Goldman Sachs has admitted that bitcoin could succeed as a form of money.
In a nine-page research note on cryptocurrencies, analyst Zach Pandl said bitcoin could work if 'it proves capable of facilitating transactions at a low cost and/or providing better risk-adjusted returns for portfolios'.
In practice, however, the bar looks high Pandl acknowledged. 'The currencies of most developed market economies already deliver these monetary services quite well. And if blockchain technologies go mainstream, as seems likely, the bar will look even higher.'
However, in countries where traditional services of money are not adequately supplied, he said bitcoin and other cryptocurrencies could succeed in terms of facilitating transactions at a lower cost and/or
providing better risk-adjusted returns for portfolios.
Yet Pandl thinks these gains look small, especially in developed markets. 'Transaction costs are relatively low, exchange rates and price inflation are broadly stable, precious metals can be used for portfolio diversification, and governments place few restrictions on holding foreign currency or foreign assets'.
Having said that, Pandl highlighted that the widespread use of the dollar outside the US and full dollarisation in some countries—suggests there is already demand for an internationally accepted medium of exchange and store of value.
'In those countries and corners of the financial system where the traditional services of money are inadequately supplied, bitcoin (and cryptocurrencies more generally) may offer viable alternatives.'
The new gold?
The Goldmans note, published on Tuesday evening, came before bitcoin crashed by 14% on Wednesday morning after South Korea said it was looking to ban cryptocurrency trading.
In his note Pandl said digital currencies generally face significant practical hurdles to their adoption of outside forms of money, with many of their possible benefits coming with significant drawbacks.
He pointed out that some features of cryptocurrencies that might make them competitive with alternative stores of value are also features that are likely to attract government scrutiny.
'[In particular] the anonymity of many cryptocurrencies makes them a useful medium of exchange for criminal activities, including tax avoidance and the circumvention of capital controls,' Pandl said.
'As such, it would be surprising if continued growth in their popularity did not eventually attract greater regulation and law enforcement action by government.'
Another issue comes from the fact that cryptocurrencies function without central banks, which while making valuable inflation hedges or stores of value, also makes them vulnerable to demand-drive fluctuations in price.
'Such volatility makes them poorly suited as a substitute for money generally - which is why most nations eventually abandoned the
gold standard in favour of fiat currencies that can more easily stabilise the purchasing power of money by making the necessary supply adjustments in response to changes in money demand,' Pandl said.
He believes the recent fluctuations in bitcoin and its relatives suggest they are much too volatile to serve as money (see graph above).
'Volatility would likely need to come down dramatically (either naturally or through the widespread adoption of cryptocurrencies designed to better stabilise purchasing power via supply adjustments)
before we see broader adoption,' Pandl said.
Despite their recent high returns, Pandl expects cryptocurrencies to have low expected returns in the long run.
Goldman Sachs' long-term cryptocurrency view is that returns should be equal to (or slightly below) growth in global real output. This equates to a low single digit number.
'Thus, digital currencies should be thought of as low/zero return or hedge-like assets, akin to gold or certain other metals,' Pandl added.
'This could still mean that prices increase at a faster rate as the technology is adopted -an analogy might be the value of a biotech company that invents a drug, which eventually becomes a generic - but there is an inherent contradiction between cryptocurrencies as high return assets on the one hand, and stores of value relative to
goods and services on the other.'