Will cryptocurrencies become an important part of our financial system?

Current issues related to economics, (responsible) investment, pensions and income: every week an APG expert gives a clear answer to the question of the week. This time: macroeconomist and expert strategist Charles Kalshoven on whether the era of institutionalized crypto-currencies has arrived. “Crypto currencies are not going to play a hugely important role in our financial system.”

The U.S. stock market watchdog Securities and Exchange Commission (SEC) last week authorized the listing of mutual funds in bitcoins. This is done through stock market trackers called ETFs, which stands for exchange-traded funds. This makes it possible to invest in bitcoins without owning the crypto currency itself. This was already an option in the EU, Canada and Australia, among others, but now that it is also possible in the world’s biggest capital market, it leads to the question of whether cryptocurrencies have been institutionalized. Kalshoven thinks not. “Crypto coins, or at least bitcoin, were once intended as an alternative to the existing financial system, at a time when banks were anything but popular because of the last financial crisis. Bitcoin creator Satoshi Nakamoto’s idea was that if people trusted each other enough - through a decentralized system and cryptography - banks would be sidelined.”

Difficult to determine value

The irony is precisely that bitcoin is actually encapsulated in the mainstream financial system, Kalshoven continued. “Banks do more than just make payments. They also perform an important intermediary function. People take their savings there, take a mortgage for their home or a loan for their business. Of course, things have gone wrong at banks in the past, often because of too much debt, and rules or supervision that are too lenient. But all the mistakes made by banks in the past hundred years have now been repeated by crypto companies to a greater or lesser extent. Consider the scandal surrounding crypto exchange FTX, which toppled because of too much debt and fraud. The fact that there was too little or no oversight at all was exploited, so it is not surprising things went wrong.”

Thanks to the ETF in bitcoin, offered by asset manager BlackRock, investing in this crypto currency is getting easier. For example, it removes the worry of losing the key to your digital “wallet” containing your crypto coins. “BlackRock takes care of all that now, and for a low fee, too. But the question remains, why would you want to invest in bitcoins? What is its value, and what can you do with it? If you invest in housing, you know that it generates rent every month. Based on the interest rate and risk premium, as an investor, you know roughly what the value of houses in your portfolio is.” Something similar applies to investing in stocks, whose value can be determined based on expected economic growth, corporate profits and dividends. “That way, as a long-term investor, you put together a robust, diversified portfolio.”

In the case of bitcoins, there is no revenue stream, which makes it difficult to determine their fundamental value, Kalshoven said. “The value is determined by supply and demand and the supply is already known. The demand can be determined by the number of useful applications of crypto coins. People have been talking about that for years, but as a payment system, for example, crypto is slow and expensive. In El Salvador, where bitcoin is a legal tender, it doesn’t seem to be that popular either.”

Private investors

Kalshoven compares speculating with crypto currencies to a pyramid or marbles game. “If more and more people want to buy marbles - and there is only a limited number of them - then those marbles will increase in value. Until the moment the popularity of marbles collapses and people start selling them. Then their value can drop hard. That is also a major reason why crypto coins are not an attractive asset class for institutional investors like pension funds and insurers.” The huge and constant fluctuations in the value of crypto coins also contributes to this. “Adding a new asset class should make a portfolio more attractive, either through higher expected returns or more stable returns. The latter happens when a category fluctuates opposite to, say, stocks. But that is usually not the case with bitcoins.”

Bitcoin has now become more accessible to retail investors. Kalshoven: “Actually, ‘investing’ is not the right word; it’s more like speculating. But then again, you can also gamble on soccer matches, so why not on the price of bitcoin? I also do have the impression that the population of bitcoin fans has shifted somewhat from cryptocurrency enthusiasts in the early years to people with a speculation motive now. Typical of the latter group is that they often respond to critical voices with ‘have fun staying poor’. That doesn’t sound very idealistic. I guess this ETF from BlackRock will stay, and bitcoin won't disappear either. But I haven’t seen a groundbreaking application after all these years, so that doesn’t mean crypto currencies will play a hugely important role in our financial system.” Kalshoven believes this has to do not only with the lack of a fundamental value of the currency, but also with the fact that crypto coins can be misused for illegal purposes, and with the large amounts of energy required to “mint” bitcoins.

Proof first

So, our APG economist does not think that the era of institutionalized cryptocurrencies has arrived. “You could say that now that bitcoin is encapsulated in the existing financial system; it has just not proven itself as an alternative to our current money system. I think central bank digital currencies (CBDCs - Central Bank Digital Currencies) have a better chance of growing into a serious part of our payments system. For that, by the way, you also pass commercial banks - perhaps some consolation for Satoshi Nakamoto after all.”