Bitcoin’s Growth Rate

It depends entirely on demand.

Cryptocurrency is here to stay, and the financial services industry has succeeded in convincing investors that it’s another asset class, alongside the traditional ones of stocks, bonds, cash, and so on. The advent of crypto ETFs mainstreamed the asset class to the point of appearing in many portfolios. “You have to own a little crypto, just in case,” is a phrase I hear regularly.

A growing percentage of my readers has requested that I research the possibility of running a rules-based plan for crypto, reminiscent of The Kelly Letter’s Signal plans for the stock market.

The Signal System growth plans introduced in my book The 3% Signal are built on quarterly growth targets derived from the stock market’s long-term growth rate of 10% per year. That is a fundamentally driven pace, arising from the growth of corporate earnings, the lifeblood of the stock market. We can be reasonably confident that stocks will maintain their average annualized growth rate of 10% per year because we have every reason to believe that corporations will continue their focus on growing earnings. Every management team strives for growth.

But what drives growth in crypto?

There seems to be no fundamental reason for a digital, non-productive asset to grow in value. Its price fluctuates, which can be useful, but absent a reason to achieve overall growth over time, how can we be sure it won’t reverse entirely toward zero? It features no earnings foundation.

Let’s explore whether bitcoin offers any organic growth pressure. If so, what is the annualized pace?

The following are the major bitcoin moves since 2015:

Bitcoin Level Change (%)
– – – – – – – – – – – – – – –
+3,184 Dec 2015 to Dec 2017
-74 Dec 2017 to Dec 2018

+1,474 Dec 2018 to Mar 2021
-41 Mar 2021 to Jun 2021

+75 Jun 2021 to Oct 2021
-73 Oct 2021 to Dec 2022

+342 Dec 2022 to 3/13/24
-16 3/13/24 to 4/17/24

After all the fluctuation, bitcoin’s compound annual growth rate since December 2015 tops 85%.

Sustaining such a growth rate is impossible over the long run, and the above history shows the trajectory heavily weighted toward early liftoff, and already slowing considerably. The CAGR since April 2021, for example, is only 3%.

So, what drives the price of bitcoin?

Apparently, just finite supply and fluctuating demand.

Bitcoin exhibits the three functions of money, as explained by the St. Louis Fed. It is a store of value, a unit of account, and a medium of exchange. It has no intrinsic value, but neither do dollars. Bitcoin is made from thin air, but so are dollars. It’s not clear why the world needed another currency, other than to break the chokehold of central banks on mediums of exchange, but once governments regulate and tax crypto this distinction will fade as well.

For now, let’s say bitcoin is neither better nor worse than fiat currency. It’s not quite true because fiat currency is better established. It’s easier to pay for dinner with your credit card than with bitcoin, but I’ll assume further mainstreaming of crypto and call the medium-of-exchange function of cryptocurrency and fiat currency a draw. Fine, but from such a characterization no intrinsic growth rate presents itself.

An advantage of dollars over bitcoin is that they offer a reprieve from stock-market volatility. Bitcoin does not. In fact, it has been more volatile than stocks.

One advantage of bitcoin over dollars is that there’s a restriction on how many bitcoins can be created, whereas the Federal Reserve can conjure dollars to the moon — and does, which is why the purchasing power of the dollar erodes over time, and why you need to invest outside of dollars. Savings accounts don’t cut it, to say nothing of envelopes under the proverbial mattress. Those stores of value pave the way to the poorhouse.

It’s good for bitcoin’s value that its supply is restricted. We cannot know, however, whether demand for it will grow over time. What if it stagnates or declines? All else being equal, its value would decline. It’s possible that the number of bitcoins in circulation will decline, but we can’t know. The supply of bitcoins is capped at 21 million. As of yesterday, there were 19,685,675 in existence. That’s almost 94% of the total supply, with the remaining 1,314,325 being created at a rate of about 900 per day.

To delay the date at which all bitcoins will have been created, the currency’s underlying code includes a halving mechanism. The reward for mining bitcoin is cut in half every 210,000 blocks mined. This happens every four years, and this week marks the fourth halving event. The first halving happened in November 2012, the second in July 2016, and the third in May 2020.

According to NerdWallet:

“When Bitcoin was released in 2009, the reward for miners to validate each transaction block was 50 BTC. The most recent halving occurred in 2020, when the reward was reduced from 12.5 BTC to 6.25 BTC. In April 2024, the next scheduled halving will occur, and the reward will be reduced to 3.125 BTC.”

On the current halving schedule, bitcoin won’t reach its total supply until 2140. The date is so far away, across a time frame that will see the exponential improvement of AI, that I find it hard to believe bitcoin will proceed by initial plan for another century. For practical considerations, we need to consider only whether it will maintain an intrinsic growth rate for another few decades, or remain purely speculative, driven only by fluctuating demand.

Proponents of bitcoin sometimes argue that the currency has intrinsic value because of the vast network of computers required to make and store it, but given that their only purpose in relation to the currency is to make and store it, this rings false. If they were being used to generate profit beyond the asset itself, then maybe, but nobody is going to get their bitcoin investment back from the book value of a miner or other business associated with the asset. Just as paintings and a certain historically famous type of flower did not derive value from the cost of canvas, brushes, and soil, nor does bitcoin derive value from the cost of computers.

Nope, it’s all supply and demand, fear and greed, making it speculative.

As Investopedia put it: “Bitcoin may or may not have a future as an investment.”

Hard to argue with that.

However, bitcoin’s speculative nature does not preclude it from working as an investment asset. To some investors, the stock market is nothing but speculation. I disagree, given the history of earnings growth, but fear and greed drive daily prices far afield of intrinsic worth, such as book value and earnings potential. Stock prices are not logical.

The Signal plans manage this illogic in a rules-based framework to profit greater than the market over time. Such an approach may be possible with bitcoin. Could it be possible without being able to determine an organic appreciation rate?

Yes. A key would be removing rules to keep market exposure high. Such rules are a necessity for long-term stock-market plans if they’re to stand a chance of beating the market, given its upward bias. You would never suspect from prevailing bearishness in mainstream financial media, but the stock market usually rises. Because we can’t know this for certain about crypto, a plan that is happy to methodically remove profits would probably work best.

One promising aspect of bitcoin’s 5-year price chart is that it exhibits a pattern similar to tech-heavy stock indexes, but at much higher volatility, making it look similar to a highly leveraged fund, maybe 5x. This is bad news for those who had hoped to use bitcoin as a hedge against stock-market volatility, but good news for those hoping to apply stock investing techniques to crypto. We already run plans that manage leveraged stock funds, suggesting that a similar approach could be wrapped around bitcoin’s volatility. Such a plan would probably perform best with magnified sell signals under certain conditions.

Specifics of a rules-based bitcoin plan require more research.

For today, know that there is no fundamental reason that the price of bitcoin should rise over time. It depends on demand, which is driven by collective emotion, and is therefore impossible to predict.

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Sources

The 3% Signal
by Jason Kelly

Federal Reserve Bank of St. Louis
Functions of Money

Bitbo
How Many Bitcoins Are There?

CoinCodex
Bitcoin Halving Dates: When Is the Next BTC Halving?

NerdWallet
How Many Bitcoins Are There in 2024?

Investopedia
What Will Happen to Bitcoin in the Next Decade?