In its June cryptocurrency report entitled “Digital Assets: Beauty Is Not in the Eye of the Beholder,” Goldman Sachs’ Investment Strategy Group opined for 60 pages on the cryptocurrency ecosystem with the purpose of providing “ … an objective and balanced view on the role of cryptocurrencies in a portfolio.”
While the authors of the Goldman Sachs report believe that “It is likely that blockchain technology will be as high impact in the future as the internet has been over the past several decades,” they see a much more uncertain future for cryptocurrencies and how it will be used by their clients.
I spent four years as an equity analyst at Goldman Sachs (1996–2000), and I have tremendous respect for the firm. However, I was disappointed by the report for many reasons. Most notably, there was a total lack of understanding of the social revolution underway and for the massive positive impact crypto could have on society.
The global investment bank even gave credence to the spurious argument that the 21 million cap on Bitcoin’s eventual supply isn’t relevant “…since there are many cryptocurrencies.” And the report barely mentioned DeFi, a $60 billion market growing by leaps and bounds.
For all the disappointment, I applaud the effort, and believe it to be in good faith. So I suggest serious crypto investors read the entire report. But recognizing that most people won’t read it, here are the 10 points made in the report that I found most telling:
1. Goldman Report Highlights A Wide Spectrum Of Thoughts On The Crypto Ecosystem
At one end of the spectrum are proponents whose basic premise is that the U.S. government is on an inexorable march to currency debasement. Hence, the the world needs trusted alternatives like Bitcoin.
At the other end of the spectrum are naysayers who dismiss cryptocurrencies as having no tangible value as discerned via traditional valuation methods.
Unfortunately, Goldman Sachs is very much in the latter camp, and the report’s authors state that proponents ignore that “ … the reserve currency status of the US dollar is arrived at by world consensus and backed by a $21 trillion economy.”
2. Goldman: ‘Of the three roles that Bitcoin was purported to play in the real world, we believe that none has materialized,’ including store of value
Goldman’s report noted that the original objective of Bitcoin was a peer-to-peer payment system (i.e. a currency). However, the digital currency is too slow, and its throughput is too limited, to serve that purpose. Goldman also stated that Bitcoin is too volatile to be a medium of exchange. Its volatility also precludes the cryptocurrency from being a unit of measurement for pricing goods like crude oil.
Most notably, the authors of the report don’t believe that Bitcoin’s a long-term store of value or an investable asset class for diversified portfolios. Interestingly enough, Goldman Sachs has stated before that it doesn’t believe gold to be an investable asset class either. So claiming that Bitcoin is “digital gold” doesn’t confer any value to the digital currency.
3. Goldman On The Bitcoin Blockchain: ‘Its greatest success has been in inspiring the development of blockchains with faster transaction speeds and far greater functionality’
Goldman highlighted Ethereum’s enablement of decentralized applications (DApps) on its blockchain, built to use smart contracts, which allow computer programs to be executed on the blockchain. Goldman highlighted these six blockchains:
But Goldman gave no insight as to why these six blockchains were highlighted, while others, like Cardano, Stellar, Casper, and Avalanche, were not.
The first section of the report (Understanding the Digital Assets Ecosystem: Bitcoin, Blockchains and Web 3.0) finishes with “Use Cases of Blockchain Technology,” with only a brief discussion of DeFi.
4. Goldman: “We do not believe that cryptocurrencies are a strategic asset class that adds value to our clients’ portfolios”
The Goldman Sachs report describes Bitcoin as “the oldest and has the largest market capitalization among cryptocurrencies.” Bitcoin was not the first cryptocurrency, as various parties worked on cryptocurrencies before the first units of bitcoin were mined in 2009.
The second claim made in the report, that bitcoin is the largest cryptocurrency by market value, was true at the time of this report, according to CoinDesk data.
Due to bitcoin’s prominence in the word of digital currencies, Goldman focused on this particular digital asset to present the analysis that crypto is not an investable asset, as it does not meet at least 3 of the 5 criteria:
- Generate steady, reliable cash flow on a contractual basis, like bonds
- Generate earnings through exposure to economic growth, like equities
- Provide consistent and reliable diversification benefits to a portfolio
- Dampen volatility
- Provide consistent and reliable evidence of hedging inflation or deflation as a store of value
According to Goldman’s “robust optimization model,” given it’s volatility, risk premium, and Sharpe ratio, Bitcoin would need to return 165% per annum to strategically allocate 1% of a moderate-risk portfolio to Bitcoin. Since January 2014, Bitcoin has provided an annualized return of 69%, far from the levels Goldman would need to justify an allocation.
To me this is nonsensical and needs more detail to better appreciate how the authors of this Goldman Sachs report can dismiss an asset that has performed remarkably better than any other asset in the history of mankind.
5. Goldman: “The argument that Bitcoin is digital gold and a store of value has three major shortcomings”
First, the Goldman Sachs report disagrees with the assertion that inflation is inevitable. But even if it materialized, the authors don’t believe that Bitcoin is a good hedge because:
- The data does not support the contention that gold is a good store of value during periods of inflation.
2. The frequency and magnitude of Bitcoin price declines are too high to provide the peace of mind that a store of value should provide.
3. For gold bugs, bitcoin and other cryptocurrencies don’t share the key attributes of gold that make it a better store of value than other assets.
This is where Goldman Sachs loses me. The report quotes one gold bug who says that “Bitcoin’s current stated limit of 21 million creates relative scarcity since there are many cryptocurrencies and some are functionally superior.” Aren’t there many commodities that are functionally superior to gold?
Goldman’s report states that “It is virtually impossible to think that central banks will buy Bitcoin to supplement their reserves,” without providing any reasoning whatsoever.
Finally, the document states that “Bitcoin has not behaved like gold” given its low correlation. Therefore, it can’t be digital gold/a store of value. Goldman somehow misses the fact that it has performed far better than gold in terms of “storing value.” But why would gold bugs want that?
6. Goldman: “We believe that it is virtually impossible to build a defensible framework for valuing cryptocurrencies”
Since it can’t be valued, cryptocurrency is an asset whose appreciation is primarily dependent on whether someone else is willing to pay a higher price for it, and that’s not a suitable investment for Goldman’s clients.
7. Goldman: “In our view, there is near certainty that the S&P 500 will rise over the coming decade”
Legendary crypto OG Wences Casares has long made the case that Bitcoin is the world’s greatest asymmetric bet. He told Goldman that “Bitcoin has a higher-than-60% chance of succeeding and being worth more than $1 million in less than 10 years, a 25–30% chance of not disappearing but becoming irrelevant (in which case it will still have a price, but much lower than what it is today, and probably less than $1,000 per bitcoin), and a 10–15% chance of failing and being worthless.”
Goldman Sachs tried to turn that argument against Bitcoin, making the ludicrous statement that U.S. equities are almost certain to go up over the next decade.
As evidence of that view, Goldman writes that “ … the S&P 500 has generated positive total returns 97% of the time over rolling 10-year periods in the post-WWII period.” I’m pretty sure that’s what Goldman Sachs was telling clients about home prices in 2008.
8. Goldman “Regulation is needed to maintain financial stability, protect less-informed market participants.”
Goldman stated that even crypto proponents must recognize the importance of the role the Federal Reserve plays as “… a lender of last resort,” without noting that the policies used by the central bank helped create the massive leverage that caused the economy to implode during great financial crisis.
The reportgoes on to state that the crypto market will inevitably have a credit crisis, and the absence of a lender of last resort makes it unclear whether and how a recovery would be orchestrated.
At the end of the day, what the authors amazingly miss is that it’s all a confidence game. And confidence in the Fed, as well central banks around the world, is waning.
Goldman remains locked in to looking in the rearview mirror to see where we’re going, and fails to recognize the seismic changes underway.
9. Goldman: “We believe the impact of increased regulation, especially from the US, should not be underestimated”
Goldman does not mention the massive regulatory arbitrage going on in the world, where forward looking countries like Singapore, Switzerland, and even El Salvador, are all experiencing an influx of capital and engineers moving to geographies that are promoting crypto innovation, instead of strangling it.
10. Goldman: At some point, proponents of ESG may consider divesting their cryptocurrency activities because of the energy usage and the extent of the illicit activities for which cryptocurrencies are used
There’s lots of great work showing why these arguments lack validity. But more importantly, the Goldman Sachs report makes no mention of the potential for crypto to improve the lives of billions of people through financial inclusion, or something as simple as identity. For crypto proponents like myself, it’s hard to imagine a world in which crypto does not become the greatest benefit to ESG in the history of humanity.
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This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.
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