Ray Dalio’s essay ‘What I think of Bitcoin’ appeared on 28 January 2021, and is a clear signifier that the asset class has truly crossed over into the institutional imagination.
For those uninitiated few, Dalio is one of the most lauded billionaire investors, serving as joint head of the world’s largest hedge fund, Bridgewater Associates. With $150bn of assets under management, Dalio’s Bridgewater invests capital for the richest entities on earth, including government pension funds, central banks, charitable foundations and university endowments.
As with Scott Minerd of Guggenheim Partners, or The Big Short inspiration Michael J Burry, gurus and financial professionals hang on his every word, waiting for nuggets of insight that could signify where the next major investments should be made.
So to see Dalio dig deep into Bitcoin and show interest in to what extent the cryptocurrency should form part of standard portfolio asset allocation? This is serious business. In truth, he is just the latest in a long line of dominos to fall.
We’ve come a very long way from institutional scorn over Bitcoin. We’re a world apart from infamous assessments like Warren Buffett’s “rat-poison squared”, or JP Morgan CEO Jamie Dimon’s “fraud...worse than tulip bulbs”.
“I believe Bitcoin is one hell of an invention. To have invented a new type of money via a system that is programmed into a computer and that is rapidly gaining popularity as both a type of money and a storehold of wealth is an amazing accomplishment,” he begins.
Dalio now subscribes to the idea popularised by JP Morgan that Bitcoin has become an “alternative gold-like asset”, and because there are not many of these gold-like store of wealth assets available — while central banks continue to flood markets with cheap cash and implement once-emergency policy levers of infinite quantitative easing — “Bitcoin and its competitors can fill that growing need.” Bitcoin’s hard-coded scarcity makes it “especially attractive,” too.
“The big questions to me are what it can realistically be used for and what amount of demand it will have. Since the supply is known, one has to estimate the demand to estimate the price.”
It is this institutional demand that will determine Bitcoin’s future.
Dalio — who caveats his essay with the assertion that “I am not a Bitcoin expert” — is nevertheless a useful proxy for the average institutional knowledge of the market.
This candour belies one obvious error.
“While I recognize that Bitcoin can be held offline via ‘cold storage’, I understand it is difficult to do and that very few people actually do it,” he writes.
As knowledge of the options widens, it’s likely that institutional investors will seek out cold storage custody services whose security includes critical functions like multi-party computation and key sharding.
Much institutional portfolio allocation rests on the twin priorities of moving quickly to exploit opportunity while determining appropriate risk profiles.
“Holding on to digital assets at a time when cyber offense is much more powerful than cyber defense, the cyber risk is a risk that I can’t ignore,” Dalio writes.
Citing but not naming the recent SolarWinds hack, he notes: “When the Department of Defense can’t protect its systems from being hacked it would be naive to be totally comfortable that digital assets can’t be hacked [as] one of the advantages of gold-like assets.”
And with more countries researching and implementing central bank digital currencies: “I think there is a good chance that someday we will see the financial system, which consists mostly of digits, be shown to be more vulnerable to disruption and/or to cyber blackmail than is now recognized.”
It appears clear, now, that major asset managers like Bridgewater Associates will seek out cryptoassets with the most secure networks. 51% attacks on little-used cryptoassets like Ethereum Classic, and repeated leaks from cryptoexchanges as large as Binance prove this point.
We would also expect spending on cryptoasset custody to increase exponentially.
“Since the way Bitcoin works is fixed, it won’t be able to evolve and I presume that a better alternative will be invented as pass it by,” Dalio asserts.
This assessment does not, of course, take into account the evolution of Ethereum, whose multi-year network switch away from Proof of Work to Proof of Stake is already transforming its usage and utility.
But that Dalio and his institutional colleagues are already looking ahead to the ‘next’ Bitcoin is inherently bullish, in our opinion.
As part of the Bridgewater Associates outlook, Dalio commissioned four researchers to look at the path ahead for Bitcoin if it is to become an alternative storehold of wealth. They express traditional concerns over price volatility, market size and liquidity, which Dalio himself admits are likely to be smoothed as adoption continues, but note that regulation casts the longest shadow.
These analysts write: “Bitcoin still faces meaningful regulatory tail risks and lacks any of the underlying government backing or deep history that would provide a more fundamental baseline of future demand. While greater regulation might help Bitcoin gain broaden institutional acceptance, it could also trigger selling by some of its largest existing owners whole prioritize a lack of public oversight around the asset.”
Their conclusion is ever cautious: “We see it as more like buying an option on potential ‘digital gold’ — it has a wide cone of outcomes, with one path leading to it becoming a true institutionally accepted alternative storehold of wealth.”
What of the future of Bitcoin?
“It seems to me that Bitcoin has succeeded in crossing the line from being a highly speculative idea that could well not be around in short order,” Dalio asserts.
He notes that “future challenges may still come from quantum computing, regulatory backlash, or issues we haven’t yet determined.” To this first point, we would say that the world is many years away from widespread quantum computing use. The first such working machine was only built in 1998, and 20 years later they remain the preserve of military installations and research laboratories at IBM and Google.
The regulatory angle, as ever, is likely to be where we see the greatest conflict and opportunity.
Nowhere was this more obvious than in the recent Senate confirmation hearing of Joe Biden’s Treasury Secretary Janet Yellen, as Dalio’s researchers confirm.
Selectively reported comments that Yellen had a suspicious outlook on Bitcoin cast a gloomy pall over the market, until her speech was parsed in more detail as quite positive for cryptocurrency as a whole.
The researchers note: “Bitcoin, for now, feels more to us like an option on a potential storehold of wealth.”
And while Dalio himself recognises the “uncertain” future they paint, he concludes: “To me, Bitcoin looks like a long-duration option on a highly-unknown future.”
It is also heartening to hear that even billionaires do not assume they know everything. “I am eager to be corrected and to learn more,” he says.
Bitcoin is king. And in Ray Dalio and Bridgewater Associations it has supremely powerful potential new champions. Toppling it will prove more unlikely than ever before.
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