The Bitcoin salvation scenario

Ultimately, crypto investors must hope that institutional money rides to their rescue

meme by @MAFigueroa

Stocks are down again. Tech stocks are down more, as you’d expect (since stocks with higher expected return tend to go down more when the market goes down). And crypto is down as well. This provides more support for the theory that crypto behaves like a tech stock, rather than an inflation hedge.

The crypto crash understandably has a lot of people upset. Somewhat hilariously, celebrity boxer Jake Paul blamed Joe Biden for letting crypto prices fall:

Jake Paul @jakepaul

Biden accomplishments 1. Highest gas prices 2. Worst inflation 3. Plummeting crypto prices 4. Highest rent prices ever 5. Created new incomprehensible language If you’re reading this and voted for Biden and you still don’t regret it then you are the American problem.

Now, it’s a little bit hilarious to see people calling for government policy to support crypto prices. The whole story of Bitcoin was that it was supposed to make governments and their fiat currencies obsolete — now they’re begging the government to make their crypto worth more fiat? Comedy gold.

But the truth is that Jake Paul is probably not a hardcore Bitcoin bro — he’s just a regular guy who bought crypto because he thought it was a Thing That Goes Up. A Goer-Upper. In financial economics, we call this kind of thinking “extrapolative expectations”.

Well, harsh news: High expected returns almost always come at the price of high risk. Being a Goer-Upper in the long term means that an asset will tend to spend a decent amount of time as a Goer-Downer.

When it comes to Bitcoin and crypto in general, there are scenarios where it does go up in the long term. In a previous post, I laid out one such scenario — a world where web3 figures out how to provide real value to consumers, and where Bitcoin serves as the onboarding process for people to get into web3.

I think there’s another scenario, though, where Bitcoin goes up even more in the medium term. It’s the idea that institutional money will eventually come in and buy up a ton of crypto, pumping up prices to previously-undreamt-of levels. At this point the regular folks who don’t buy into the “Bitcoin will replace fiat” origin myth are probably, on some level, hoping for this sort of institutional bailout. So it’s worth thinking about whether this will happen, and why.

Why would institutional investors buy crypto?