Why Bitcoin is my Largest Position
At some point consensus hallucination just becomes reality
Apologies for my hiatus these past few weeks. I’ve decided to spend December back home, so putting down the pen to spend more time with family. I hope you have a chance to do likewise.
However, I did have a chance to write the following piece for Coindesk’s year-end review which was published today (under a slightly different title), and I figured I would share it with Emerging readers as well. If you are not interested in crypto / Bitcoin, please feel free to skip. If you are, Coindesk is a great resource for staying up to speed, and I hope you enjoy :).
I’m quite bullish on both Bitcoin and the emerging applications on top of Ethereum.
As of this writing, the price of Bitcoin is ~US$19k and, at >15% of my net worth, the single largest position in my portfolio. In the below paragraphs, I hope to articulate why - contrary to the common narrative - this is not crazy.
The core narratives I use to justify my significant holdings in BTC are as follows:
Bitcoin as Insurance - the probability of a reserve currency meltdown near-term is exceptionally low. However, as the probability inches up, more people will want an insurance policy. There are only 21 million bitcoins. More people wanting an insurance policy + static number of policies = price increases per policy
Bitcoin as Exit - due to accommodative monetary policy, asset prices have not undergone their typical cycles which would have allowed millennials to access assets at affordable prices while artificially boosting the wealth of Gen X and Boomers. Instead of playing in a “rigged system,” many millennials are exploring alternatives. More and more millennials will choose to “exit”.
Bitcoin as Reflexivity - Bitcoin is the ultimate speculative asset. Like other forms of money, Bitcoin only has value because other people believe it has value. There is a legit argument to be made that as prices increase and more people learn about the asset, the greater the probability bitcoin will be more widely accepted which merits a further increase in price.
Bitcoin as an “option” on digital gold - The bitcoin as digital gold metaphor is not quite right. Today it’s more of a call option on digital gold. A bet that over time, more and more investors will accept this view. Every new wave of investors which come to understand the narrative - retail investors, early adopting institutions, laggard asset managers, and finally governments (in the ultimate bull case) - presents a step change in price as narrative becomes reality.
Editor’s note: I’m writing from the perspective of a millennial with a high risk-tolerance, lean expense structure, and long-term time horizon. Clearly, the allocations would be different for a parent heading towards retirement with college tuition payments and a mortgage to fund monthly. The asset is exceptionally volatile with a decent chance of total collapse. However, if you are able to stomach near-term volatility and are aware of the risks, the upside makes the below allocations justifiable:
~15% Gold, ~15% Bitcoin / ETH, ~10% Cash, and ~70% equities / RE.
Let’s find out why.
The World We Live In
The only way to understand why this allocation makes sense is to zoom out and take in the big picture. There is a war going on: the accelerating deflationary forces of technology vs. the inflation-desperate central banks. A reflexive loop has formed:
The avenues for paying back the massive government debts now building are 1) austerity, 2) restructuring, 3) faster GDP growth, or 4) devaluing the currency. Austerity is politically untenable and often limits GDP growth hurting debt to GDP ratios. GDP growth is hard to come by in our stagnating, debt-laden economies. Restructuring would likely be catastrophic to the existing financial system. Devaluing the currency is the only realistic, politically tenable option.
Growing GDP and controlled inflation are the means by which central banks have typically reduced debt burdens. Stimulus - providing cheap credit - has been the tool of choice. However, the ever-increasing stimulus is having a diminishing impact. We need more and more cheap debt to buy $1 of GDP growth.
Debt growth is outpacing GDP growth, which means the best option to stabilize the Debt / GDP ratio is stoking inflation.
However, in recent years inflation has been hard to come by despite quantitative easing on a global scale: (the Fed has missed its 2% inflation target in 8 of the last 12 years since the global financial crisis). This seems to be brought on by an increasing debt overhang as well as the deflationary forces of technology.
As Jeff Booth points out in “The Price of Tomorrow”, the easiest place to see the deflationary forces of technology is your smart phone. What would have previously been a separate collage of supercomputer + flashlight + calculator + wallet + camera + television + yellow pages + a zillion other things now fits into your pocket for prices affordable for billions. You get more for less. Many things today are basically free.
The deflationary forces of exponential digitization vs. central banks desperate to stoke inflation to pay back their large debt burdens. The key economic struggle of the 21st Century.
Based on rates of inflation, tech seems to have the upper-hand. Our government’s response? More stimulus.
Clearly, this cannot go on forever, but it will last longer than many people think. Let’s look at the winners and losers of this current monetary regime.
The Bull Case for Equities & the One-Eyed King
Clearly, in a monetary regime of near zero interest rates, savers are hit hard and yields on bonds turn progressively negative (in real or even nominal terms). The increased liquidity in the system has not flowed to goods and services (causing inflation) but is flowing into the equity markets (inflating asset prices - the only place with real returns to act as a store of value for future spending). The more money printed (or cheap debt issued), the higher equity prices are likely to go given the lack of alternatives in other asset classes to store wealth. If you look at the equity indices globally since the unprecedented QE post the 2008 financial crisis, I think the trend is pretty clear:
If you believe we will continue to be in a deflationary environment (which seems likely given the increasing role of tech) and you believe governments will try desperately to stoke inflation (which they will because it is the least painful way to “repay debts”) and you believe their tools for stoking inflation are limited largely to more stimulus (which appears to be the case), then this trend will continue.
In that case, equities - with decent exposure to tech (adjusting for valuation) - seem like a good place to play ball. Hence my 70% weighting (as a young person with a long-term outlook).
However, how long can this cycle last?
As I mentioned in a previous post, it could last until the USD loses its status as the global reserve currency. In short, for quite some time.
I think the below excerpt from my newsletter back in June explains the dynamic well:
To quote 15th Century Dutch Philosopher Desiderius Erasmus, “in the land of the blind, the one-eyed man is king”.
In 2020, the U.S. is the one-eyed king.
Despite poor fiscal and monetary practices, near-zero interest rates, and an increasingly ailing balance sheet, demand for USD and treasuries remains strong. There is simply nowhere else to go.
Japan has been stagnating since the 90s with a Debt / GDP ratio of ~230%. The European Union is following suit and the very existence of the monetary union in question. There is a high probability the Euro doesn’t see 2030. The sterling is a relic from a colonial past and is rapidly being weaned from reserves. While China has a healthier government balance sheet, there are strict capital controls for a reason. It’s doubtful China will rapidly open its financial borders after the strong outflow pressures witnessed in 2015 and 2016. The rule of law is still too arbitrary.
That leaves…. the U.S.
Even with the record stimulus, there is an “insatiable demand” for US treasuries. From the FT on a possible additional US$3t in US government borrowing:
Financial markets have so far had little difficulty in digesting the supply, with Treasury yields ticking slightly higher but still hovering close to record lows. The 10-year note now trades at 0.67 per cent, roughly 1 percentage point lower than where it began the year…
There is a seemingly insatiable demand for US dollar debt. There is little to suggest that the Treasury will have any issue funding [the government]”
The US is still the only game in town.
These current trends, the central bank remedy, and the sticky nature of reserve currency status points to a bull case for the continued expansion of global equities. If this base case happens, a majority equities portfolio will do well, and gold will underperform but still likely appreciate slowly.
However, a lot of smart people are starting to analyze this cycle and concluding it cannot last forever. Dalio’s extended debt cycle will need to unwind slowly or pop. Unfortunately, while still a ways off, the short-term nature of four year election cycle makes the latter scenario increasingly likely. Populism is in. Technocrats are out.
To hedge against the downside, a mixture of cash, gold, and Bitcoin seem compelling. USD in the event of a non-catastrophic downturn, gold in the event of a non-catastrophic or catastrophic downturn, and BTC in the event of a catastrophic downturn, but with simultaneous upside characteristics near-term as penetration grows.
Considering this backdrop, a not-insignificant allocation to BTC strikes me as justifiable. If you are wrong, then equities will likely continue to perform well, and your portfolio should be fine. Even if it goes to zero, you will not be on the street.
Despite being young and extremely risky, Bitcoin’s narratives resonate with me. Assuming others think similarly, there is a lot of upside in being in early.
Bitcoin as Insurance
As stated above, Bitcoin could be seen as a put option on continued irresponsible monetary & fiscal policy - surging in price when the extended debt cycle finally pops. Foreign governments eventually balk at buying US treasuries as debts continue to pile-up.
Under this scenario, the financial system would likely have a catastrophic collapse leading to a scramble for “hard money” of which Bitcoin (along with gold) is a leading candidate. However, reserve currencies are notoriously sticky; the above scenario is unlikely to play out on a medium-term time horizon. What is more likely is…
Bitcoin as an option on digital gold
As more investors piece together the above reflexive loop, they will explore allocations to protect their downside. Gold has clearly been a recent favorite. However, BTC’s current market cap is just ~US$350b (at time of this writing) relative to gold at ~US$10T. As the narrative around “digital gold” continues to gain adoption, step change increases in value are possible as different waves of investors decide to take a bet on the narrative. As historian Niall Ferguson notes, if all the world’s millionaires decide a ~1% portfolio allocation to Bitcoin is worth the hedge, then the price per coin is ~US$75,000.
Bitcoin as Exit
There is growing discontent among millennials with expanding inequality. The low returns to labor and the monetary shenanigans which are propping up asset prices beyond their grasps are key drivers. While the increasing popularity of hard left politicians like Bernie Sanders or AOC is one symptom, crypto provides a more libertarian option. “If the existing system isn’t working for me and protects the wealth of my parents and baby boomers, then its time to play in a new sandbox”. Crypto is the new sandbox with algorithmically transparent rules of play. As cohorts age, more people and $ will find themselves in the crypto sandbox.
Bitcoin as Reflexivity
As readers of my newsletter know, I’m a fan of George Soros’ reflexivity framework - essentially that subjective & objective reality are intertwined and dynamic. I believe in 2020 we are reaching an era of peak reflexivity, and Bitcoin is the ultimate reflexive asset; perfectly crafted to ride these trends.
As Naval Ravikant put it: “Money is the bubble that never pops. It’s a consensus hallucination”
I’m bullish on Bitcoin because of the unique technical properties ensuring scarcity but even more so because of the hard-core evangelical following. Many will never sell. More folks getting religion + constrained supply = a one-way impact on price.
At the end of the day, humans are social creatures and use narratives to derive meaning. Bitcoin presents a compelling narrative to many people - especially below the age of 40. The top-heavy baby-boomer demographic disparages it; the same people who will be gone when the massive debt bills finally come due.
This narrative isn’t for them.
Crypto is a vehicle outside of the existing political system to serve as a forcing function. A mechanism to exit the old game headed for bankruptcy and start a new one which cannot be co-opted politically. The potential to serve as the massive inter-generational wealth transfer which never happened under the current system because the Fed keeps propping up asset prices.
A fresh start.
Against the backdrop of this monetary & fiscal circus, Bitcoin’s narratives are finding their way into more and more portfolios.
At some point, the hallucination just becomes reality.
Note: Please note I am not a financial planner, and this should not be considered professional investment advice. Please do your own research and only invest what you are comfortable losing in its entirety. I would also like to disclose my current sizing has benefitted from appreciation over time (BTC & ETH). I would encourage anyone new to the space to smart small and average down during the inevitable volatile swings. This is a high-risk investment.
Think for yourself.