investments and into cryptocurrencies can have outsized impacts on prices.

At present, the value of all digital currencies is about $300 billion, according to coinmarketcap.com. That compares with $6 trillion of global gold holdings, $55 trillion in equities, $94 trillion in securitized debt and $162 trillion in residential real estate, according to a 2016 report by real estate agency Savills Plc.

Gold provides an instructive lesson here. The value of all the yellow metal ever mined comes to about $7.76 trillion at current prices, 1  and just $1.66 trillion of that is held for private investment purposes. Falling interest rates and the widening ease of investment via ETFs in the wake of the 2008 financial crisis helped drive prices up from $641 a troy ounce at the start of 2007 to a peak of $1,900 an ounce in September 2011.

In absolute price terms that sounds dramatic. But when you set the stock of available investment gold against the size of equity and debt markets, the rebalancing involved was relatively slight -- equivalent to a shift of about 1 percent in the world's stock and bond portfolios. 2

A similar dynamic can be perceived in relation to cryptocurrencies. Until 2009 they didn't exist, and to date they've been pretty difficult to buy and hold, let alone trade. Getting that exposure will become considerably easier within weeks, as CBOE Global Markets Inc. and CME Group Inc. look to establish futures and options linked to bitcoin. Even noted skeptics like JPMorgan Chase & Co. are reported to be exploring ways to facilitate client trades in the derivatives. Once the barriers to investment start to fall and any schmo can take a punt via their Charles Schwab account, don't be surprised to see digital-currency prices go higher, at least temporarily.

Just how high? Trying to guess such a thing is pointless in relation to any idea of fundamentals, but the ballpark figures you could back out from funds flows are eye-wateringly large. If the current vogue for bitcoin is just a quarter as powerful as the 2007-2011 run-up in gold, you could easily add another $400 billion to the current $300 billion crypto market cap. 3

Alternatively, you could place the $300 billion in digital currencies next to the $1.66 trillion of investment gold holdings to produce a portfolio of purportedly negative-beta assets. 4  At present, crypto has about 15 percent of that notional global portfolio. Should it rise to 20 percent of the total, the value would climb almost a third, to $392 billion; at 25 percent, you reach $490 billion. Shifts between bitcoin and its rivals in the digital-currency space could further accentuate those movements.

It's equally possible that the crypto market cap falls to $200 billion, or $100 billion, or less -- but while individual digital currencies may well go to zero just as individual stocks do, at this point it's becoming hard to argue the asset class as a whole will go permanently out of fashion (barring extraordinarily coordinated global government action to prohibit it).

That's because people bid up the price of bitcoin for the same reason they flock to the best-performing mutual funds -- they make the rookie error of assuming past performance is a guarantee of future returns. That motivation may be irrational, but it's as old as investing. Trying to reason with it is as fruitless as asking the wind not to blow.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. That number differs from Savills' estimate of $6 trillion, but gold prices have risen about 22 percent since the end of 2015, accounting for most of the difference.

  2. You get a somewhat larger shift when you add in the value of central bank bullion reserves, jewelry, and commercial stocks used for medical and electronic uses -- but most of those are less responsive to movements in investor demand. Not many people sell their heirlooms and wedding rings simply because spot gold is trading high.

  3. Calculate the 2007-2011 run-up in gold prices in relation to total above-ground stocks and that number rises to $1.88 trillion, but we've assumed in the previous footnote that investment gold alone is the better comparator.

  4. Gadfly has doubts about whether bitcoin really does have negative beta, but that's a topic for another column.

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