I do not invest in crypto and am reluctant even to consider cryptocurrency as an asset class. You can think of me as a hater, and if I could have bet against cryptocurrency, I would have. Why would any rational investor put their hard-earned money into something that is so speculative and is not backed by any store of value when you could get outsized returns in the equity market? People just like being wrong and losing their money.
Yet, I can’t shake the feeling now that I am the one who is wrong.
Reasons why Bitcoin would never succeed
The most significant headwind to the widespread adoption of bitcoin is the core underlying technology behind the currency, decentralization.
Governments and banks lose control
For the US dollar, we have the Federal Reserve, our central bank, that determines our monetary policy and works with our central government to move money in and out of our economy. Each country has its central bank that functions the same way as the Fed — since central governments regulate all currency, every nation tightly controls its money supply.
The demand for each currency determines the international exchange rates, and Forex traders make money following these trends. Bitcoin, being a cryptocurrency, is not regulated by any central bank or monetary policy. Instead, the supply is determined by the current protocol, allowing for a fixed amount of 21 million coins circulated.
Lack of regulatory oversight also means more crime. Criminals can use bitcoin to move money across borders quickly without the need to pay tax, nor can the movements be traced to them. Current banks and financial institutions prevent this through KYC (know your customer)and AML (anti-money laundering) policies. The ease of bitcoin in the facilitation of crime leads to resistance in adoption.
Loss of investment
The decentralization approach of Bitcoin offers anonymity; however, it also makes it impossible to prove ownership if the owner loses or forgets the password to the bitcoin wallet. I know of a friend who has a few bitcoin stuck on his computer from high school. If a thief steals our bitcoin, it is nearly impossible to trace where the location of the stolen coins and funds.
Having strong opinions weakly held is a pretty standard turn of phrase in the tech startup community. Moreover, I think emerging investors also need to adopt this mindset for long term success. No matter how much research or work backs a thesis, the market is fickle and will humble anyone in a heartbeat. Being able to recognize when we are wrong and change directions quickly will help us recover quickly from a series of bad decisions to avoid drastic underperformance.
Let’s look at what has changed for Bitcoin and the supporting points for my investment thesis.
The staying power of bitcoin
Bitcoin came into existence in early 2009 and started trading for real value on July 12, 2010. It’s been a little over ten years since, and not only has bitcoin not crashed and burned as I thought it would, but bitcoin’s trading volume has been steadily increasing.
What this tells me is that enough people believe in bitcoin as an asset class that the market supports $4.3 billion in bitcoin liquidity a day. The more liquid an asset becomes, the more stable the price of the asset becomes. We saw this above with the Fed injecting liquidity into the repo and bond markets! What’s exciting here is that the continued drop in volatility makes bitcoin more accessible and inviting to long-term investors.
The CARES (Coronavirus Aid Relief and Economic Security) Act is a $2.2 trillion response to the shutdown of businesses by the US government to prevent a deep recession brought on by a global pandemic.
The Federal Reserve resorted to printing money (digitally) and issued new debt to finance our $2,200,000,000,000 stimulus package, broken down to zeros and commas for effect. As a nation, we will need to pay down the $2.2 trillion principal plus interest in the future. Congress is currently convening on a second COVID-19 stimulus package that will potentially add another 2 trillion dollars to the tab. For context, the Iraq war has cost the US government an estimated $1.9 trillion over the last two decades. The war against COVID-19 is one the US government cannot afford to lose.
Printers go brrrrrrr
The Federal Reserve’s job is to keep inflation in check while balancing the unemployment rate. In times of economic growth, monetary hawks make sure inflation stays below 2% a year. In times of financial hardship like our current pandemic, money is pumped into the system to keep unemployment numbers below 10%.
Outside of paying for congressional bills, the Federal Reserve also injects money into our financial markets. It acts as a buyer to stabilize asset prices during turmoil to avoid a systematic crash like The Great Depression. During the past few months, the Fed purchased nearly $9 billion in fixed-income ETFs and had announced $1.5 trillion in capital injections to stabilize the repo markets.
Previously, I wrote a short writeup that explains how our central bank injects money into the economy in response to the repo markets.
We can see the inflationary effects of the Fed’s actions in our M1 money supply.
To learn more about our money supply and macro-economic impacts on the stock market, signup and play Paper Chase, an investing role-playing game developed by Archimedes.
Will the US default on its debt?
The question on everyone’s mind is, should we be worried about what seems to be the US debt ballooning out of control? Will the US default on the loans? The short answer is NO.
The US has a significant advantage over many other countries by issuing its debt denominated in US dollars. The USD denomination means that the borrower (the US) pays back the interest and principal payments in USD to the lender. And when payment is due, the government always has the option to have the central bank print money to pay off the loan.
“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default”. — Alan Greenspan, Former Fed Chair
“debt isn’t going to be paid, it’s going to be refunded” — Warren buffet
Not every country has this luxury. For example, Argentina’s currency is the pesos, but their debt is in dollars. The central bank of Argentina cannot print dollars for the debt payment. Instead, the bank prints pesos and then exchanges the pesos on the Forex market for dollars. The continued printing of pesos increases the supply of pesos while simultaneously, the exchange rate for dollars drops. This steep devaluation of the currency becomes a real problem because the ability for Argentinians to pay off loans decreases every day, eventually leading to a default.
Inflation and bitcoin
Ok, so now that we know that the US debt isn’t an issue and that we will keep printing money. What is the argument for buying bitcoin?
Bitcoin, unlike the USD, has a ceiling in supply. The protocol limits the pool of bitcoin to 21 million coins, with around 18 million coins currently in circulation. The process of mining for the remaining 2.6 million coins increases in difficulty, and may take many decades to reach the full supply of 21 million coins. Two possible scenarios will drive up the price of bitcoin.
- The current increase in M1 still doesn’t account for the additional printing of USD to pay future debt service. As the USD money supply increases (inflation), the limited amount of bitcoin increases the bitcoin price — this price increase of the asset results from the limited supply and more dollars chasing assets.
- Increased acceptance of bitcoin as an asset class drives demand to grow further. Other inflation-protected assets like gold and silver behave similarly.
While we covered scenario one above, the second part of the thesis discusses the future adoption of bitcoin.
A narrative shift is coming
Traditional finance books never teach about narrative shifts, yet it’s one of the most important things to understand for any investor. Here are a few examples of changes in a narrative in recent years.
Twilio (TWLO) IPO’ed in 2016 at $15 a share, and for the next two years, the stock hovered around $30 per share even as the business grew. Wallstreet didn’t understand APIs or how Twilio charged money on API usage. Twilio seemed just like another tech startup unproven to be profitable. As Twilio signed on more customers, and those businesses improved services to their customer base, Twilio’s revenue started compounding heavily. In 2018, there was a clear path to profitability, and that’s when the narrative shifted. Twilio was no longer just a silicon valley cash burner but instead, Twilio is a company leading the digital transformation in communications.
For the longest time, TSLA was one of the most heavily shorted stocks. Elon Musk, CEO of Tesla, has aired his grievances against short-sellers.
When questioned about short-term financials in 2018, Musk snapped back at the analysts.
“Boring bonehead questions are not cool. Next” — Elon Musk
As deliveries continued to pick up, and TSLA surprised Wallstreet with a profitable quarter towards the end of 2019, the narrative shifted. Since, TSLA stock price skyrocketed to, on a pre-split basis, over $2500 a share from $300 a share in 2019.
JETS is an airline ETF. Top 6holdings including LUV, DAL, AAL, UAL, SKYW, and JBLU
Airlines took a significant hit after global travel came to a halt in response to Covid-19. It turned worse for long-term stockholders when Warren Buffet dumped his entire position worth $4B last December.
“When we bought [airlines], we were getting an attractive amount for our money when investing across the airlines. It turned out I was wrong about that business because of something that was not in any way the fault of four excellent CEOs. Believe me. No joy of being a CEO of an airline…”
“I don’t know that three, four years from now people will fly as many passenger miles as they did last year…You’ve got too many planes.” — Warren Buffet
Selling their entire position during a bear market was a costly narrative shift for Berkshire Hathaway. The new story is that people will avoid flying, and the whole airline industry will look different after Covid-19.
Bitcoin’s narrative shift
Apart from the increased daily trading volume and the staying power of bitcoin, billionaires and venture capitalists with massive followings have been increasingly bullish and publicly vocal about the new asset class.
The most significant shift in narrative happened just last week when the publicly traded company MicroStrategy (NASDAQ: MSTR) completed a $425 million purchase of bitcoin as an asset to be held by the company’s treasury!
What is notable about the treasury purchase is that, traditionally, companies invest the cash they don’t use into securities to earn a return. For example, APPL in 2017 owned $52.6 billion in US bonds. Like APPL, the treasury department of companies invests in securities that are safe with the primary goal of keeping up with inflation, not generating income. It’s quite surprising and unheard of that a public company will receive board consent to park cash reserves in an alternative asset like bitcoin.
2019 balance sheet from MSTR’s 10k
What’s even more astounding about this story is that if we look at MSTR’s balance sheet, we can see that the cash and cash equivalents, in addition to short-term investments, added to roughly $565 million at the end of 2019. A $425 million bitcoin position makes up approximately 75% of the company’s cash reserves! The CEO accredited the strategy behind this move due to the anticipated inflation resulting from the Fed’s monetary policy.
Our decision to invest in Bitcoin at this time was driven in part by a confluence of macro factors affecting the economic and business landscape that we believe is creating long-term risks for our corporate treasury program ― risks that should be addressed proactively. Those macro factors include, among other things, the economic and public health crisis precipitated by COVID-19, unprecedented government financial stimulus measures including quantitative easing adopted around the world, and global political and economic uncertainty.
It was validating to see that the CEO and the board of a public company share similar long-term views of my investment thesis behind bitcoin, and also inspirational to see the conviction behind their execution. If more companies follow suit, we’re in store for a massive narrative shift for bitcoin.
I covered in a previous post that I would start looking at cryptocurrency as an alternative asset class. After the considerations I have laid out in this article, I have decided to put my plan into action on Robinhood. Last week, I started to dollar cost average into bitcoin with purchases of 0.5% of my portfolio. I plan to continue to do this until I am at a 3% total allocation. After that, I plan to diversify my crypto portfolio with another asset that’s not bitcoin. Thanks for reading and tune in for future posts of more of my portfolio modifications!
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