I’m an economist who invests in Bitcoin as insurance against the dollar

Wolfgang Münchau is a columnist for DL News. He is co-founder and director of Eurointelligence, and writes a column on European affairs for the New Statesman. Opinions are his own.

Trying to put a fair value on Bitcoin easily lands you in a doom loop of circular logic with the capacity to drive you mad.

The difficulty is that both the classic definitions of money and of asset value cannot easily be transferred to crypto.

Your average macroeconomist, for example, would put the fair value of a Bitcoin at exactly zero because cryptocurrencies do not carry value in the way that economists define it.

So here is my attempt to escape this doom loop.

‘You should worry about a bubble’

If you think of Bitcoin as a modern asset class, scarce by design, and sought after for that reason, I would say yes, you should worry about a bubble.

If you only care about the dollar return of your investment, you may still find Bitcoin an attractive investment, but you need to have an extreme tolerance towards volatility.

‘A greedy fool with an electronic wallet is still a fool’

We should remember that a bubble is not intrinsically a financial phenomenon, but a psychological one.

In that specific respect, Bitcoin investment is no different from any other.

You may buy because the price is rising, and the price is rising because you are buying. It is the financial equivalent of famous for being famous.

It is how bubbles form — and it does not matter whether the asset class is tulips in 17th century Netherlands, or Bitcoin. A greedy fool with an electronic wallet is still a fool.

During the dotcom bubble at the beginning of the century, people used to say: this time is different. Now they say: Bitcoin is different.

This is both true and irrelevant because sentiment that drives the price is the same.

It is naïve to think that the arrival of spot Bitcoin exchange-traded funds would lead to higher permanent inflows and support the price.

When it becomes easier to move into an asset, it also becomes easier to move out again. In the long run, the effects will cancel.

The halving — an event that happens every fourth year and that cuts rewards miners get for maintaining the blockchain, effectively cutting the supply of new Bitcoins hitting the market — may also lead to higher demand and rising prices.

But this predictable event cannot have permanent effects on prices.

‘I am not a conspiracy theorist’

Also beware of statistical fallacies.

The Bitcoin price does indeed correlate imperfectly with token velocity and the stake ratio, but that does not tell us anything about causality. What causes what?

Remember, the value of a Bitcoin should in theory have gone up when inflation hit the West in 2022. The exact opposite happened.

But that does not settle the issue. It is all about why you are buying.

I personally do not treat Bitcoin as a financial investment but as a financial options contract — one that insures the holders against debasement, financial repression, confiscation and transaction barriers.

In other words: an option contract that gives me the right to transact when everything goes pear-shaped in the world.

I am not a conspiracy theorist. This is absolutely not my baseline scenario, but it is a scenario that carries a sufficiently high probability that I take seriously as a reasonable tail risk.

If you attach a low, but non-trivial probability to such an outcome as I do, then it would make sense to hold a proportion of your wealth in a crypto asset that would keep you transactionally afloat.

But it makes no sense for someone in that category to buy Bitcoin ETFs, which are dollar-based investment vehicles.

Car insurance is also not an investment. Options that are not in the money expire — and that’s that. You don’t get your car insurance premium back when you don’t have an accident.

These considerations both determine the value, but also limit it.

You would surely not pay more money for a put option for a stock that cannot fall below zero than the price of the stock itself. Insurance against tail risks makes sense, but not any price.

I still struggle to place a dollar value on this contract for the obvious reason that it is the debasement of the dollar we are insuring against.

I am reminded of a joke that made the rounds during the global financial crisis about credit default swaps, the instrument with which investors placed large bets on defaults in the credit market.

The joke was that a CDS was the equivalent of an insurance contract you bought from someone on the Titanic to protect yourself against the sinking of the Titanic.

‘You could compare Bitcoin to gold’

If you fear dollar debasement, the last thing you would want to do is hold Bitcoins in a dollar ETF or a stablecoins.

To place a fair value on it, you will have to take the dollar out of the equation — literally.

You could compare Bitcoin to gold for example. I saw a calculation that the total value of all known gold reserves is about $18 trillion.

The total value of Bitcoin — at $70,000 per coin — was less than 8% of that.

Here we can safely use the dollar as a denominator, since we are doing it for both gold and Bitcoin — and it cancels out.

‘Nothing special about Bitcoin’

You could infer from this that the fair value of a Bitcoin is approximately 12 times higher than it is today because that would be the value at which one unit of the total supply of gold would buy the equivalent of the same unit of the total money supply of Bitcoin — in some dystopian world where that would be the entire money supply.

The trouble is that we are not comparing like with like.

Gold is still a physical asset. Even if no one will ever use it for monetary transactions, gold still has physical uses — in electronics, or dentistry and in engineering.

That would tip the balance in favour of gold. What redresses the balance massively in favour of Bitcoin is that you can actually transact with Bitcoin.

For gold to work as a transaction currency would require the issue of a gold-backed transaction currency.

That’s not going to be so easy to do. What also speaks in favour of Bitcoin is that the total supply is capped at 21 million.

We are not going to find any in a pirate’s treasure chest, or another planet. This is why, for me, it is not a bubble. But it may be for you.

Oscar Wilde’s definition of a fool was someone who knew the price of everything and the value of nothing. This indeed is the test.

If Bitcoin still has value to you if the dollar collapses, then you are a true Bitcoin value investor. If it is dollar returns you are after, then bubbles matter.

There is nothing special about Bitcoin. You may be the lucky person who sells the tulip before the peak. Or you might be that other person.