Fellow Partners,
We are taking a break this week from our First Principles Reasoning series and will resume that series next week.
A number of you have asked for my thoughts on Bitcoin. I am happy to share, but will approach this from the perspective of how I am thinking about Bitcoin. My intent is not to endorse or renounce. Also, please note that I am intentionally using the words “Bitcoin” (the protocol and payment network) and “bitcoin” (the currency of the network), not “crypto” or the names of other crypto assets.
I offer my usual disclaimer that I refuse to join fanatical “pro” or “con” sides of the debate. Zealots on both sides are unhelpful in helping us think calmly and rationally about how this invention may impact our world. The immense volume of uniformed opinions are equally unhelpful. A useful screen for this is to watch a person’s behavior when interviewed on the topic. If they are excessively excited, zealous, angry, or spiteful, tread carefully. There’s too much emotion in all directions.
Whether bitcoin’s price goes up, down, or sideways, it is an important invention and this is a fascinating time in monetary history.
Framing
Be curious. Read widely. Try new things. I think a lot of what people call intelligence boils down to curiosity.
Aaron Swartz
I find it most helpful to frame any discussion on Bitcoin in the context of the currently predominant valuation frameworks. It must be acknowledged that very thoughtful, successful, and well credentialed people fall in all camps, from “it’s a scam” to “Bitcoin will rule the world”. It must also be acknowledged that no one alive today has ever witnessed the invention of a genuinely new asset class, and no one has ever witnessed the invention of a digital asset class. We are watching history, however things turn out. This should give us curiosity — and humility — in our assessments.
Valuation frameworks
There are four predominant valuation frameworks (my thanks to Vijay Boyapati for this articulation). They are:
Bitcoin is not useful for anything. It’s a bubble. A scam. Tulip mania. Rat poison. Rat poison squared. If this is true, the long-term value of one bitcoin is $0.
Bitcoin is a new technology with a limited audience of interested participants e.g. the tech savvy, libertarians, and citizens of countries that can’t effectively govern their currencies. Collectively this group has a large amount of savings, but globally it is still a relatively small group. If this is true, bitcoin’s price will likely remain very volatile, and the long-term value of one bitcoin is likely in the $10k to $100k range.
Bitcoin is a direct competitor to gold, with the same monetary properties (store of value, medium of exchange, and unit of account) but better execution (e.g., more portable, more divisible, more durable, more limited supply). That is, the same properties that make gold good for savings over long periods of time make bitcoin great for savings over long periods of time. If this is true, the long-term value of one bitcoin is likely in the $300k (just below gold) to $1M (3-4x gold) range.
Bitcoin will eventually become the world’s reserve currency, assuming the role that gold had in the 19th century as the dominant means of savings used by nation states and large savers around the world and the final means of settlement between large banks and financial institutions. Everything will eventually be priced in bitcoin. If this is true, the long-term value of one bitcoin is likely in the $10M to $100M range.
It is a useful thought experiment to assess where we may be within these frameworks, and why. To this end, observing adoption (and lack thereof) is helpful.
Adoption
As I grow older, I pay less attention to what people say. I just watch what they do.
Andrew Carnegie
In the context of history, adoption is moving fairly quickly. Bitcoin is just over 12 years old, yet even a year ago most of the below had not yet happened. As of the time of writing:
America’s oldest bank, BNY Mellon, will soon hold and transfer bitcoin on behalf of its asset management clients
America’s largest bank, JP Morgan Chase, has accepted major bitcoin exchanges Coinbase and Gemini as banking clients, who themselves are licensed by financial regulators (e.g., the New York State Department of Financial Services )
The world’s largest asset manager, Blackrock, has enabled its funds to engage in futures contracts based on bitcoin
The world’s third-largest asset manager, Fidelity, provides custody and trade execution services for digital assets such as bitcoin through Fidelity Digital Assets
Mastercard is bringing crypto onto its network in 2021, driven by demand from customers, merchants, and businesses
Some large corporations are starting to hold bitcoin in their corporate treasuries in lieu of cash e.g. Square and S&P 500 index member Tesla1
Asset management heavyweights including Stan Druckenmiller, Paul Tudor Jones, and Bill Miller now hold bitcoin in some of their funds
None of these are reasons to buy or sell bitcoin. But if one were to sit alone in a quiet room and answer, from first principles, “What would be required for adoption of a new asset class?”, I believe these items would be on the list. They are not sufficient in and of themselves, but should cause one to think about the forces driving these decisions and why such people and institutions have been willing to take such actions. I suspect we are about to see many more similar actions.
Positioning
How might one deal with this reality?
First, it is worth considering that if anything except valuation framework #1 above turns out to be true, today’s value of one bitcoin (about $50k at the time of writing) is somewhere between very cheap and fully valued. It is a compelling risk/reward profile for those with long-term, patient behavior.
From this perspective, an investment in bitcoin can be viewed as a position designed to benefit from the invention and adoption of a new digital asset class. Its age (more than twice as old as the next-oldest crypto asset — see the Lindy effect) and decentralized nature (the only crypto asset with both wide adoption and true decentralization) are favorable properties in this thesis.
Related to this positioning is a perspective of bitcoin as a call option on the future of digital money. Fiat money (that is, all money issued by major central banks) has not evolved in any substantive way for decades. Bitcoin’s decentralized, internet-native properties make it a favorable component in the broader context of innovation and re-architecture of financial technology and services.
Second, bitcoin’s low correlation with other asset classes is attractive in the context of portfolio construction. This is not suggesting that bitcoin is a hedge against a market downturn (it wasn’t in 2020), but it is to suggest that bitcoin’s largely uncorrelated returns over shorter timeframes are beneficial in the operation of a portfolio that may have inflows and outflows.
Finally, Bitcoin’s property of absolute scarcity (Bitcoin is limited to 21 million bitcoins) is attractive in the context of a rapidly expanding money supply. The U.S. Dollar money supply has expanded 5 - 15% each year for decades. In 2020, 25% of all U.S. Dollars ever in existence were created. Bitcoin — along with other absolutely scarce assets (e.g., fine art) — will benefit should this dramatic expansion in the money supply convert into excessive inflation.
On the point of inflation, I encourage the reader to think through price changes in goods and services they wish to consume. While technological forces have driven down the cost of many items (e.g., the laptop I recently purchased is far superior to and also less expensive than the one I had in college), the value of scarce assets unaffected by technology (e.g., high quality real estate) are rising at rates far above official measures of inflation. It is possible for reported inflation (e.g., the Consumer Price Index) to remain low while our individual realities are that of high price inflation in some of the assets we actually want to own (e.g., high quality homes and high quality businesses).
We are in virgin territory, with new and old monetary theories battling new and old deflationary forces (e.g. technology) and inflationary forces (e.g. money printing). Rapid inflation of our monetary base will have consequences. No one knows how severe they will or will not be. Likewise, financial technology is starting to radically evolve (finally), and there is growing evidence of the adoption of Bitcoin as part of a new, digital asset class.
I’ll say it again: these realities call for curiosity — and humility — in our assessments.
Closing thoughts
To reiterate: my intent is not to endorse a specific point of view. Rather, with a rapidly evolving landscape and with a potentially valuable asset, I hope to provide some simple, hopefully helpful ways to think about this time in monetary history.
We’ll return to our First Principles Reasoning series next week.
Until then —
All the best,
John
Founder and Managing Partner
Interestingly this means anyone who holds an S&P 500 index fund is now exposed to Bitcoin