Crypto has delivered the best returns of any asset class in the last 7 years. What role should crypto play in long term investors’ portfolios? On the one hand, completely ignoring crypto going forward means disregarding 7 years of data and missing out on the opportunity to earn substantial returns. On the other hand, the huge runup in crypto prices this year begs the question: Does crypto have a long-term expected return? Or, rather, what known asset class should crypto long term returns resemble most closely?
Advocates of Bitcoin have a simple and powerful story: Bitcoin is a decentralized sound money system. With a fixed supply of coins, the price has to increase as adoption increases. Other cryptocurrencies may have different technical specifications, making trade-offs between security and faster transaction times, network computation capacity, anonymity and other technical features, but they all share this basic story: a decentralized financial system which is not controlled by any central bank or government.
I am not trying to disprove or dispute this story. Rather, my goal is to understand at a fundamental level which asset class crypto resembles most clearly. This should be helpful in thinking about possible long term implications of investing in crypto and expected returns.
One way to think about coins such as ethereum, bitcoin and its clones is as ingredients required to run decentralized open payment networks. We can think of the coin as a commodity that is an input into making a payment network, similarly to how nickel is a commodity that goes into making electric car batteries and oil is a commodity that powers our fossil fuel driven economy.
Cryptocurrencies are commodities. They are digital, modern age commodities but commodities nonetheless. They are not the final product, but an ingredient, an input. I posit, therefore, that in the long run, cryptocurrencies will have a similar return profile to commodities. Let’s take a look at some charts:
Thus, investors should treat cryptocurrencies as commodities for the purpose of porfolio allocation strategies. The aim of this analysis is strictly to understand the expected return profile of crypto going forward, not to analyze usefulness of crypto or blockchain technology.