Theoretical Four Asset Classes: How Bitcoin Fits In and Its Future Valuation
There is an ongoing debate over the future of Bitcoin, with opinions sharply divided. Currently, the spot market price of Bitcoin stands at $66,587.10. Some experts predict it will breach $1 million, while others argue that Bitcoin is a speculative bubble reminiscent of the tulip mania of the 17th century. To investigate this issue scientifically, we will begin with a deductive analysis of economic mechanisms, categorize assets into four main types, and examine how Bitcoin fits into these categories. Our objective is to validate our theory using evidence-based data, providing a comprehensive understanding of Bitcoin’s place in the financial ecosystem.
Gold: The Proven Store of Value
Let’s start with gold. Gold has been a valuable asset since ancient times due to its unique properties and intrinsic value. Its durability, malleability, attractive color, resistance to corrosion, and scarcity made it an ideal candidate for use in monetary systems. These characteristics led civilizations to recognize gold as a store of value, transcending generations and geographical boundaries.
The Greeks were among the first to use gold coins in commerce over 2,500 years ago. Gold remained the cornerstone of monetary systems well into the 20th century. For instance, Great Britain adopted the gold standard in 1717, followed by the United States with a gold-silver standard in 1792. These systems pegged the value of local currencies to specific weights of gold or silver, ensuring stability and trust in the currency.
The onset of World War I challenged the gold standard, as major economies expanded their monetary supplies to finance the war. Post-war monetary stability was restored with the Bretton Woods Agreement in 1944, which established the U.S. Dollar, backed by gold, as the primary global currency. This system persisted until 1971, when the U.S. officially abandoned the gold standard, transitioning to fiat currency — government-issued money without intrinsic value or gold backing.
Bitcoin: Digital Gold or Modern Tulip Mania?
Bitcoin’s rise has sparked significant debate over its long-term value and utility. Often referred to as “digital gold,” Bitcoin shares several characteristics with gold: scarcity, durability, and divisibility. However, its role as a medium of exchange and a store of value faces significant challenges when compared to traditional fiat currencies and gold.
Bitcoin’s potential as a medium of exchange is hampered by several factors. First, its price volatility makes it difficult to use as a stable medium of exchange. The value of goods and services can fluctuate significantly if priced in Bitcoin, leading to uncertainty and reluctance among merchants and consumers. Second, while Bitcoin transactions can be fast, they are often slower and more costly than those involving fiat currencies, particularly during times of high network demand. This inefficiency limits Bitcoin’s practicality for everyday transactions.
In contrast, fiat currencies are designed to be stable and widely accepted for daily transactions. Central banks manage the supply and value of fiat currencies to ensure economic stability. With the development of Central Bank Digital Currencies (CBDCs) and stablecoins like Tether (USDT) or USD Coin (USDC), the role of Bitcoin as a medium of exchange becomes even less compelling. These digital assets provide the benefits of digital currency while maintaining the stability of fiat money.
Bitcoin is often touted as a store of value similar to gold, but this comparison has its weaknesses. Gold has intrinsic value due to its physical properties and historical significance as a monetary metal. It is used in jewelry, electronics, and other industries, giving it a tangible value base. Bitcoin, on the other hand, derives its value primarily from market perception and speculative interest. Additionally, gold has a long history of maintaining its value over centuries. It is seen as a hedge against inflation and economic instability. Bitcoin’s history is much shorter and marked by significant price swings, raising questions about its reliability as a long-term store of value.
The emergence of asset-backed tokens like PaxGold (PAXG), which combines the stability of gold with the advantages of digital assets, challenges Bitcoin’s position as a store of value. These tokens are pegged to physical gold, offering investors a digital asset that maintains intrinsic value and stability.
As digital assets and financial technologies evolve, Bitcoin’s perceived advantages may diminish. Stablecoins and CBDCs provide efficient, stable mediums of exchange, while asset-backed tokens like PAXG offer secure stores of value. These developments could lead to a scenario where Bitcoin’s price and utility decrease over time, as it is overshadowed by more stable and practical digital alternatives.
Theoretical Four Asset Classes: Nature of Return and Risk
The categorization of assets into four types helps to understand their distinct roles in an economy and their varying risk and return profiles. This division is based on the fundamental characteristics and functions of each asset class.
Medium of Exchange: Fiat Currency
Fiat currencies are government-issued currencies not backed by a physical commodity like gold. They derive their value from the trust and authority of the issuing government. Examples include USD and GBP, which are 100% fiat currencies with no asset backing. In contrast, EUR and JPY are typically fiat but occasionally backed by assets through certain monetary policies, while THB (Thai Baht) is based on a basket of values, making it slightly different from pure fiat currencies.
Fiat currencies are essential for daily transactions and liquidity. However, they are prone to inflation, leading to a loss of purchasing power over time. Central banks in modern economies manage the money supply (M2) and policy interest rates to keep inflation around 2% annually. This ensures economic stability but means fiat currencies generally have low returns and minimal risk.
Store of Value Assets
Store of value assets are those that retain or increase in value over time, providing a hedge against inflation. These include gold and other precious metals, valued for their intrinsic properties and historical significance, as well as certain commodities and high-quality bonds. These assets are characterized by moderate fluctuations and have historically provided returns that outpace inflation, making them suitable for preserving wealth over the long term.
Investment Grade Assets
Investment-grade assets are those that meet or exceed certain credit quality criteria, offering reliable returns with higher risk compared to store of value assets. Examples include pension funds, mutual funds, and ETFs benchmarked to indices like the S&P 500. These assets offer higher returns due to their exposure to a broad range of industries and economic sectors. They provide a balance between risk and return, making them attractive for long-term growth.
High Growth Assets
High growth assets are those with the potential for substantial returns, driven primarily by innovation. This category is particularly relevant in the context of an aging society and declining reproductive rates, where demographic growth is limited. Innovation becomes the key driver of economic growth. Examples include technology stocks, venture capital investments, and ETFs focusing on innovative sectors such as QQQ. These assets are associated with the highest risk but also the highest potential returns, making them suitable for investors seeking significant growth.
Based on the above characteristics, we theorize four asset classes:
- Medium of Exchange: Low fluctuation, but loses value against inflation.
- Store of Value Assets: Moderate fluctuation, but win over inflation, hence preserve value.
- Investment Grade Assets: Higher fluctuation, but promising returns.
- High Growth Assets: Highest risk and highest return, tied to innovation.
Testing Our Hypothesis with Evidence-Based Data
Medium of Exchange (BIL)
The first asset class we examined is the medium of exchange, represented by the SPDR Bloomberg Barclays 1–3 Month T-Bill ETF (BIL). This asset class is characterized by its low growth and minimal risk. The Compound Annual Growth Rate (CAGR) for BIL is 0.94%, reflecting its stable nature. The variance, at 2.72e-08, and the standard deviation of 0.000165 highlight its minimal risk, making it a reliable but low-return investment. This asset class is crucial for daily transactions and liquidity management.
Store of Value (GLD)
Gold (GLD) serves as our store of value asset class. With a CAGR of 4.90%, gold has historically been a stable and moderately growing investment. The variance of 7.78e-05 and the standard deviation of 0.008818 indicate moderate risk. Gold’s intrinsic value, due to its physical properties and historical significance, makes it a preferred choice for long-term value preservation. This asset class is seen as a hedge against inflation and economic instability, providing a safe haven during market volatility.
Investment Grade Assets (SPY)
The investment class is represented by the SPDR S&P 500 ETF Trust (SPY). With a CAGR of 13.46%, SPY reflects the higher growth potential of broad market investments. The variance of 1.27e-04 and the standard deviation of 0.011287 illustrate higher risk compared to medium of exchange and store of value assets. This class includes a diversified portfolio of large-cap U.S. companies, offering investors exposure to overall economic growth and stability. SPY is ideal for long-term growth and wealth accumulation.
High Growth Assets (QQQ)
The innovation-driven asset class is epitomized by the Invesco QQQ Trust (QQQ). This class has the highest CAGR at 18.19%, driven by its focus on technology and consumer discretionary sectors. The variance of 1.94e-04 and the standard deviation of 0.013940 reflect the high risk associated with this class. Companies within QQQ are leaders in innovation, driving technological advancements and market disruption. This asset class offers substantial growth potential but comes with significant volatility and risk.
Bitcoin: A Speculative Outlier
Bitcoin (GBTC) was also analyzed, showing a remarkable CAGR of 66.29%. However, its variance of 3.01e-03 and standard deviation of 0.054869 highlight its extreme volatility and speculative nature. While Bitcoin has achieved significant growth, its high risk and volatility differentiate it from the traditional asset classes. Its role as a medium of exchange and store of value is challenged by the emergence of stablecoins, CBDCs, and asset-backed tokens, which offer more stability and practicality.
Conclusion
Our theoretical framework categorizes assets into four main types, each with distinct characteristics in terms of return and risk. Medium of exchange assets like BIL provide stability with minimal risk, while store of value assets like GLD offer moderate growth and risk. Investment-grade assets like SPY deliver higher growth with higher risk, and innovation-driven assets like QQQ present the highest growth potential alongside significant risk. Bitcoin, with its high volatility and speculative nature, stands apart from these traditional classes.
Evidence-based data validates our theory. For instance, the SPDR Bloomberg Barclays 1–3 Month T-Bill ETF (BIL) showed low growth and minimal risk, aligning with the characteristics of a medium of exchange asset. Gold (GLD), as a store of value, demonstrated moderate returns and risk, consistent with our theoretical expectations. The SPDR S&P 500 ETF Trust (SPY) provided higher returns and higher risk, typical of investment-grade assets, while the Invesco QQQ Trust (QQQ) exhibited the highest returns and significant risk, fitting the profile of high-growth assets.
Bitcoin’s performance, with a CAGR of 66.29% and high volatility, parallels the returns seen by elite funds like the Medallion Fund. However, Bitcoin’s lack of intrinsic value and the potential for competition from more advanced digital assets suggest it may depreciate over time. This aligns with our theory that assets without intrinsic value and subject to high speculation are prone to volatility and long-term decline.
We deduce that while Bitcoin currently appreciates at a rate similar to high-performing funds, its future is uncertain. Given the rapid development of stablecoins, CBDCs, and asset-backed tokens, Bitcoin may face significant challenges. We hypothesize that Bitcoin’s value may decline within 20 years of its inception, as competition and technological advancements overshadow its perceived advantages. This period roughly aligns with the timeline since Satoshi Nakamoto’s white paper.
Investors should remain vigilant, recognizing Bitcoin’s potential for continued uptrend due to perceived intrinsic value — a concept similar to Soros’s reflexivity. However, this uptrend is uncertain and subject to high risk. The evidence-based analysis underscores that Bitcoin follows the initial part of our theory, characterized by high returns and high risk, but its long-term viability remains in question.
Liquidity is often overshadowed by discussions of risk and profit, yet it plays a crucial role in financial stability and the ability to capitalize on opportunities. It acts as a buffer during times of uncertainty, providing the flexibility needed to navigate economic downturns and avoid the forced sale of assets at unfavorable prices. Liquidity serves as a protective shield against unexpected events like market volatility and economic disruptions. Unlike overleveraged positions, a highly liquid portfolio or business can absorb shocks without the need to sell assets at a loss or incur additional debt, preserving capital and maintaining financial stability.
One of liquidity’s greatest strengths is its ability to enable quick action when opportunities arise. In times of crisis, when other investors are forced to sell, those with liquidity can purchase high-quality assets at discounted prices, allowing for strategic decision-making and better timing in investments. During economic downturns, liquidity becomes a lifeline, positioning companies and investors to meet obligations, sustain operations, and invest in growth, even when revenues decline. By ensuring solvency, liquidity helps avoid the devastating consequences of financial distress.
Warren Buffett’s success is a testament to the power of liquidity. His strategy of maintaining substantial cash reserves at Berkshire Hathaway enables him to act decisively during market downturns, buying assets at attractive prices when others are forced to sell. This conservative approach to financial management ensures stability and long-term success. Liquidity is the unsung hero in financial strategy, providing the resilience needed to weather economic storms and seize opportunities. It’s a crucial, yet often underappreciated, component that ensures sustainability and adaptability in both investments and business operations. In a world focused on risk and profit, liquidity stands as the quiet force enabling long-term financial success.
