Bitcoin has seen a great run both in recent months and over broader history. Yes, it roughly tripled in 2020, but let’s not forget it’s also up around 30-times over the past 5 years. Focus on medium-term price swings, which are undoubtedly extreme, should not obscure that Bitcoin has been one of the great assets to own in recent history. For example, even if the recent rally were to entirely reverse, Bitcoin would still show a strong medium-term track record as an investment asset.
However, all this comes with a catch. Bitcoin is challenging to value. Here, the Lindy effect is useful in assessing valuation for the cryptocurrency.
The Lindy Effect
The Lindy effect, or Lindy’s Law, named after a New York delicatessen where comedy shows were discussed, argues that for a non-perishable object, its life expectancy increases with how long it has lasted. This is true for comedy shows, but also perhaps digital currencies.
For example, its reasonable to think that the Great Wall Of China at over two thousand years old, will continue to be around for many centuries. However, we can’t say the same for the iPhone 12 launched last October, which has just been around for months, and it’s a fair bet will be obsolete in just a few years as technology moves on. As things exist for longer, so their life expectancy increases according to this theory.
This matters for Bitcoin. Early in its life there were fears it could be hacked or the technology would fail. This hasn’t happened. Yes, Bitcoin wallets and other means of storage have seen various issues and failures, but the underlying technology has not.
As Bitcoin continues to exist for longer, so following Lindy’s Law we might expect it to be around for longer. This suggests that all else equal, the value of Bitcoin may trend up over time as it proves itself. Indeed, this is broadly what has happened, though Lindy’s Law can’t account for quite as extreme price swings as we’ve seen. In fact, in the 2017 rally, Bitcoin was many cryptocurrencies surging in value. Indeed Bitcoin was actually a relative laggard for some of the 2017 run-up compared to other digital currencies. Those seemed hotter at the time. Now many are burned out. This time around in the 2020-2021 rally it’s mostly about Bitcoin, there’s lots of innovation in the space still, but many other cryptocurrencies have fallen by the wayside in recent years.
That said, this same argument also gives us reason to pause for Bitcoin. Bitcoin has only existed for a little over a decade. That’s not long in investment terms. If it existed for merely another decade, then many investors would be devastated and today’s valuation would make little sense.
So we’ve seen enough success from Bitcoin to be confident that will be a meaningful part of the investment landscape for several years, but certainly not enough that it will approach the relative timelessness of an asset like gold.
Gold does offer a good comparison for Bitcoin. Gold has been used as a store of value throughout history. Bitcoin can’t claim that, and indeed following the Lindy effect it would be many centuries before it may be able to claim even close to the track record of gold as an investment. With each year that passes, Bitcoin becomes a more credible investment, though it still has some way to go when compared to more established assets.
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