CRYPTO: A NEW ASSET CLASS?
ISSUE 98| May 21, 2021| 6:00 PM EDT
—’’’’’T’’’’’
’’’’ ’ ’ ’ ’
Global Macro
Research
Investors should consider this report as only a single factor in making their investment decision. For
Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to
The Goldman Sachs Group, Inc.
With cryptocurrency prices remaining extremely volatile even as interest in cryptos
from credible investors has been rising, and legacy financial institutions—including
ourselves—have been launching new crypto products and services, crypto is
undoubtedly Top of Mind. Amid the recent volatility, we ask experts whether cryptos
can and should be considered an institutional asset class, including Galaxy’s
Michael Novogratz (Yes; the mere fact that a critical mass of credible investors is
engaging with cryptos has cemented this), NYU’s Nouriel Roubini (No; cryptos have
no income, utility or relationship with economic fundamentals), Grayscale’s Michael
Sonnenshein (Yes; their strong rebound in 2020 reassured investors about their
resiliency as an asset class), and GS’s own Mathew McDermott (clients increasingly say “yes”). And GS research
analysts also weigh in. We then speak to former SEC advisor Alan Cohen, Trail of Bits’ Dan Guido, and Chainalysis’
Michael Gronager to explore the regulatory, technological, and security obstacles to further institutional adoption.
Bitcoin and other cryptocurrencies aren’t assets. Assets
have some cash flow or utility that can be used to
determine their fundamental value... Bitcoin and other
cryptocurrencies have no income or utility.
- Nouriel Roubini
“We’ve now hit a critical mass of institutional engagement [in crypto]. Everyone from the major banks to PayPal and Square is getting more involved, which is a
loud and clear signal that crypto is now an official asset
class.
- Michael Novogratz
“
INTERVIEWS WITH:
Michael Novogratz, Co-founder and CEO, Galaxy Digital Holdings
Nouriel Roubini, Professor of Economics, New York University Stern
School of Business
Michael Sonnenshein, CEO, Grayscale Investments
Mathew McDermott, Global Head of Digital Assets, Goldman Sachs
Alan Cohen, former Senior Policy Advisor, US Securities and
Exchange Commission
Dan Guido, Co-founder and CEO, Trail of Bits
Michael Gronager, Co-founder and CEO, Chainalysis
BITCOIN AS A MACRO ASSET
Zach Pandl, GS Markets Research
CRYPTO IS ITS OWN CLASS OF ASSET
Jeff Currie, GS Commodities Research
WHAT IS A DIGITAL STORE OF VALUE?
Mikhail Sprogis and Jeff Currie, GS Commodities Research
THE ROLE OF CRYPTO IN BALANCED PORTFOLIOS
Christian Mueller-Glissmann, GS Multi-Asset Strategy Research
WHAT’S INSIDE
of
Allison Nathan | @
...AND MORE
I have yet to find somebody who has really done their
homework on crypto assets that isn’t truly amazed by the
potential for the asset class.
- Michael Sonnenshein
TOP
MIND
Jenny Grimberg | @ Gabriel Lipton Galbraith | @
Note: The following is a redacted version of the original report published May 21, 2021 [41 pgs].
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Goldman Sachs Global Investment Research 2
Top of Mind Issue 98
Macro news and views
US Japan
Latest GS proprietary datapoints/major changes in views
• We now expect core PCE inflation to peak at % in May and
fall to % by year-end 2021 after the strong April CPI print.
Datapoints/trends we’re focused on
• Taper timeline; we think the Fed will only start to hint at tapering
in 2H21 and begin to taper in early 2022.
• Fed liftoff; if our taper timeline is right, then liftoff will probably
not be on the table for about two years.
• Unemployment; we expect a somewhat less front-loaded jobs
recovery, but still see unemployment at 4% by year-end 2021.
Latest GS proprietary datapoints/major changes in views
• We lowered our 2Q21 and CY21 real GDP growth forecasts to
% qoq ann. and %, respectively, after the imposition of a
third state of emergency, and see a more back-loaded recovery.
Datapoints/trends we’re focused on
• Pent-up demand, which should boost spending by ¥
(1% of consumption) and ¥ (%) in the first and
second years after reopening, respectively.
• Fiscal policy; additional support is a possibility.
• BoJ policy; we expect the status quo in policy to remain for a
long time with little impact from the inflation outlook.
Pandemic distortions to core inflation should peak soon
Core PCE and contributions to its 2020-22 deviation from trend
Third state of emergency delays recovery
Aggregate mobility index, index (1/3-2/6/2020 =100)
Source: Department of Commerce, Haver Analytics, Goldman Sachs GIR. Source: Google LLC "Google COVID-19 Community Mobility Reports";
Accessed: 5/20/21. Goldman Sachs GIR.
Europe Emerging Markets (EM)
Latest GS proprietary datapoints/major changes in views
• We raised our 2021 UK GDP forecast to % based on upward
revisions to GDP and stronger growth momentum.
Datapoints/trends we’re focused on
• Euro area lockdowns, which should continue to loosen ahead of
a summer reopening, supporting a growth surge.
• Tourism season; delaying int’l travel into early August would
reduce av. growth in Southern Europe by pp in Q2/Q3.
• Vaccine pace, which has more than doubled since March, putting
the Euro area on track to vaccinate 50% of the pop. by mid-June.
Latest GS proprietary datapoints/major changes in views
• We lowered our Q2 and full-year 2021 India real GDP growth
forecasts to % qoq ann. and % yoy, respectively.
Datapoints/trends we’re focused on
• Virus growth, which remains high in India and parts of LatAm.
• China turning point; with the V-shaped recovery complete, the
policy focus is shifting to long-term stability and growth.
• Impact of rising US yields, particularly rising real rates, which
remains a key risk for EMs.
• Rising oil prices; we see Brent crude prices rising to $75/bbl
over 3m, which should support EM HY oil exporters.
Europe still facing much tighter restrictions than US
GS Effective Lockdown Index, index
A COVID-19 tidal wave for parts of EM
Daily change in confirmed cases (7dma), thousands
Source: University of Oxford, "Google COVID-19 Community Mobility Reports";
Accessed: 5/20/21, Goldman Sachs GIR.
Source: JHU, Goldman Sachs GIR.
Oct-19 Apr-20 Oct-20 Apr-21 Oct-21 Apr-22 Oct-22
Stimulus-Sensitive and/or Bottlenecked Core Goods
Virus-Sensitive Services and Apparel
Combined Impulse on YoY Core PCE Inflation
Core PCE Inflation (YoY) and GS Forecast
Forecast
Note: Virus-sensitive categories include airfares, hotels, recreation admissions, and ground transport.
Stimulus/bottlenecked categories include new cars, used cars, appliances, electronics, recreation vehicles, and
miscellaneous core goods. Trend calculated as the 2015-2019 category average. April 2021 reflects GS nowcast
based on available source data.
2% Inflation Target
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Brazil (Left)
Russia (Left)
Mainland China (Left)
South Africa (Left)
India (Right)
We provide a brief snapshot on the most important economies for the global markets
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Goldman Sachs Global Investment Research 3
Top of Mind Issue 98
With cryptocurrency prices remaining extremely volatile on
news about regulatory crackdowns, environmental concerns
and heightened tax scrutiny even as interest in crypto assets
from credible investors has been rising and legacy financial
institutions—including ourselves—have been launching new
crypto offerings, crypto is undoubtedly Top of Mind. We first
wrote about bitcoin in 2014 and cryptos more broadly in 2018,
exploring the potential and risks of the crypto ecosystem.
Amid the recent volatility, here we focus on whether crypto
assets can be considered an institutional asset class.
We start by speaking with Michael Novogratz, Co-founder and
CEO of Galaxy Digital Holdings, which is active in crypto
investing and trading, asset management, and venture
financing. He argues that the mere fact that a critical mass of
credible investors and institutions is now engaging with crypto
assets has cemented their position as an official asset class.
And, despite the price volatility, he doesn’t see the institutional
interest in bitcoin, which he primarily views as a convenient
store of value, waning as long as the current macro and political
backdrop—in which the government has no imperative to stop
spending on social issues that the Fed is largely financing—
continues, and crypto remains in the adoption cycle.
Michael Sonnenshein, CEO of Grayscale Investments, the
world’s largest digital asset manager, agrees that institutional
investors now generally appreciate that digital assets are here
to stay, with investors increasingly attracted to the finite quality
of assets like bitcoin—which is verifiably scarce—as a way to
hedge against inflation and currency debasement, and to
diversify their portfolios in the pursuit of higher risk-adjusted
returns. Even though crypto assets have behaved as anything
but a diversifier over the past year—selling off more than
traditional assets as the COVID-19 pandemic set in—he says
that their faster and stronger rebound in 2020 only reassured
investors about their resiliency as an asset class.
But what makes a crypto like bitcoin—which has no income, no
practical uses and high volatility—a good store of value?
Novogratz’s answer: because “the world has voted that they
believe” it is. Zach Pandl, GS Co-Head of Global FX, Rates, and
EM Strategy, largely agrees, arguing that bitcoin’s potential for
widespread social adoption given its strong brand on top of its
other properties, such as its security, privacy, transferability and
the fact that it’s digital makes it a plausible store of value for
future generations. And he believes that institutional investors
today should treat bitcoin as a macro asset, akin to gold.
GS commodity analyst Mikhail Sprogis and Jeff Currie, Global
Head of Commodities Research, for their part, argue that
cryptos can act as stores of value, but only if they have other
real world uses that create value and temper price volatility.
This, they say, best positions cryptos whose blockchains offer
the greatest potential for such uses, like ether, to become the
dominant digital store of value. More broadly, Currie contends
that cryptos are a new class of asset that derive their value
from the information being verified and the size and growth of
their networks, but that legal challenges to their future growth
loom large due to their decentralized and anonymous nature.
And Nouriel Roubini, professor of economics at NYU’s Stern
School of Business, entirely disagrees with the idea that
something with no income, utility or relationship with economic
fundamentals can be considered a store of value, or an asset at
all. Despite the recent crypto mania, he doubts the willingness
of most institutions to expose themselves to cryptos’ volatility
and risks, which the volatile price action in recent days has
served as a stark reminder of.
Christian Mueller-Glissmann, GS Senior Multi-Asset Strategist,
then makes the case that for an asset to add value to a
portfolio, it has to offer either an attractive risk/reward or low
correlations with other macro assets, and preferably both. He
finds that a small allocation to bitcoin in a standard US 60/40
portfolio since 2014 would’ve led to strong outperformance,
owing both to higher risk-adjusted returns for bitcoin compared
to the S&P 500 and US 10y bonds, as well as diversification
benefits from relatively low correlations between bitcoin and
other assets. But with this outperformance largely owing to
only a handful of idiosyncratic bitcoin rallies, he concludes that
bitcoin’s short and volatile history makes it too soon to
conclude how much value it adds to a balanced portfolio.
But beyond the debatable role of cryptos as a store of value
and investible asset, does the broader crypto ecosystem
provide promise for investors? Novogratz and Sonnenshein
strongly believe that the answer is yes, given a myriad of
potential use cases for crypto assets. In particular, Novogratz
sees the three biggest developments in the crypto
ecosystem—payments, Decentralized Finance (DeFi), and non-
fungible tokens (NFTs)—mostly being built on the Ethereum
network, which suggests substantial upside for it and various
DeFi applications. But Roubini contends that few successful
applications of blockchain technology exist today. And he sees
many potential corporate uses of it as “BINO”—Blockchain In
Name Only. In short, he’s skeptical that blockchain technology
will prove revolutionary because “the idea that technology can
resolve the question of trust is delusional.”
Mathew McDermott, GS Global Head of Digital Assets, then
explains why GS has (re)engaged in the space—in two words:
client demand—and how interest in cryptos differs between
client types—from asset managers who are seeking portfolio
diversification, to high-net-worth clients who are increasingly
looking for exposure to broader crypto use cases, to hedge
funds that are largely aiming to profit from the basis between
going long the physical and short the future—an arbitrage that
reflects the difficulties that still persist in accessing the market
today.
Beyond this issue of market fragmentation, we conclude with a
look at some of the other main obstacles to further institutional
adoption of crypto assets. Alan Cohen, previous senior policy
advisor to former SEC Chairman Jay Clayton and former GS
Global Head of Compliance, explains how regulators are looking
at crypto assets today. Michael Gronager, Co-founder and CEO
of blockchain investigations firm Chainalysis, explains what is—
and isn’t—included in their analysis that finds that less than 1%
of all cryptocurrency activity is illicit. And Dan Guido, Co-
founder and CEO of software security firm Trail of Bits,
discusses the black swan technological and security scenarios
that all investors in the crypto ecosystem should be aware of.
Allison Nathan, Editor
Email: @
Tel: 212-357-7504
Goldman Sachs and Co. LLC
Crypto: a new asset class?
mailto:@
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Goldman Sachs Global Investment Research 4
Top of Mind Issue 98
Michael Novogratz is CEO of Galaxy Digital Holdings Ltd. Below, he discusses the potential for
crypto assets and their ability to transform the financial system and beyond.
The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.
Allison Nathan: How does Galaxy
invest in the crypto universe?
Michael Novogratz: Galaxy Digital
grew out of my family office, which
operates like a merchant bank, and
has become a nearly full-service
business for the digital asset and
blockchain technology communities.
Being involved across the ecosystem
is important to us, namely so that we can be positioned to help
grow the industry that we believe will transform the way we
live and work globally. We own and trade coins, have a large
venture business, and invest in the virtual world that will be
used not by finance, but by consumers—the metaverse,
gaming studios, and non-fungible token (NFT) projects. We
believe you learn by being at the frontier and that’s why we
started the company—to learn about the crypto space and
share that knowledge with our institutional customers as we
create the next generation of financial services companies.
Allison Nathan: You’ve been involved in and excited about
the crypto space for a while now, but it’s had fits and
starts, including the dramatic price rise and collapse in
2017/18. What makes this time different?
Michael Novogratz: 2017/2018 was the first-ever truly global
and retail-driven speculative mania. It was blind excitement. It’s
not that there are no excesses, knuckleheaded Twitter
comments, cheerleading, or tribalism today, but that’s all there
was back then. And crypto’s market cap cratered %. But
out of that mania grew a much smarter investor base that took
the lessons learned and is more willing to differentiate between
the different use cases for crypto—from stores of value to
decentralized finance (DeFi) to stablecoins and payment
systems. And in turn, the community has built up a more logical
investment process.
Importantly, that price downturn didn’t result in a downturn in
investments being made in the underlying crypto infrastructure,
so the custody and security infrastructure necessary to attract
institutions has been built. As a result, we’ve now hit a critical
mass of institutional engagement. Everyone from the major
banks to PayPal and Square is getting more involved, which is a
loud and clear signal that crypto is now an official asset class.
There’s still a lot of volatility, so people will wash in and out.
But crypto is not going away. And a core group of crypto people
see this as—and I quote the Blues Brothers here —“a mission
from god”. They want to rebuild the infrastructure of the
financial markets in a way that’s more transparent and
egalitarian and doesn’t rely on governments who make bad
decisions with our finances. They will never sell. And because
of that, bitcoin and ether can’t go to zero.
Allison Nathan: But can the crypto ecosystem survive if it
isn’t intertwined with the traditional financial system?
Michael Novogratz: No. Institutions need to participate
because they have most of the money in the world and there’s
actually a symbiotic relationship between the two. The advisor
model that Galaxy possesses is important because many
people don’t have time to learn to become investors. And as
traditional financial advisors and asset managers understand
the space and become crypto preachers, they bring more
people into the tent, which is key for the future of crypto.
That said, payments will be an interesting battleground. The
money transfer business is a very high margin one for legacy
financial institutions and it’s under threat from new payment
systems that are faster, more transparent, and cheaper.
Facebook is coming out with their Dollar-based payment
system, the Chinese government is coming out with theirs, and
stablecoins are gaining traction. At some point, I believe our
phones will have crypto wallets that will replace bank accounts.
The competition to see who dominates payments is just
starting along with the competition between exchanges and
derivative markets. So the question is, how fast will banks
iterate and compete?
A core group of crypto people see this
as—and I quote the Blues Brothers here —
“a mission from god”… They will never sell.
And because of that, bitcoin and ether can’t
go to zero.”
Allison Nathan: But will it be bitcoin that’s transformative
in payments?
Michael Novogratz: No. Bitcoin isn't set up to process
thousands of transactions per second. Paying for a diet coke
with bitcoin would be like paying for it with gold. That won’t
happen. But payment rails will be built on other blockchains.
Right now, if I want to send money to my sister in Holland, it
would be painful, costly, and slow. But soon, I’ll be able to send
her a Dollar stablecoin and transferring money will become
free. Most of this will be built on the Ethereum network, which
is why ethereum prices have been rising. The three biggest
moves in the crypto ecosystem—payments, DeFi, and NFTs—
are mostly being built on Ethereum, so it’s going to get priced
like a network. The more people that use it and the more stuff
that gets built on it, the higher the price will ultimately go.
Allison Nathan: What’s the value proposition of bitcoin,
then?
Michael Novogratz: Bitcoin is a really convenient way to store
value. One of the main reasons people have gotten excited
about bitcoin recently is that they’re worried that we currently
have an unsustainable balance of monetary and fiscal policy
Interview with Michael Novogratz
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Goldman Sachs Global Investment Research 5
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that will eventually set off an inflationary spiral. And that worry
isn’t going away anytime soon. More and more Americans are
in favor of paying for college for people whose families earn
less than $100k annually. President Biden just gave half of the
$ fiscal package directly to people who needed it, which
was very well-received. Some version of universal basic income
(UBI) is coming; it may not be called UBI, but capital will be
taxed and given to labor. None of that is fiscally prudent, but
there’s no political imperative to say stop spending money.
Even before COVID-19, deficits were bad, but now they’re
insane. And monetary policymakers are financing everything
the government wants to spend, not just in the US but all over
the world. So the main reason everyone got into bitcoin is the
same reason they got into gold—the current macro backdrop is
tailor-made for it. And, as long as that macro and political
backdrop persists and crypto remains in the adoption cycle, it’s
crazy to get out.
The three biggest moves in the crypto
ecosystem—payments, DeFi, and NFTs—are
mostly being built on Ethereum, so it’s going
to get priced like a network. The more people
that use it, the more stuff that gets built on it,
and the higher the price will ultimately go.”
Allison Nathan: But why is bitcoin, which has no income
and no other uses, a good store of value?
Michael Novogratz: Bitcoin is one of the few uniform stores
of value in the world. It’s the most widely distributed asset in
history outside of the Dollar and Euro; 140 million people own
some bitcoin. And it’s easily stored and transported, unlike
gold. Stores of value are social constructs—they have value
because we believe they do. There has never been a more
successful brand created in such a short period of time. It’s like
they floated the baby in the river and the community raised the
baby, and now it’s worth around $1tn. Today, it’s recognized
and believed in by exceptionally credible people. So the world
has voted that they believe bitcoin is a store of value. People
still make stubborn arguments against it, but every single bank
we know of is building a wealth channel for crypto, 14 entities
have bitcoin ETFs in line at the SEC, and most tech companies
are building bitcoin into their wallet and interface. To think
we’re going to have less people believing in bitcoin isn’t logical.
Allison Nathan: Haven’t people been buying bitcoin and
other cryptos just because their prices were rising?
Michael Novogratz: Of course that’s part of the equation.
People in general are momentum investors. All great fortunes
on this planet have been made by trends—I learned that from
Paul Tudor Jones thirty years ago and Jeff Bezos and Bill Gates
are proof points to this as well. Bitcoin adoption and the macro
factors behind it are a mega bull trend.
Allison Nathan: So what are the remaining roadblocks to
further institutional adoption?
Michael Novogratz: Institutions need a little more regulatory
clarity, which they’ll likely get soon. Former SEC Chair Jay
Clayton didn’t want crypto to be his legacy, and so he punted.
But Gary Gensler is very knowledgeable about and interested in
the crypto space. Within his first nine months, a clear
regulatory framework will likely emerge that will make it easier
for institutions to get involved. For example, institutions have a
hard time using DeFi products right now due to uncertainty
around how Know Your Customer (KYC) requirements are
applied to smart contracts and DeFi companies that are
comprised of code. With a little more innovation and regulator
understanding over the next few years, DeFi protocols and
projects will probably explode. Uniswap could become a bigger
exchange than the CME or the NYSE which will pull people in.
More clarity on the tax side would also be helpful. But
policymakers today are rational and have high intellectual
integrity, so I don’t see them singling out cryptocurrencies and
do expect they will be taxed like any other asset. I’m much
more confident than I’ve ever been that this is inevitable.
Allison Nathan: What do you make about the rise of
Dogecoin and other meme coins?
Michael Novogratz: Dogecoin is a very speculative asset,
much more so than bitcoin. It likely doesn’t have long-term legs
because no institution is buying it and at some point, retail will
lose interest. Dogecoin started as a joke and grew for two
reasons. First and foremost is tribalism in the investing
community. It’s the same thing we saw with the rise in
GameStop, which was driven by a young community of
investors who have been empowered as financial players
through trading apps and social media platforms. Second, value
is showing up in new places because the government is
printing a lot of money. It’s important to keep that in mind
when thinking about some crypto assets and equities like
GameStop that have short-term potential but no long-term
viability.
People in general are momentum
investors. All great fortunes on this planet
have been made by trends… Bitcoin adoption
and the macro factors behind it are a mega
bull trend.”
Allison Nathan: What would make enthusiasm for the
asset class diminish?
Michael Novogratz: I am not sure what could dent enthusiasm
for the broader ecosystem at this point. But, at least for bitcoin,
the biggest risk in this cycle is, in the words of Ray Dalio, a
beautiful de-leveraging. If the Fed successfully taps the brakes,
pulls back liquidity, and slows the economy down just enough
to ensure inflation doesn’t run away and deficits come down,
then the impetus for having a store of value will fall. But this is
the hardest macro environment policymakers have ever dealt
with, and only a tiny window exists to get it right. And even if
they do, bitcoin won’t just collapse into oblivion. Why has gold
been a mediocre asset to own this year and bitcoin’s generally
been a great one? Because gold isn’t in the adoption cycle.
Bitcoin is.
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Bitcoin and ether have performed strongly YTD
Total returns YTD, %
And other cryptocurrencies have seen even larger rallies
Total returns YTD, %
Note: Total returns in USD; all market prices as of May 19, 2021.
Source: Bloomberg, Goldman Sachs GIR.
Note: Total returns in USD.
Source: Bloomberg, Goldman Sachs GIR.
But crypto returns remain very volatile
Average daily volatility in ann. terms, %
Activity on Bitcoin and Ethereum networks is around 2018 highs
Total active addresses, million
Note: Based on returns since 2014 and since 2015 for ether.
Source: Bloomberg, Goldman Sachs GIR.
Note: Includes unique addresses active in the network as a sender or receiver.
Source: Glassnode, Goldman Sachs GIR.
The market cap of bitcoin had surged above $1tn
Crypto market cap. vs private investment gold stock, $tn
Around 70% of bitcoin and 85% of ether is held in profit today
Percent of total supply in the network with positive balance, %
Note: Private investment gold stock based on ETFs and bars/coins held privately.
Source: World Gold Council, CoinMarketCap, Goldman Sachs GIR.
Note: The percentage of circulating supply bought below the current market price.
See more detail here; as of May 19. 2021.
Source: Glassnode, Goldman Sachs GIR.
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Ju
l-1
6
O
ct
-1
6
D
ec
em
be
r
20
13
M
ed
ia
a
tte
nt
io
n
pu
sh
es
B
TC
to
a
n
al
l-
tim
e
hi
gh
.
Ja
nu
ar
y
20
14
Zy
ng
a
an
d
O
ve
rs
to
ck
.c
om
be
gi
n
ac
ce
pt
in
g
B
TC
.
Fe
br
ua
ry
2
01
4
A
tta
ck
s
on
ex
ch
an
ge
s
le
ad
to
a
ha
lt
on
s
om
e
w
ith
dr
aw
al
s;
M
t.
G
ox
e
xc
ha
ng
e
co
lla
ps
es
.
A
pr
il
20
14
R
ep
or
ts
in
di
ca
te
th
at
th
e
P
B
O
C
p
la
ns
to
s
hu
t d
ow
n
th
e
ba
nk
a
cc
ou
nt
s
of
C
hi
ne
se
B
TC
e
xc
ha
ng
es
.
Ja
nu
ar
y
20
15
C
oi
nb
as
e
la
un
ch
es
its
o
w
n
U
S
-
lic
en
se
d
B
TC
ex
ch
an
ge
(
G
D
A
X
).
Ju
ne
20
15
Th
e
N
ew
Y
or
k
S
ta
te
D
ep
ar
tm
en
t o
f
Fi
na
nc
ia
l S
er
vi
ce
s
un
ve
ils
th
e
fir
st
s
et
o
f
st
at
e-
le
ve
l r
eg
ul
at
io
ns
ta
rg
et
in
g
cr
yp
to
cu
rr
en
ci
es
.
S
ep
te
m
be
r
20
15
Th
e
U
S
C
om
m
od
ity
Fu
tu
re
s
Tr
ad
in
g
C
om
m
is
si
on
(C
FT
C
)
de
fin
es
B
TC
a
s
a
co
m
m
od
ity
, w
hi
ch
fa
lls
un
de
r
its
re
gu
la
to
ry
pu
rv
ie
w
.
O
ct
ob
er
20
15
Th
e
E
U
de
ci
de
s
no
t t
o
im
po
se
a
v
al
ue
-a
dd
ed
ta
x
(V
A
T)
o
n
cr
yp
to
tra
ns
ac
tio
ns
, e
ffe
ct
iv
el
y
re
gu
la
tin
g
B
TC
(
an
d
ot
he
r
cr
yp
to
cu
rr
en
ci
es
)
in
th
e
sa
m
e
w
ay
a
s
fia
t c
ur
re
nc
ie
s.
Fe
br
ua
ry
2
01
6
In
flu
en
tia
l m
em
be
rs
in
th
e
B
TC
co
m
m
un
ity
m
ee
t i
n
H
on
g
K
on
g
to
di
sc
us
s
a
po
ss
ib
le
ch
an
ge
in
B
TC
's
tra
ns
ac
tio
n
fo
rm
at
th
at
w
ou
ld
e
ffe
ct
iv
el
y
in
cr
ea
se
th
e
si
ze
o
f B
TC
bl
oc
ks
; t
he
a
im
is
to
sp
ee
d
up
tr
an
sa
ct
io
n
pr
oc
es
si
ng
ti
m
es
.
Ju
ly
2
01
6
Th
e
re
w
ar
d
fo
r B
TC
m
in
er
s
ha
lv
es
fo
r t
he
se
co
nd
ti
m
e,
fa
lli
ng
fr
om
25
B
TC
to
1
2.
5B
TC
.
A
ug
us
t
20
16
B
itf
in
ex
, t
he
la
rg
es
t
B
TC
e
xc
ha
ng
e
by
vo
lu
m
e,
is
h
ac
ke
d;
cy
be
rc
rim
in
al
s
ca
pt
ur
e
$7
2m
w
or
th
o
f B
TC
.
M
ar
ch
2
01
3
A
n
ac
ci
de
nt
al
fo
rk
o
cc
ur
s
in
th
e
B
TC
bl
oc
kc
ha
in
; d
ue
to
th
e
in
tro
du
ct
io
n
of
a
fla
w
ed
s
of
tw
ar
e
up
da
te
, t
he
c
or
re
ct
ve
rs
io
n
of
th
e
pu
bl
ic
le
dg
er
b
ec
om
es
un
cl
ea
r f
or
n
ea
rly
6
h
ou
rs
.
A
pr
il
20
13
M
t.
G
ox
e
xc
ha
ng
e
go
es
do
w
n
fo
r
a
da
y.
M
ar
ch
2
01
3
Fi
nC
en
s
ay
s
th
at
B
TC
w
ill
b
e
tre
at
ed
in
th
e
sa
m
e
w
ay
as
m
on
ey
fo
r
th
e
pu
rp
os
es
o
f A
M
L
la
w
s.
A
fte
r
be
in
g
un
ve
ile
d
in
2
00
9,
B
TC
's
p
ric
e
re
m
ai
ns
re
la
tiv
el
y
fla
t,
pe
ak
in
g
at
a
bo
ut
$3
0
in
2
01
1.
O
ct
ob
er
2
01
3
U
S
la
w
en
fo
rc
em
en
t
of
fic
ia
ls
s
hu
t d
ow
n
th
e
S
ilk
R
oa
d.
$
0
$
5
,0
0
0
$
1
0
,0
0
0
$
1
5
,0
0
0
$
2
0
,0
0
0
$
2
5
,0
0
0
$
3
0
,0
0
0
$
3
5
,0
0
0
$
4
0
,0
0
0
$
4
5
,0
0
0
$
5
0
,0
0
0
$
5
5
,0
0
0
$
6
0
,0
0
0
$
6
5
,0
0
0 Ja
n
-1
7
A
p
r-
1
7
Ju
l-1
7
O
ct
-1
7
Ja
n
-1
8
A
p
r-
1
8
Ju
l-1
8
O
ct
-1
8
Ja
n
-1
9
A
p
r-
1
9
Ju
l-1
9
O
ct
-1
9
Ja
n
-2
0
A
p
r-
2
0
Ju
l-2
0
O
ct
-2
0
Ja
n
-2
1
A
p
r-
2
1
M
ar
ch
2
01
7
Th
e
S
E
C
re
je
ct
s
tw
o
se
pa
ra
te
B
TC
E
TF
ap
pl
ic
at
io
ns
.
A
pr
il
20
17
Ja
pa
n
re
co
gn
iz
es
B
TC
a
s
le
ga
l t
en
de
r,
w
hi
le
b
rin
gi
ng
th
e
cr
yp
to
cu
rr
en
cy
u
nd
er
A
M
L/
K
Y
C
ru
le
s
an
d
re
gu
la
tio
ns
.
A
ug
us
t
20
17
A
"
ha
rd
fo
rk
"
oc
cu
rs
a
s
B
itc
oi
n
C
as
h
(B
C
H
)
sp
lit
s
of
f o
f B
TC
; B
C
H
pr
om
is
es
s
pe
ed
ie
r
pr
oc
es
si
ng
ti
m
es
, a
s
its
bl
oc
ks
c
on
ta
in
8
x
th
e
da
ta
c
ap
ac
ity
o
f B
TC
bl
oc
ks
.
S
ep
te
m
be
r
20
17
Th
e
C
hi
ne
se
go
ve
rn
m
en
t b
an
s
IC
O
s
an
d
su
bs
eq
ue
nt
ly
cl
os
es
th
e
na
tio
n'
s
B
TC
ex
ch
an
ge
s.
N
ov
em
be
r
20
17
Fu
tu
re
F
ed
c
ha
ir
Je
ro
m
e
P
ow
el
l
sa
ys
B
TC
is
n
ot
bi
g
en
ou
gh
to
po
se
a
th
re
at
to
th
e
U
S
e
co
no
m
y.
M
ay
2
01
8
U
S
D
O
J
op
en
s
cr
im
in
al
p
ro
be
in
to
c
ry
pt
oc
ur
re
nc
y
pr
ic
e
m
an
ip
ul
at
io
n;
U
S
a
nd
C
an
ad
ia
n
re
gu
la
to
rs
a
nn
ou
nc
e
"O
pe
ra
tio
n
C
ry
pt
o-
S
w
ee
p"
to
p
ol
ic
e
cr
yp
to
in
ve
st
m
en
t s
ch
em
es
.
Ju
ly
2
01
8
S
E
C
re
je
ct
s
ap
pl
ic
at
io
n
fo
r
B
TC
E
TF
.
O
ct
ob
er
2
01
8
Fi
de
lit
y
an
no
un
ce
s
in
iti
at
iv
e
to
h
an
dl
e
tra
di
ng
an
d
cu
st
od
y
of
c
ry
pt
o
as
se
ts
fo
r i
ns
tit
ut
io
na
l
in
ve
st
or
s.
Ju
ly
20
19
P
re
si
de
nt
T
ru
m
p
tw
ee
ts
th
at
B
TC
a
nd
o
th
er
cr
yp
to
cu
rr
en
ci
es
a
re
"
ba
se
d
on
th
in
a
ir"
.
S
ep
te
m
be
r
20
19
N
Y
S
E
la
un
ch
es
B
TC
fu
tu
re
s.
N
ov
em
be
r
20
19
P
eo
pl
e'
s
B
an
k
of
C
hi
na
la
un
ch
es
c
ra
ck
do
w
n
on
cr
yp
to
cu
rr
en
ci
es
. J
an
ua
ry
2
02
0
C
M
E
b
eg
in
s
to
tra
de
o
pt
io
ns
o
n
B
TC
fu
tu
re
s
co
nt
ra
ct
s.
M
ay
2
02
0
Th
e
re
w
ar
d
fo
r B
TC
m
in
er
s
ha
lv
es
fo
r t
he
th
ird
ti
m
e,
fa
lli
ng
fr
om
1
2.
5B
TC
to
6.
25
B
TC
; i
nv
es
to
r P
au
l
Tu
do
r
Jo
ne
s
an
no
un
ce
s
B
TC
h
ol
di
ng
s.
Ju
ly
2
02
0
U
S
O
ffi
ce
o
f t
he
C
om
pt
ro
lle
r
of
th
e
C
ur
re
nc
y
(O
C
C
)
al
lo
w
s
na
tio
na
lly
ch
ar
te
re
d
ba
nk
s
to
c
us
to
dy
cr
yp
to
cu
rr
en
ci
es
.
A
ug
us
t
20
20
M
ic
ro
S
tra
te
gy
an
no
un
ce
s
ad
op
tio
n
of
B
TC
a
s
pr
im
ar
y
Tr
ea
su
ry
r
es
er
ve
as
se
t.
A
pr
il
20
21
C
oi
nb
as
e
IP
O
.
D
ec
em
be
r
20
17
B
TC
fu
tu
re
s
co
nt
ra
ct
s
be
gi
n
tra
di
ng
o
n
th
e
C
B
O
E
a
nd
C
M
E
ex
ch
an
ge
s.
Ja
nu
ar
y
20
18
C
hi
ne
se
of
fic
ia
ls
o
rd
er
m
in
in
g
op
er
at
io
ns
to
c
lo
se
;
ha
ck
er
s
st
ea
l m
or
e
th
an
$
50
0m
n
of
X
E
M
—
an
ot
he
r
cr
yp
to
—
fro
m
th
e
Ja
pa
ne
se
e
xc
ha
ng
e,
C
oi
nc
he
ck
.
Ju
ly
20
19
U
S
C
on
gr
es
s
ho
ld
s
he
ar
in
gs
o
n
cr
yp
to
cu
rr
en
cy
re
gu
la
tio
n.
Fe
br
ua
ry
2
02
1
Te
sl
a
an
no
un
ce
s
$1
.5
bn
B
TC
p
os
iti
on
a
nd
ac
ce
pt
an
ce
a
s
pa
ym
en
t;
B
N
Y
M
el
lo
n
an
no
un
ce
s
it
w
ill
c
us
to
dy
B
TC
.
Fe
br
ua
ry
2
02
1
N
Y
A
G
$
18
.5
m
n
Te
th
er
se
ttl
em
en
t.
O
ct
ob
er
2
02
0
P
ay
P
al
to
ac
ce
pt
B
TC
;
S
qu
ar
e
an
no
un
ce
s
$5
0m
n
B
TC
in
ve
st
m
en
t,
ac
ce
pt
an
ce
a
s
pa
ym
en
t.
Fe
br
ua
ry
2
02
0
Tr
ea
su
ry
S
ec
. Y
el
le
n
w
ar
ns
o
f i
lli
ci
t f
in
an
ci
ng
vi
a
cr
yp
to
cu
rr
en
ci
es
.
2
0
1
7
-2
0
2
1
2
0
1
3
-2
0
1
6
A
pr
il
20
21
B
TC
c
or
re
ct
s
dr
iv
en
by
li
qu
id
at
io
ns
, C
hi
na
m
in
in
g
ou
ta
ge
, a
nd
re
gu
la
to
ry
c
on
ce
rn
s.
M
ay
2
02
1
Te
sl
a
an
no
un
ce
s
it
w
ill
n
o
lo
ng
er
a
cc
ep
t
bi
tc
oi
n;
C
hi
na
w
id
en
s
cr
yp
to
r
eg
s.
El
Goldman Sachs Global Investment Research 8
Top of Mind Issue 98
Nouriel Roubini is a professor of economics at New York University’s Stern School of
Business. He is CEO of Roubini Macro Associates, LLC, a global macroeconomic consultancy
firm. Below, he discusses his skepticism about the value of cryptocurrencies and their ability to
radically transform the financial system.
The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.
Allison Nathan: Why do you think
bitcoin and other cryptocurrencies
are in a bubble?
Nouriel Roubini: To start, calling them
currencies is a misnomer. Currencies
must have four qualities: they must be
a unit of account, a means of payment,
a stable store of value, and act as a
single numeraire. Bitcoin and most
other cryptocurrencies have none of these features. It's not a
unit of account; nothing is priced in bitcoin. It's not a scalable
means of payment; the Bitcoin network can only complete
seven transactions per second, versus the Visa network that
can conduct 65,000. It's not a stable store of value for goods
and services; even the crypto conferences I've attended don't
accept bitcoin for payment because the price volatility could
wipe out their profit margin overnight. And the crypto universe
doesn’t offer a single numeraire in which the prices of different
items can be denominated because there are thousands of
tokens and thus limited price transparency. Even the
Flintstones had a more sophisticated system by using shells as
a single numeraire to compare the price of different goods.
Bitcoin and other cryptocurrencies also aren't assets. Assets
have some cash flow or utility that can be used to determine
their fundamental value. A stock provides dividends that can be
discounted to arrive at a valuation. Bonds provide a coupon,
loans provide interest, and real estate provides rent or housing
services. Commodities like oil and copper can be used directly
in different ways. And gold is used in industry, jewelry, and has
historically been a stable store of value against a variety of tail
risks, including inflation, currency debasement, financial crisis,
and political and geopolitical risk. Bitcoin and other
cryptocurrencies have no income or utility, so there's just no
way to arrive at a fundamental value. A bubble occurs when the
price of something is way above its fundamental value. But we
can’t even determine the fundamental value of these
cryptocurrencies, and yet their prices have run up dramatically.
In that sense, this looks like a bubble to me.
Allison Nathan: Why are more institutions interested in
getting involved in cryptocurrencies if they are in a bubble,
and will this help stabilize and credentialize the market?
Nouriel Roubini: Given the large trading volumes, it pays to
facilitate trading activity, custodial services, etc. But do
institutional investors really want to get more involved? Maybe
some do, but I don’t see it becoming mainstream. There's an
argument that because only a fraction of institutional money is
currently invested in bitcoin relative to gold, the price of bitcoin
could go to the moon as a result of asset re-allocation from
gold. But I'm doubtful institutions want exposure to an asset
that can drop by 15% overnight. There's also always the risk
that something else backed by real assets might end up
completely replacing bitcoin as an alternative store of value.
Bitcoin could disappear one day, but gold won’t. And the idea of
corporate treasurers allocating to crypto assets is totally crazy.
No serious company would do that because treasury accounts
must be invested in stable assets with minimal risk, even if they
provide a very low return. Any treasurer who invests in
something that falls 15% in value overnight will be fired. Sure,
Elon Musk can do it because he's the boss, although he’s since
backtracked somewhat on bitcoin due to environmental
concerns. But few other people are in that position.
Allison Nathan: But didn’t gold also have highly volatile
periods before it matured as an institutional asset?
Nouriel Roubini: While gold has experienced periods of
volatility, a set of economic fundamentals generally drove those
price swings. Gold rises with inflation and inflation expectations
because it’s an inflation hedge, and it falls when the Fed
tightens monetary policy and rates rise, not just in nominal but
also in real terms, for the same reason. Gold is inversely related
to the value of the Dollar, because a falling Dollar leads to
higher commodity production costs and prices, including for
gold. When there's serious political or geopolitical risk or a
financial crisis, the value of gold rises because it serves as a
safe haven asset, as does the Swiss Franc, the Japanese Yen
and US Treasuries. A whole set of variables can be used to
determine the demand for gold relative to its supply, which
makes it possible to establish a fundamental price. In contrast,
the prices of bitcoin and other cryptos don’t have a consistent
relationship with economic fundamentals that explains their
volatility or suggests it will eventually subside.
Allison Nathan: But couldn’t bitcoin serve as an inflation
hedge similar to gold given that it doesn't have exposure to
currency debasement?
Nouriel Roubini: It's true that inflation and inflation
expectations have moved higher, the Dollar has started to
weaken, and US breakevens are now well above 2%. But while
the price of gold and other inflation hedges has reflected these
shifts to a limited extent, at their peak, bitcoin’s price had
increased by more than tenfold from a low of $5K to more than
$60K in a year. That can't be explained by a fear of currency
debasement, because if there was really such a strong worry,
gold and other assets like TIPS would likely have rallied more.
So, something else must account for the rise in bitcoin and
other crypto prices.
Does bitcoin offer protection against debasement? At least
among the cryptos, it can't be debased because a cryptographic
rule determines the increase in supply and caps total supply at
21mn. But just because something is scarce doesn't mean it
has fundamental value. It's not difficult to create something
with limited supply, and there's no reason artificial scarcity is
Interview with Nouriel Roubini
El
Goldman Sachs Global Investment Research 9
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valuable in and of itself. Beyond bitcoin, the supply of most
cryptocurrencies is determined by a bunch of whales and
insiders based on random rules that can be used to increase
supply ad-hoc. And their supply has actually increased at a
much faster rate than the balance sheet of any central bank
given the proliferation of the number of coins. Scarcity also
doesn't make something a reliable store of value. It took a
hundred years for the value of the Dollar to fall by 90% in real
terms. In 2018, it only took 12 months for thousands of
cryptocurrencies to lose the same amount of value, and even
bitcoin fell by more than 80%. That's currency debasement.
Bitcoin isn't even a reliable hedge for risk-off events, let alone
inflation shocks. It's actually highly pro-cyclical. During the peak
of the COVID-19 shock in early 2020, US equities fell by about
35%, but bitcoin collapsed by around 50%. Other top 10 crypto
currencies fell by even more. In difficult times, crypto assets
don't go up; they go down. If investors want inflation hedges, a
wide variety of assets have proven to be good inflation hedges
for decades, including commodities and their stocks, gold, TIPS,
inflation-adjusted and other forms of inflation-indexed bonds. I
do worry that monetized deficits might eventually lead to fiscal
dominance and higher inflation. But I wouldn't recommend
bitcoin or other cryptocurrencies to protect against this risk.
Allison Nathan: Nascent technologies are often volatile in
their adoption phase. What makes this moment for crypto
any different than the early days of the internet?
Nouriel Roubini: More than a decade on from the advent of
Bitcoin, it's nowhere near as transformative as the internet was
at a similar stage. The World Wide Web already had around a
billion users ten years in. While it's difficult to know the total
number of crypto users today, active users for the most traded
coins probably amount to a maximum of a hundred million.
Transaction growth for cryptocurrencies has been slower than
in the case of the internet, and transaction costs remain very
high, with mining revenues as a share of the total volume of
transactions still very high. After ten years of the internet, there
was email, millions of useful websites and apps, and
technologies like the TCP and HTML protocols with broader
applications. In the case of cryptocurrencies, there are so-called
"dApps", or decentralized apps, but 75% of dApps are games
like CryptoKitties or literally pyramid or Ponzi schemes of one
sort or another. And the other 25% are "DEXs", or decentralized
exchanges, that for now have few transactions and little
liquidity. So the comparison with the internet just doesn't ring
true.
Allison Nathan: Doesn’t the concept of decentralized
ledgers and networks have value, though?
Nouriel Roubini: I am not sure it does, but the reality is that
the crypto ecosystem is not decentralized. An oligopoly of
miners essentially controls about 70-80% of bitcoin and ether
mining. These miners are located in places like China, Russia,
and Belarus, which are strategic rivals of the US and have a
different rule of law. That's why the US National Security
Council is starting to worry about the risks that could pose for
the United States. And 99% of all crypto transactions occur on
centralized exchanges. Many crypto currencies also have a
concentrated group of core developers who are police, judge,
and jury whenever updates to or conflicts over the blockchain
arise. Rules assumed to be fixed have been changed in these
situations. So the blockchain isn't even immutable.
There’s some evidence that the ownership of crypto wealth is
also highly concentrated. Less than % of addresses own
around 85% of all bitcoin, based on CoinMarketCap data.
There's also evidence that whales holding a large amount of the
total supply of bitcoin and other cryptocurrencies actively
manipulate their prices. Tons of news articles have detailed
active manipulation in chat rooms in the form of pump-and-
dump schemes, spoofing, wash trading, front-running, etc. This
behavior is much worse than even penny stocks, which
suggests a high likelihood of an eventual regulatory crackdown.
Allison Nathan: Does any innovation in the crypto
ecosystem look promising to you?
Nouriel Roubini: Not really. The next decade will see radical
financial innovation across many dimensions, disrupting the
traditional financial system. But it will have nothing to do with
cryptocurrencies. Driving this innovation will be a revolution in
fintech owing to some combination of AI, machine learning, and
the use of the Internet of Things (IoT) to collect big data.
Fintech is already transforming payment systems, borrowing
and lending, credit allocation, insurance, asset management,
and parts of the capital markets. In the context of payment
systems, billions of transactions are made every day using
AliPay and WeChat Pay in China, M-Pesa in Kenya and most of
Sub-Saharan Africa, and Venmo, PayPal, and Square in the
United States. These are all great companies that are scalable,
secure, and are disrupting financial services. They're not based
on decentralized finance (DeFi), and have nothing to do with
crypto or blockchain.
I’ve honestly spent a lot of time looking at this because more
and more people are saying that while maybe these aren't
currencies, blockchain technology could be revolutionary. There
are now all these buzzwords like "enterprise distributed ledger
technology (DLT)" or "corporate blockchain." But I call most of
these projects BINO—"Blockchain In Name Only". Something
truly based on blockchain technology should be public,
decentralized, permissionless, and trustless. But looking at DLT
and corporate blockchain experiments, almost all of them are
private, centralized and permissioned—because a small group
of people has the ability to validate transactions—and most are
authenticated by a trusted institution.
And even among these projects, few have actually worked.
One study looking at 43 applications of blockchain technologies
in the non-profit sphere for reasons such as banking the
unbanked, giving IDs to refugees, and transferring remittances
found that zero actually worked. The fundamental problem with
this whole space is that it assumes the idea that technology can
create trust. But that's mission impossible. Resolving the
challenge of authenticating ownership or quality requires due
diligence and testing. Why should I trust a DLT that says my
tomatoes are organic? I trust Whole Foods that actually tests
the tomatoes for chemicals. The idea that technology can
resolve the question of trust is delusional. So, I'm deeply
skeptical that blockchain, DLT, and cryptocurrencies for that
matter will be the revolutionary technologies that their
proponents suggest.
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Goldman Sachs Global Investment Research 10
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Zach Pandl argues that institutional investors
should treat bitcoin as a macro asset, akin to
gold, going through a social adoption phase
Although bitcoin is now seeing wider institutional adoption,
many sophisticated investors still struggle to understand why a
digital asset should have any value—much less a market
capitalization of more than $500bn. And because of the
parabolic price increases and high retail participation, many treat
the cryptocurrency phenomenon as a classic speculative mania
or “bubble”. Regardless of whether bitcoin will prove to be a
good investment over time, this perspective is too narrow.
Bitcoin is a medium which is beginning to serve the functions
of money—primarily as a “store of value”. Virtually anything can
serve this purpose as long as it gains widespread social adoption,
and bitcoin has made meaningful progress down that path.
The need for stores of value
To understand bitcoin, it is best to begin with gold. Gold serves
a unique function in the global financial system. It is both a
useful commodity and a money-like, “store of value” asset.
However, unlike conventional money mediums, it is not issued
by a government and does not denominate any transactions in
goods or assets. In effect, gold serves as an alternative fallback
money instrument for adverse states of the world—when
investors are unsure about the safety of conventional assets or
fiat money in general (. due to the risk of inflation or
confiscation). In foreign exchange markets, gold behaves like an
“inverse currency”: its price tends to fall when the
fundamentals of major currencies improve, and tends to rise
when the fundamentals of major currencies worsen. Over time,
the most important driver of nominal exchange rates is the
relative rate of inflation between two economies. Because gold
has a quasi-fixed supply, its nominal value tends to rise at the
rate of inflation in major markets. These correlation and store of
value properties allow gold to play a very useful diversification
role in portfolios.
Originally, gold was likely adopted as a money medium due to
its elemental properties. Gold and copper are the only metals
which are not greyish in color in their natural state0F1, and they
have captivated humans since ancient times. Gold is also
relatively dense, malleable, and ductile (stretchable), and unlike
many other metals it does not tarnish, rust, or corrode. These
features have underpinned gold’s use as a money instrument
throughout human history.
But the use of gold today has as much to do with inertia as it
does with the metal’s physical properties. After all, US Dollar
notes are also a store of value, and they are made of paper1F2.
Money, like language, is a social device—it is closer to a
concept than a thing. Money is a social device that facilitates
commerce, in much the same way that language is a social
device that facilitates other aspects of our lives. It is useful for
society to have a type of money that is not issued by a
sovereign government. But the specific medium used for that
purpose is partly arbitrary. Throughout history, a diverse array of
1 Gold’s periodic symbol AU comes from the Latin word aurum, meaning “shining dawn.”
2 Technically a 75% cotton-based and 25% linen-based material.
objects has functioned as money, dictated by the demands of
place and time—as Bitcoiners and monetary historians are fond
of pointing out. Classic examples include the tobacco-based
money standards of the early American colonies, and the
regular use of mobile phone minutes as money throughout
Africa. Gold serves a money function today primarily as an
artifact of history, not because it is literally the best possible
medium for society’s store of value needs.
Gold plays an important diversification role in portfolios
10-year annualized returns
Source: Bloomberg, MeasuringWorth, Goldman Sachs GIR.
When inflation accelerated in the mid-20th century and investors
sought out options to protect the real value of their assets, gold
was the natural choice. At the time, major currencies were
pegged to gold via the US Dollar through the Bretton Woods
gold exchange standard, and, before the Great Depression,
most currencies, as well as most US Treasury notes, were
directly backed by gold. The US government provided an official
price of gold in Dollars, which changed only twice in the nearly
two centuries between the 1790s and 1970s. During the 1960s,
under the gold exchange standard, gold trading above its official
stated price was the clearest way to observe depreciation
pressure on the US Dollar. In short, over much of the post-
WWII period, there was a close association between the price
of gold, currency stability, and the real value of money—making
it the obvious inflation hedge for portfolios.
But the official link between the Dollar and the price of gold
was severed 50 years ago when President Nixon ended the
convertibility of Dollars into gold in August 1971. As a result, a
generation of asset holders have grown up in a world without a
tight connection between gold and money. So when the need
for a store of value asset arises, could it be that they reach for
something else?
Gold for the digital generation
This is where bitcoin comes in. Any alternative medium would
need to be secure, privately held, have a fixed or quasi-fixed
supply, and be transferable, ideally outside the traditional
payments system. In our modern globalized society, where a
substantial portion of social interaction and commerce occurs
online (especially among younger people), it may also need to
be digital. But, most importantly, it would need to have the
potential for widespread social adoption—anything can be
money, as long as it has that. Bitcoin is therefore a plausible
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Bitcoin as a macro asset
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Goldman Sachs Global Investment Research 11
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alternative store of value medium to gold and, at the moment,
the best candidate among cryptocurrencies with a similar structure
because of its broader social adoption (. its “name brand”).
In equilibrium, a store of value as volatile as bitcoin would not
be very useful. But cryptocurrencies are in their infancy; it is
better to think of today’s prices as reflecting some probability
that bitcoin or another coin/token could achieve greater
adoption in the future, at which time its price could be
extremely high. Therefore, small changes in those probabilities
can result in high price volatility today. Bitcoin investors are
speculating that it will eventually achieve near-universal
acceptance as a non-sovereign money, with high returns (and
high volatility) along the way.
Today’s bitcoin prices reflect some probability that cryptos
could achieve greater adoption in the future
Time (x-axis) vs. price (y-axis)
Source: Goldman Sachs GIR.
The critical ingredient to bitcoin’s success—widespread social
adoption—has now crossed many notable thresholds: Tesla,
the sixth largest company in the S&P 500, is carrying bitcoin on
its balance sheet; storied macro hedge fund Brevan Howard
has begun investing in cryptocurrencies; and Coinbase is now
listed on the Nasdaq. Other blockchain networks, especially
Ethereum, are developing decentralized banking platforms,
Facebook is expected to introduce its stablecoin Diem later this
year, and many central banks are exploring distributed ledger
technology for their own digital currencies. Whether bitcoin will
succeed as a store of value in the long run remains an open
question—and its consumption of real resources may be a
headwind over time—but for now social adoption of
cryptocurrencies appears to be moving forward.
Bitcoin as a macro asset
Bitcoin has also matured enough that its price behavior
resembles that of other macro assets. For example, at its
March 17th meeting, the Federal Reserve said that most
policymakers did not expect to raise interest rates until after
2023—later than financial markets had expected. Macro assets
reacted in the conventional way to a “dovish policy shock”:
shorter-maturity Treasury yields declined, the yield curve
steepened, the Dollar fell, and stock prices increased. Bitcoin
rose, just like gold, but with about four times the volatility.
Investors should treat bitcoin in this way. Gold is a commodity
that serves a money function and behaves like a currency.
Bitcoin is exactly the same, even though it is a digital
commodity created through cryptography, rather than a physical
commodity found in the Earth’s crust. From a markets
standpoint, the main difference between the two assets is that
bitcoin is going through a one-time social adoption phase—
which may succeed or fail. When social adoption is rising,
bitcoin should offer superior returns compared to gold. When
social adoption is declining (. due to adverse regulatory
changes), bitcoin will likely offer inferior returns compared to
gold. Because of the speculative nature of the asset class and
high uncertainty around valuation, investors should be prepared
for prices to overshoot fundamentals in both directions. While
bitcoin has generally appreciated in value over time, there have
already been several waves of speculative excess followed by
large drawdowns.
Bitcoin behaved like gold following the March FOMC
announcement
Prices on March 17, 2021, $
Source: Bloomberg, Goldman Sachs GIR.
Technological issues aside, the current macroeconomic outlook
appears favorable for store of value assets, whether physical or
digital. The Federal Reserve has adopted a more ambitious
labor market goal of “broad and inclusive” full employment, and
seems more tolerant of above-target inflation than in the recent
past. Our economists expect real cash yields to remain negative
across developed market economies for a number of years to
come. Equity market multiples are at historic highs. Many
developing countries will struggle with the fiscal hangover from
the COVID-19 crisis for years to come. In this environment,
unless investors can find other sources of real returns, demand
for assets that protect purchasing power should remain high.
Low real interest rates should support high demand for
“store of value” assets over the next several years
%
Source: Goldman Sachs GIR.
Zach Pandl, Co-Head of Global FX, Rates, EM Strategy
Email: @ Goldman Sachs and Co. LLC
Tel: 212-902-5699
Successful
Adoption
Where we are
today
Failed
Adoption
54,500
55,000
55,500
56,000
56,500
57,000
57,500
58,000
58,500
1,725
1,730
1,735
1,740
1,745
1,750
1,755
Gold (lhs)
Bitcoin (rhs)
FOMC
announcement
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1
2
3
4
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Mar-04 Mar-07 Mar-10 Mar-13 Mar-16 Mar-19 Mar-22
Core Inflation Fed Funds Rate Real Rate
Forecast
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Goldman Sachs Global Investment Research 12
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Jeff Currie argues that cryptos are a new
class of asset that derive their value from the
information being verified and the size and
growth of their networks, but legal challenges
loom large
The term “cryptocurrencies”—which most people take to mean
that crypto assets act as a digital medium of exchange, like fiat
currency—is fundamentally misleading when it comes to
assessing the value of these assets. Indeed, the blockchain that
underlies bitcoin was not designed to replace a fiat currency—it
is a trusted peer-to-peer payments network. As a cryptographic
algorithm generates the proof that the payment was correctly
executed, no third party is needed to verify the transaction. The
blockchain and its native coin were therefore designed to
replace the banking system and others like insurance that
require a trusted intermediary today, not the Dollar. In that
sense, the blockchain is differentiated from other “digital”
transactional mechanisms such as PayPal, which is dependent
upon the banking system to prevent fraud like double-spending.
In order to be trustworthy, the system needed to create an
asset that had no liabilities or contingent claims, which can only
be a real asset just like a commodity. And to achieve that,
blockchain technologies used scarcity in natural resources—oil,
gas, coal, uranium and hydro—through ever-increasing
computational-power consumption to “mine” a bit version of a
natural resource.
From this perspective, the intrinsic value of the network is the
trustworthy information that the blockchain produces through
its mining process, and the coins native to the network are
required to unlock this trusted information, and make it
tradeable and fungible. It’s therefore impossible to say that the
network has value and a role in society without saying that the
coin does too. And the value of the coin is dependent upon the
value and growth of the network.
That said, because the network is decentralized and
anonymous, legal challenges facing future growth for crypto
assets loom large. Coins trying to displace the Dollar run
headlong into anti-money laundering laws (AML), as exemplified
by the recent ransoms demanded in bitcoin from the Colonial
Pipeline operator and the Irish Health service. Regulators can
impede the use of crypto assets as a substitute for the Dollar or
other currencies simply by making them non-convertible. An
asset only has value if it can either be used or sold. And
Chinese and Indian authorities have already challenged crypto
uses in payments.
As a result, the market share of coins used for other purposes
beyond currencies like “smart contracts” and “information
tokens” (see pgs. 26-27) will likely continue to rise. However,
even these non-currency uses will need to be recognized by
courts of law to be accepted in commercial transactions—a
question we leave to the lawyers.
The network creates the value, unlike other commodities
Unlike other commodities, coins derive their entire value from
the network. A bitcoin has no value outside of its network as it
is native to the Bitcoin blockchain. The value of oil is also largely
derived from the transportation network that it fuels, but at
least oil can be burned to create heat outside of this network.
At the other extreme, gold doesn’t require a network at all.
Non-currency crypto assets are starting to dominate use
Transactions on the Ethereum blockchain vs. transactions on the
Bitcoin blockchain, ratio (lhs); Number of active nodes on Ethereum
network vs. active nodes on Bitcoin network, ratio (rhs)
Source: Bloomberg, Goldman Sachs GIR.
Derived demand leaves the holder of the commodity exposed
to the risk of the network becoming obsolete—a lesson that
holders of oil reserves are now learning with decarbonization
accelerating the decline of the transportation network, and, in
turn damaging oil demand. Likewise, bitcoin owners face
accelerated network decay risk from a competing network,
backed by a new cryptocurrency.
As the demand for gold is not dependent on a network, it will
ultimately outlive oil and bitcoin—gold entropy lies at the unit,
not the network, level. Indeed, most stores of value that are
used as defensive assets—like gold, diamonds and
collectibles—don’t have derived demand and therefore only
face unit-level entropy risk. This is what makes them defensive.
The world can fall apart around them and they preserve their
value. And while they don’t have derived demand, they do have
other uses that establish their value, . gold is used for jewelry
and as a store of value.
Transactions drive value, creating a risk-on asset
Crypto doesn’t trade like gold and nor should it. Using any
standard valuation method, transactions or expected
transactions on the network are the key determinant of network
value. The more transactions the blockchain can verify, the
greater the network value. Transaction volumes and the
demand for commodified information are roughly correlated
with the business cycle; thus, crypto assets should trade as
pro-cyclical risk-on assets as they have for the past decade.
Gold and bitcoin are therefore not competing assets as is
commonly misunderstood, and can instead co-exist.
Because the value of the network and hence the coin is derived
from the volume of transactions, hoarding coins as stores of
value reduces the coins available for transactions, which
reduces the value of the network. Because gold doesn’t have
this property, it is the only commodity that institutional
investors hold in physical inventory. Nearly all other
commodities are held in paper inventory in the form of futures
to avoid disrupting the network. This suggests that, like oil,
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network (lhs)
Relative size of active Ethereum network vs. active
Bitcoin network (rhs)
Crypto is its own class of asset
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Goldman Sachs Global Investment Research 13
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crypto investments will need to be held in the form of futures
contracts, not physically, if they are to serve as stores of value.
Crypto assets aren’t digital oil, either, as they are not non-
durable consumables and can therefore be used again. This
durability makes them a store of value, provided this demand
doesn’t disrupt network flows. The crypto assets that have the
greatest utility are also likely to be the dominant stores of
value—the high utility reduces the carry costs.
Payment networks—and hence cryptocurrencies—are pro-
cyclical, as greater use drives value
Source: Bloomberg, Goldman Sachs GIR.
So what is crypto? A powerful networking effect
The network provides crypto an extremely powerful networking
externality that no other commodity possesses. The
operators—miners, exchanges and developers—are all paid in
the native coin, making them fully vested in its success.
Similarly, users—merchants, investors and speculators—are
also fully vested. This gives bitcoin holders an incentive to
accommodate purchases of their own products in bitcoin,
which in turn, creates more demand for the coins they already
own. Similarly, ether holders have an incentive to build apps
and other products on the Ethereum network to increase the
value of their coins.
Because the coin holders have a stake in the network,
speculation spurs adoption; even during bust periods, coin
holders are motivated to work to create the next new boom.
After the dot-com bust, the shareholders had no commodity to
promote. In crypto assets, even when prices collapse, the coin
holders have a commodity to promote. They will always live for
another boom, like an oil wildcatter.
It’s all about information
As the value of the coin is dependent on the value of the
trustworthy information, blockchain technology has gravitated
toward those industries where trust is most essential—finance,
law and medicine. For the Bitcoin blockchain, this information is
the record of every balance sheet in the network, and the
transactions between them—originally the role of banks. In the
case of a smart contract—a piece of code that executes
according to a pre-set rule—on Ethereum, both the terms of
that contract (the code) and the state of the contract (executed
or not) are the information validated on the Ethereum
blockchain. As a result, the counterparty in the contract cannot
claim a transfer of funds without the network forming a
consensus that the contract was indeed executed. In our view,
the most valuable crypto assets will be those that help verify
the most critical information in the economy.
Over time, the decentralized nature of the network will diminish
concerns about storing personal data on the blockchain. One’s
digital profile could contain personal data including asset
ownership, medical history and even IP rights. Since this
information is immutable—it cannot be changed without
consensus—the trusted information can then be tokenized and
traded. A blockchain platform like Ethereum could potentially
become a large market for vendors of trusted information, like
Amazon is for consumer goods today.
Crypto beyond this boom and bust cycle
By many measures—Metcalfe’s Law or Network Value to
Transactions (NVT) ratio —crypto assets are in bubble territory.
But does the demand for “commodified information” create
enough economic value at a low enough cost to be scaled up in
the long run? If the legal system accommodates these assets,
we believe so. While many overvalued networks exist, a few
will likely emerge as long-term winners in the next stage of the
digital economy, just as the tech titans of today emerged from
the dot-com boom and bust. This transformation is happening
now—there are already an estimated million owners of
cryptocurrencies in the US alone. However, technological,
environmental and legal challenges still loom large.
Ethereum is expected to ramp up capacity to 3,000
transactions per second (tps), while sharding—which will scale
Ethereum ’s Proof of Stake (PoS) system through parallel
verification of transactions—has the potential to raise capacity
to as much as 100,000 tps. For context, Visa has the capacity to
process up to 65,000 tps but typically executes around 2,000
tps. PoS intends to have validators stake the now scarce and
valuable coins to incentivize good behavior instead of having
miners expend energy to mine new blocks into existence, as
under Proof of Work, making crypto assets more ESG friendly.
PoS also can significantly boost computational time in terms of
transactions per second, which will further incentivize
technological adoption. Ironically, this is likely where the value
of and demand for bitcoin will come from—being used as the
scarce resource to make the PoS system work instead of
natural resources.
While overcoming the economic challenges will likely be
manageable, the legal challenges are the largest for many
crypto assets. And this past week was challenging for crypto
assets with confirmation that the 75 bitcoin ransom over the
Colonial Pipeline was actually paid. This is a reminder that
cryptocurrencies still facilitate criminal activities that have large
social costs. For Ethereum, new companies which aim to
disrupt finance, law or medicine by integrating information
stored on the platform into their algorithms are likely to run into
problems with being legally recognized. If crypto assets are to
survive and grow to their fullest potential, they need to define
some concept of “sufficiently decentralized” that will satisfy
regulators; otherwise, the technologies will soon run out of
uses.
Jeff Currie, Global Head of Commodities Research
Email: @ Goldman Sachs and Co. LLC
Tel: 44-20-7552-7410
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GS Risk Appetite Indicator (rhs)
mailto:@
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Around 90% of all bitcoin that will ever exist is in circulation
Total circulating and adjusted supply, million
Artificial scarcity is programmed into the bitcoin market
Annual bitcoin inflation rate (new units as % of current supply), %
Note: Adjusted supply includes estimate of lost coins based on those that
haven't moved in over seven years.
Source: Glassnode, Goldman Sachs GIR.
Source: Glassnode, Goldman Sachs GIR.
One measure suggests that 80% of bitcoin supply is illiquid
Percent of total supply by liquidity, %
The footprint of short-term bitcoin holders is fairly small
Age distribution of bitcoin supply based on last transaction
Note: Based on the ratio of the cumulative inflows/outflows of all entities in the
Bitcoin network. See more details here.
Source: Glassnode, Goldman Sachs GIR.
Note: Based on the percentage of bitcoin in existence that was last moved within
each given time period. See more detail here.
Source: Glassnode, Goldman Sachs GIR.
One measure that looks at network addresses suggests
bitcoin holdings are fairly concentrated
Total supply held by size of addresses' coin holdings, % total
A measure that looks at bitcoin entities shows less concentration
among "whales", because entities can own many addresses
Total supply held by size of entities' coin holdings, % total
Note: Shows share of total bitcoin supply held by the balance of different addresses.
See more detail here.
Source: CoinMarketCap, Goldman Sachs GIR.
Note: Shows share of total bitcoin supply held by the balance of different entities.
See more detail here.
Source: Glassnode, Goldman Sachs GIR.
0
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Adjusted supply (- lost coins)
Circulating supply
Lifetime cap on bitcoin supply: 21mn
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
2014 2015 2016 2017 2018 2019 2020 2021
Second halving:
Reward for each
mined bitcoin drops
to BTC
Third halving:
Reward for each
mined bitcoin drops
to BTC
0
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50
60
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2015 2016 2017 2018 2019 2020 2021
Highly liquid Liquid Illiquid 24h 1d-1w 1w-1m 1m-12m
1y-5y 5y-7y 7y-10y >10y
Medium
term: 41%
(1w - 1yr)
Long term: 55%
(>1yr)
Short term: 4%
(<1 week)
5%
9%
23%
21%
28%
11%
3%
<1 1-10 10-100 100-1K 1K-10K 10K-100K >100K
~14% of
bitcoin supply
is held by
small owners
Likely exchanges,
custodians, and
miners
"Whales"
5%
9%
17%
20%
22%
9%
18%
<1 1-10 10-100 100-1K 1K-10K 10K-100K >100K
Share of "whales"
Likely
exchanges,
custodians,
and miners
Bitcoin: sizing the market
5
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Goldman Sachs Global Investment Research 15
Top of Mind Issue 98
Unlike bitcoin, the all-time supply of ether isn't capped
Total circulating supply, million
But the pace of new supply creation has come down
Annual ETH inflation rate (new units as % of current supply), %
Note: A recently approved network update could reduce supply; see here.
Source: Glassnode, Goldman Sachs GIR.
Source: Glassnode, Goldman Sachs GIR.
Fees on the Ethereum network have risen with transactions
Average price paid per transaction ("gas"), $
More than decentralized apps are built on Ethereum
New and total decentralized apps, count
Note: For more details on Ethereum transaction fees see here.
Source: Glassnode, Goldman Sachs GIR.
Source: , Goldman Sachs GIR.
Ether holdings are modestly shorter duration than bitcoin
Age distribution of ether supply based on last transaction
More than 20% of ether supply is held in smart contracts
Ether supply held in smart contacts, % total supply
Note: Based on the percentage of ether in existence that was last moved within each
given time period.
Source: Glassnode, Goldman Sachs GIR.
Source: Glassnode, Goldman Sachs GIR.
20
40
60
80
100
120
140
2015 2016 2017 2018 2019 2020 2021
Intial ether supply:
72mn
Supply increases at
relatively fixed rate
with no all-time limit
Current supply:
~115mn
2016 2017 2018 2019 2020 2021
0
2
4
6
8
10
12
14
16
18
20
2016 2017 2018 2019 2020 2021
Block reward:
reduced to 2 ETH
Block reward:
reduced to 3 ETH
2016 2017 2018 2019 2020 2021
0
20
40
60
80
100
120
140
2015 2016 2017 2018 2019 2020 2021
0
500
1000
1500
2000
2500
3000New
decentralized
apps (lhs)
Total
decentralized
apps (rhs)
24h 1d-1w 1w-1m 1m-3m 3m-6m
6m-12m 1y-2y 2y-3y 3y-5y
Long term: 47%
(>1yr)
Medium
term: 50%
(1w - 1yr)
Long term: 47%
(>1yr)
Short term: 3%
(<1 week)
0%
5%
10%
15%
20%
25%
30%
2016 2017 2018 2019 2020 2021
Ethereum: sizing the market
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Goldman Sachs Global Investment Research 16
Top of Mind Issue 98
Michael Sonnenshein is CEO at Grayscale Investments. Below, he discusses the evolution of
the digital asset ecosystem and the factors behind rising institutional interest in the space.
The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.
Allison Nathan: How does Grayscale
and its parent company, Digital
Currency Group, engage in the
digital asset universe?
Michael Sonnenshein: Grayscale
Investments is a digital currency asset
manager with AUM of about $45 billion
today spread across a family of 14
unique investment products, the largest
of which is the Grayscale Bitcoin Trust.
The Grayscale business model is predicated on providing
investors access and exposure to digital currencies while
avoiding the challenges involved in buying and safely storing
digital currencies themselves. Our parent company, Digital
Currency Group, is a conglomerate that seeks to invest in, build,
and purchase businesses related to digital currency and
blockchain technology, and has invested in about 170 digital
currency/blockchain-related businesses in over 40 countries.
Allison Nathan: How do your products differ from a crypto
ETF, which has yet to gain regulatory approval in the US?
Michael Sonnenshein: All of our products are passive, long-only
funds that are directly invested in the referenced digital asset for
each product. So a $100 investment in the Grayscale Bitcoin
Trust is backed by $100 worth of bitcoin, which is bought in the
market and then stored in cold storage with a qualified custodian
that is a fiduciary under New York state banking laws, and who
also insures the assets. Today, six out of the 14 funds are also
publicly quoted and traded on the OTCQX markets, where the
ADRs of many foreign companies trade. These represent a
secondary market that in some ways mimic the attributes of an
ETF because they trade every day, but they are not ETFs. The
two largest differences between them and an ETF are, one, they
do not trade on a national securities exchange, like NYSE or
NASDAQ, and two, they do not have ongoing creation and
redemptions like ETFs. So they operate more like a closed-end
offering than an ETF.
Allison Nathan: You have a bird’s eye view on the digital
asset investor base. How has it evolved?
Michael Sonnenshein: In 2013/14, when I got my start in the
digital currency space, only Silicon Valley VCs, and maybe some
forward-thinking family offices, were speaking about digital
assets. Over time, interest in digital assets began to trickle down
to retail investors who were gaining access to crypto through
trading platforms and order books. And, more recently, the most
meaningful shift has been increased interest from institutional
investors. Several years ago, digital assets were generally
considered a taboo asset class among institutional investors
because of perceived reputational risks, regulatory concerns and
a view that engaging in digital assets was just too much of a
departure from the other strategies they typically employ.
Today, not only is there a general appreciation amongst all
investors, including the institutional community, that digital
assets are here to stay, but also all of those preconceived
notions have been shrugged off. We no longer hear concerns
about nefarious activity on the blockchain. We no longer hear
about reputational concerns; investors now want their fiduciaries
to participate in crypto. And we no longer hear concerns about
regulatory risk; regulators have provided enough clarity for
investors to feel comfortable participating.
Over just the last 12 to 18 months, the asset class has really
turned the corner as some well-known and experienced
investors have publicly come out in support of crypto,
corporations have begun to allocate to crypto on their balance
sheet as a reserve asset, and participation from legacy financial
institutions has materially increased. All of these developments
signal that, across the spectrum, the investment community
wants to participate in the crypto ecosystem, and is as smart as
ever on the asset class. I have yet to find somebody who has
really done their homework on crypto assets that isn’t truly
amazed by the potential for the asset class.
That being said, in the same way that not every investment
opportunity will be right for all investors, digital assets are not
necessarily the best fit for all institutions. It's also important to
remember that the asset class is only 10-12 years old and so is
still in its very early days. But we are now at a point where the
crypto market is as robust as it's ever been in terms of being a
two-sided market, having the ability to engage in derivatives,
lending and borrowing, and offering many of the same kinds of
products as traditional asset classes.
Allison Nathan: Why do institutional investors want to be
involved in the market?
Michael Sonnenshein: The potential for significant upside is
certainly an attraction. But more than anything, investors realize
the significant diversification benefit of adding crypto to their
portfolios, which can help them achieve higher risk-adjusted
returns. As policymakers have injected substantial stimulus into
the financial system in order to jumpstart the economy from the
COVID-related slowdown, investors have become increasingly
attracted to the finite quality of assets like bitcoin—which is
verifiably scarce—as a way to hedge against inflation and
currency debasement. Investors are starting to move out of
assets like gold, which historically have served as stores of value
or inflation hedges, as they realize that assets like bitcoin can
also serve those roles in their portfolios.
Allison Nathan: But given the short history of bitcoin/digital
assets, isn’t it too soon to conclude that these assets
provide diversification benefits or are a hedge against
inflation, especially since they seemed to act more like risky
assets during the depths of the pandemic recession?
Michael Sonnenshein: We’ve found that during some macro
shocks, like the devaluation of the renminbi in 2015 or the
unexpected Brexit vote in 2016, crypto outperformed. However,
during periods of broad-based selloffs or de-leveraging, like we
saw in March 2020 when COVID-19 brought the global economy
to a grinding halt, nothing was safe from what was taking place
in the system. Everything sold off—bonds, currencies, equities,
Interview with Michael Sonnenshein
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Goldman Sachs Global Investment Research 17
Top of Mind Issue 98
and crypto. But crypto snapped back much faster and more
significantly than other asset classes over the course of 2020.
After probably the hundredth time of pronouncing crypto
“dead”, that resiliency and staying power has solidified for a lot
of investors that this is a space they want to be in.
Allison Nathan: But can bitcoin survive as a store of value
since it has no other uses—compared to gold that is used
for jewelry, art, wine, etc.—which could temper its volatility
and put a floor on its value?
Michael Sonnenshein: People have largely left behind the idea
that bitcoin needs to be used in everyday commerce in order to
be successful, and since it hasn’t yet replaced the Dollar nor am
I yet buying my latte with it, it has failed. Again, it’s important to
drive home the notion that we are still in the early days of the
development of crypto assets and use cases for them. Today,
the developed world use case for bitcoin is primarily as a digital
store of value that is more suitable to today’s digital world
compared to the physical world in which gold may have
historically served a better purpose.
Many investors also think of digital asset exposure as an early
stage technology investment or as a conduit to the next
generation of payment systems and the way in which value may
be moved around the world, potentially disrupting remittance
networks, cross border payments, etc. But they have the
potential to unlock all kinds of other use cases, including areas
like microfinancing and micropayments, and leveraging the
underlying blockchain technology for commerce, shipping,
manufacturing, etc. This technology is truly the most secure and
most widely utilized consensus mechanism the world has ever
had. And when you think about how powerful consensus can be,
we're not yet anywhere close to utilizing the full capabilities of
what the protocol may offer.
Allison Nathan: But isn’t it now well-known that transaction
speeds on the Bitcoin blockchain are too slow for it to be
useful in the payment system and other commercial uses?
Michael Sonnenshein: You’re right to call out that one of the
flaws of Bitcoin is its relatively slow transaction speed. The
transactional nature of bitcoin is akin to what you see on Black
Friday when many payment networks are bogged down because
so many people are shopping and using their credit cards. But
slower-than-desirable transaction speeds are also a sign of
Bitcoin's success; the quantity of transactions transpiring on the
network was never conceived to be as high as it is today. A
variety of efforts have been and are underway to challenge that
attribute, and I believe we will continue to find ways to increase
transactional throughput.
Allison Nathan: There are already some offshoots of the
Bitcoin blockchain that improve upon this flaw. So isn’t it
likely that improvements won’t be captured by bitcoin itself,
but by another crypto asset?
Michael Sonnenshein: Bitcoin is an open source protocol,
which means that people are able to take its source code, copy
it over, tweak one attribute, and then launch it as a new digital
currency. Some of those currencies, like bitcoin cash, have had
staying power and have developed a real user base. That said,
the success of one crypto asset over another really boils down
to the value of the network built into them. Today, bitcoin has a
$700bn market cap, which represents 700 billion dollars of
switching costs that would need to be monetized for users to
move from bitcoin to something else. Bitcoin's open source
nature provides reassurance that over time as it is challenged, it
will integrate new and better features that prevent it from
becoming the Myspace to an eventual Facebook.
Allison Nathan: Do you hear institutional investors
expressing concerns over the high concentration of crypto
holdings or the environmental aspects of mining?
Michael Sonnenshein: There is certainly concentration within
the crypto ecosystem among a relatively small number of
entities, but that’s not unique to crypto. And we do sometimes
hear concerns about the energy consumption of bitcoin miners,
but there’s quite a lot of misinformation out there around this.
While mining is very energy intensive, it is extremely
competitive, and one way that miners can beat out others for
mining rewards is to utilize the lowest cost energy. So miners
have moved to lower-cost renewable energy sources as much
as possible, including solar, wind, hydro, etc.
Allison Nathan: So what are the remaining roadblocks to
further institutional adoption and how likely are they to be
overcome?
Michael Sonnenshein: The biggest obstacles primarily relate to
the plumbing around crypto assets, and the remaining gap
between the crypto asset ecosystem and the traditional financial
system, but both are actively being addressed. The
underpinnings of the crypto ecosystem are still maturing, but
tremendous work is underway in terms of improving order
management systems, tax lot reporting, algorithms, application
programming interfaces (APIs), custodial solutions, and all of the
nuts and bolts that digital assets need to thrive. Investors also
still can’t access digital assets as easily—or, for the most part,
through the same channels—as they do traditional instruments.
Recent and future potential developments that bridge the gap
between these two ecosystems, such as being able to buy
crypto through your prime broker or leveraging a bitcoin ETF, will
go a long way in enabling greater participation in digital assets.
Allison Nathan: How much of the interest in digital assets is
now being directed beyond bitcoin to other cryptos?
Michael Sonnenshein: There is a meaningful bid for other
digital assets from investors who appreciate not only the
diversification benefits from owning crypto as an asset class, but
also the benefits of diversifying their crypto allocation. As
investors have seen the advent of new use cases on top of
blockchains like Ethereum, whether that be the proliferation of
decentralized finance (DeFi), non-fungible tokens (NFTs), etc.,
they have increasingly moved beyond just allocating to bitcoin
and instead are seeking exposure to the entire ecosystem.
Allison Nathan: Dogecoin: a blessing or a curse for cryptos?
Michael Sonnenshein: Dogecoin is a demonstration of just how
easy it is to create a digital asset. It, along with a slew of other
digital assets, was created by enthusiasts basically for fun. That
drills home the point that it’s important for investors to scrutinize
use cases and whether the asset is viable and has the potential
to gain real world traction by solving a real world problem versus
a solution in search of a problem that may not exist.
El
Goldman Sachs Global Investment Research 18
Top of Mind Issue 98
Mikhail Sprogis and Jeff Currie argue that
other cryptocurrencies besides bitcoin are
better positioned to become the dominant
digital store of value
Based on emerging blockchain technology that has the power to
disrupt global finance, yet with limited clear use today, bitcoin
has been labeled a solution looking for a problem. Many
investors now view bitcoin as a digital store of value,
comparable to gold, housing, or fine wine. But all true stores of
value in history have provided either income or utility, and bitcoin
currently provides no income and only very modest utility.
However, unlike bitcoin, several other crypto assets have clear
economic rationales behind their creation. Bitcoin’s first-mover
advantage is also fragile; crypto remains a nascent field with
shifting technology and consumer preferences, and networks
that fail to adjust quickly could lose their leadership. We
therefore see a high likelihood that bitcoin will eventually lose its
crown as the dominant digital store of value to another
cryptocurrency with greater practical use and technological
agility. Ether looks like the most likely candidate today to
overtake bitcoin, but that outcome is far from certain.
What is a store of value?
A store of value is anything that preserves its value over time.
While financial stores of value like equities and bonds hold their
value because they produce a given cash flow, yield is not a
prerequisite for value. Art, wine, gold, and non-yielding
currencies are widely used as stores of value too. Yet all of
these non-yielding assets have a clear material use besides
being stores of value. This usefulness generates a “convenience
yield”—the incentive for people to own them—that reflects both
the utility a consumer derives from using these assets and the
relative scarcity of that utility—a fact captured by Adam Smith’s
famous Diamond-Water paradox.
We place assets on a continuum across time by their store of
value properties. We identify stores of future value, like financial
assets that offer the owner the right to future yields or the
promise of growing value over time, stores of present value, like
consumable commodities such as oil and grains for which the
utility of driving and eating today imparts a convenience yield,
and stores of past value, like gold, art or even housing in which
the assets store value generated in the past because of their
duration.
Value always stems from use
The key to stores of past value like gold and houses is that
someone demanded these assets in the past and placed value in
them by exchanging something of value, usually currency, for
them. Indeed, all important non-yielding stores of value
developed real uses before becoming investment assets. For
instance, gold was first used as jewelry to signal permanence,
commitment or immortality. The economic problem was a need
to signal permanence, and gold’s durable and inert elemental
properties solved that problem. Given the state of technology at
the time, gold was the only solution for this problem, which
explains why so many societies adopted it for this use.
Economic value is created when marginal benefit exceeds
marginal cost, and crypto fails this test
Source: Bloomberg, Goldman Sachs GIR.
And when societies began to conquer each other and needed a
means to standardize international trade, gold was the natural
choice to solve this economic problem as most societies already
owned gold and it was divisible. Real use is important for stores
of value because consumption demand tends to be price-
sensitive and therefore provides some offset to fluctuations in
investment demand, tempering price volatility. For example,
jewelry demand is the swing factor in the gold market, falling
when investment demand for gold pushes prices higher, and
vice versa.
Ether beats bitcoin as a store of value
Given the importance of real uses in determining store of value,
ether has high chance of overtaking bitcoin as the dominant
digital store of value. The Ethereum ecosystem supports smart
contracts and provides developers a way to create new
applications on its platform. Most decentralized finance (DeFi)
applications are being built on the Ethereum network, and most
non-fungible tokens (NFTs) issued today are purchased using
ether. The greater number of transactions in ether versus bitcoin
reflects this dominance. As cryptocurrency use in DeFi and NFTs
becomes more widespread, ether will build its own first-mover
advantage in applied crypto technology.
Ethereum can also be used to store almost any information
securely and privately on a decentralized ledger. And this
information can be tokenized and traded. This means that the
Ethereum platform has the potential to become a large market
for trusted information. We are seeing glimpses of that today
with the sale of digital art and collectibles online through the use
of NFTs. But this is a tiny peek at its actual practical uses. For
example, individuals can store and sell their medical data
through Ethereum to pharma research companies. A digital
profile on Ethereum could contain personal data including asset
ownership, medical history and even IP rights. Ethereum also
has the benefit of running on a decentralized global server base
rather than a centralized one like Amazon or Microsoft, possibly
providing a solution to concerns about sharing personal data.
What is a digital store of value?
El
Goldman Sachs Global Investment Research 19
Top of Mind Issue 98
Real demand for gold is a powerful price stabilization tool
tonnes
Source: World Gold Council, Goldman Sachs GIR.
A major argument in favor of bitcoin as a store of value is its
limited supply. But demand, not scarcity, drives the success of
stores of value. No other store of value has a fixed supply. Gold
supply has grown nearly ~2% pa for centuries, and it has
remained an accepted store of value. Plenty of scarce elements
like osmium are not stores of value. In fact, a fixed and limited
supply risks driving up price volatility by incentivizing hoarding
and forcing new buyers to outbid existing holders, potentially
crea
