The Real Message from Goldman Sachs' 60 Page Report on Crypto
The most interesting conclusions from the report are the ones that weren't made explicitly
Even for those of us bullish on crypto, it is hard to know where to invest for the long term. One problem is the dearth of dispassionate, unbiased commentary in the space; all the various projects are of course bullish on themselves, and aside from them, crypto Twitter seems to be populated with an array of characters who have cast themselves into a role of being “pro-Bitcoin” or “pro-Ethereum” at some point and now seem stuck that recommendation no matter what. All this is why I found a recent 60 page report on the crypto space from Goldman Sachs to be a breath of fresh air. The report covers the whole range of crypto assets, from Bitcoin and stablecoins to the various categories of tokens involved in DeFi. The report is aimed at making a recommendation on whether GS clients - think high net worth individuals - should invest in crypto. In this post, I’ll cover the one concrete conclusion they come to - that they do not think it wise to invest even 1-2% of one’s investment portfolio in Bitcoin - as well as the much more interesting conclusions they did not fully lay out, but strongly hinted at.
Goldman believes Bitcoin is too volatile and probably overvalued
Goldman’s main conclusion is that they recommend against their clients investing in Bitcoin because, using typical risk vs. reward heuristics widely used to value investment assets, Bitcoin is far too volatile relative even to its impressive 60%+ YOY price appreciation. Of course, a Bitcon proselytizer would counter that Bitcoin is a fundamentally new technology, built on top of relatively new innovations that take advantage of this unique historical moment where internet access and smartphone usage are at all time highs and increasing worldwide, while trust in many centralized institutions wanes, etc.. However, one must then answer the question: what should the value of Bitcoin be? Is the current $30K-$40K value per Bitcoin justified? Goldman provides a bunch of arguments that Bitcoin is currently overvalued; here’s a summary of the couple I found most compelling:
One seemingly massive use of Bitcoin is as a better method of remittances - the report itself notes that remittance fees worldwide are 7% on average. Still, the entire remittances market is about $500B-$600B. If all remittances were done in Bitcoin, given that a bit under ~20M Bitcoin exist today, that would imply a price of ~$3000 per Bitcoin. In one sense this is pessimistic since there are other uses for Bitcoin besides remittances, but in another sense it is also very optimistic since even today, Bitcoin is not the best solution for remittances even within the crypto space, due to its slow transaction times.
Another potentially massive use of Bitcoin would be if those gold owners who are primarily concerned with inflation instead converted their gold to Bitcoin. I myself am concerned about inflation, and Bitcoin is often brought up as an inflation hedge; however, Goldman makes the simple point that a much less risky and probably equally effective hedge would simply be to buy equities. Sure, during the German hyperinflation, the nominal value of equities did not appreciate as fast as the currency (so Germans who held equities still lost money), suggesting that in the unlikely event of hyperinflation, holding Bitcoin would be better than holding stocks; but if the US experiences double digit inflation over the next 10 years, it seems plausible that equities will track that in nominal terms. If in addition to worrying about inflation, you’re bearish on the US and its status in the world and/or on the dollar as a reserve currency, you could simply diversify further away from US equities into international stocks.
It shouldn’t be too surprising that a traditional financial institution think Bitcoin is overvalued; much more surprising is Goldman’s perspective on the rest of the space.
Goldman is quite bullish on DeFi
What about the other assets in the space? GS breaks down the space as follows: first, they distinguish between digital coins - which they further subdivide into cryptocurrencies such as Bitcoin and stablecoins such as USDC - and digital tokens, which are mostly utility tokens but also include governance tokens and NFTs. The canonical example they give of a utility token is the Basic Attention Token that forms the basis of the Brave browser: advertisers can purchase this token, and pay users to show them ads.
It is curious, and I think revealing, that they don’t here choose as their example the ultimate “utility token”: Ethereum. After all, GS defines utility tokens as tokens that “can be exchanged for some goods or services within a digital network” - by this definition, Ether is unambiguously a utility token, since all the smart contract-based services deployed on Ethereum - Aave, Uniswap, Compound, etc. - involve paying small amounts of Ether to perform various functions within these services. The tokens of upstart competitors Solana and Algorand are also utility tokens, as all these networks allow arbitrarily complex applications to be launched on top of them that users can access by paying with their respective underlying token (ETH for Ethereum, SOL for Solana etc.) Indeed, unlike BAT, which unlocks some functionality within the existing Brave browser, owning ETH, SOL, or ALGO “locks in” your access to any future services that may be launched on these platforms. You may argue that such “DeFi” applications are fads, and that the future involves fewer, not more, people staking liquidity on Uniswap or taking out overcollateralized loans on Aave (as two leading examples), but GS doesn’t address this point. Indeed, they are explicitly bullish on such smart contract blockchain-based “Web 3.0” applications themselves, noting that they can provide, among other features, “shorter or simultaneous settlement cycles”, “reduction in…liquidity and operational risks”, “greater transparency of activity”, “extended market hours”, and “automation of corporate actions via smart contract functionality”.
They go further still, noting that this same infrastructure can power applications beyond financial service, using ticket sales for concerts as an example:
Probably one of the best examples is the use of blockchain to streamline ticket sales, which would hinder the business of ticket scalpers. If every seat at an event—be it a concert or a sports event—is represented by a token, the original buyer of the seat can then resell the ticket if he or she no longer wants it, but the event promoter and the artists or the sports team can receive some of the portion of the resale value. Scalpers, as intermediaries, will be prevented from buying and hoarding tickets in bulk and capturing all the resale value. A company called Blocktix is offering such a service.
Noting how interesting these applications are is one thing; but these applications will ultimately have to be settled on a smart contract-enabled blockchain network and using them will require paying with that network’s utility token; the more people want to use these services, the more valuable these utility tokens will be (and vice versa).
GS’ recommendation on ETH and similar assets: left as an exercise to the reader
Goldman Sachs’ report is a great read for anyone interested in a dispassionate analysis of the long term prospects of the various crypto assets that exist. However, the only concrete recommendation it provides is on Bitcoin; in particular, GS provides no guidance on whether they consider utility tokens good investments, despite seeming quite bullish on such tokens’ potential for powering a range of applications in their respective ecosystems. One wonders whether they wanted to avoid any controversy that could have resulted from making an explicit recommendation here1, and simply hoped savvy readers would fill in this gap themselves.
For those looking for such an explicit recommendation based on this essay: Balaji Srinivasan, in his interview with Tim Ferriss from a few months ago, recommended 50% Bitcoin and 50% Ethereum as a first pass at a crypto portfolio allocation. If one takes the conclusions of this essay and the Goldman report seriously, an allocation of 60% Ethereum, 30% Solana, and 10% Algorand might be smarter.