February 2021 - Monthly Market Update
/Monthly Update || February 2021
“The most dangerous thing is to buy something at the peak of its popularity. At that point, all favourable facts and opinions are already factored into its price and no new buyers are left to emerge.”
Opening Remarks
Greetings from inside Ikigai Asset Management1 headquarters in Marina del Rey, CA. We welcome the opportunity to bring to you our twenty-ninth Monthly Update and hope these are helpful in better understanding some of what we’re doing and what we’re seeing. We have the privilege of deploying capital on behalf of our investors into a new technology and asset class that we believe will fundamentally change the world and create trillions of dollars of value in the process.
We believe we are obligated to be shepherds of this technology – to help the world better understand the powerful potential of DLT and crypto assets, and to fund and be an ambassador for DLT projects that will change our lives forever.
To that end, I was re-reading last month’s Monthly Update letter and I so strongly felt what I wrote a month ago, that I’m simply going to copy + paste the Opening Remarks from January 1, 2021. They’re even more true a month later. I know it’s a bit of a writing faux pas, but tbh I couldn’t have said it better myself. So…
To that end, welcome to the beginning of 2021 and likely even more importantly, the end of 2020. For many millions of Americans, it was the most challenging year of their lives. The New Year has historically been a time of hope. In many years past that hope came alongside energy and in some years, that hope came with exhaustion. Today, the country arrives at a new year with a bright red line drawn between the Americans that have been relatively unscathed or even better off from Covid-19, and those many millions of Americans that are worse off.
Source: FRed as of 12/12/20.
The current situation is such that many Americans are unable to secure employment because of Covid and responses to Covid. There is hope that in 2021 these Americans will have the opportunity to get back on their feet. But that hope is a tired hope. We must work as hard nation to fulfill that hope in 2021.
The deeply disappointing aspect to the current situation is that the government charged with making the decisions to fulfill that hope is by and large inept. At the executive level and on both sides of aisle. This is disappointing and it has left so many Americans strongly dissatisfied with their elected officials. This dampers hope.
By definition, hope is delivered through change - for the present to change into something better and new. Thus, we find ourselves on the precipice of change. Change is coming in many forms. Much change has already occurred, but many still think it will go back to the way it used to be. Some parts will. Much will not.
With just a bit hindsight, it’s clear that a Covid-led shift to remote digital work opened up many people’s eyes to the concept of digital value accrual. But even more importantly, actions of central banks and governments around the world opened many people’s eyes to the value of an insurance policy against monetary and fiscal policy irresponsibility. Which brings us to Bitcoin.
We believe Bitcoin will go much higher in 2021. There are risks to that view, but they are mostly of large-scale proportions and low probabilities. Yet they could happen. It’s Bitcoin. Bitcoin will face challenges in 2021. Those challenges will be bigger than they’ve ever been before. Bitcoin will continue to display antifragility – one of its most attractive traits. Along the way to much higher prices, Bitcoin will likely have several large pullbacks and numerous smaller pullbacks. Determining the size of those pullbacks, and whether there will be a big haymaker at some point, will be a big part of our job next year. We were pretty good at it this year.
Ikigai is an asset management business, so generating good risk-adjusted returns for our investors is what we do. But that’s not all we’re here for. I could have made a fine living doing a bunch of other things that were way easier than this job. We’re here for something bigger than that - an asset management business is just one piece of it. The bigger thing is The Trust Revolution. 2021 and beyond will require leaders with work ethic and actual ethics to make this world a better place. The world needs more light. We’re here to do our part.
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January Highlights
Elon Musk Changes Twitter Bio To “#Bitcoin”, Tweets “In retrospect, it was inevitable” and Discusses Bitcoin on Clubhouse App
$7.8tn AUM BlackRock Files to Invest in Bitcoin Futures for Two Funds
MicroStrategy Buys $10mm Bitcoin at $31,808
Ray Dalio Writes Article About His Bitcoin Stance
Highly Crypto-Experienced Gary Gensler Named Chairman of the SEC
ECB President Lagarde Calls for Increased Global Regulation of Bitcoin
Janet Yellen During Confirmation Hearing Calls for Increased Scrutiny of Crypto for Illicit Uses
Crypto Custodian Anchorage Given First-Ever Federal Bank Charter
OCC Releases Guidance Allowing US Banks to Use Public Blockchains As Settlement Infrastructure
Publicly-Traded Marathon Patent Group Purchases $150mm of Bitcoin on Balance Sheet
BlockFolio Launches Zero-Fee Crypto Trading & Tokenized Stocks for US Investors
SkyBridge Launches Bitcoin Fund With $310mm AUM.
Bitcoin Exchange Bakkt to Be Acquired by SPAC for $2.1bn
Osprey Funds Launches Trading on GBTC Competitor BTC Fund
Coinbase Proposes Direct Listing
OneRiver CIO Declares Bitcoin Will Be Worth More Than Gold
FinCEN Extends Comment Period for Crypto Regulation into Biden Term
Travel App “Maps.Me” Raises $50mm Funding Led by Alameda Research to Implement In-App Crypto Wallet
Coinbase Acquires Bison Trails, Rumored At >$100mm
Global Soccer Star David Barral Becomes First Player Traded with Bitcoin
Dogecoin Gets Wrapped Up in WallStreetBets, Hits 10x In One Day
Guggenheim CIO, After Calling For $400k Bitcoin in December, States Bitcoin Price Is Too High AT $35k, Calls for Decline To $20k
Japan Top Securities Regulator Says XRP Is Not A Security
| Asset Class | Jan | Q4-20 | Q3-20 | Q2-20 | 2020 | Instrument |
|---|---|---|---|---|---|---|
| Bitcoin | 14% | 169% | 18% | 42% | 303% | BTC |
| NASDAQ | 0% | 13% | 12% | 30% | 48% | QQQ |
| S&P 500 | -1% | 12% | 8% | 20% | 16% | SPX |
| Total World Equities | 0% | 15% | 8% | 19% | 14% | VT |
| Emerging Market Equity | 3% | 17% | 10% | 17% | 15% | EEM |
| Gold | -3% | 1% | 6% | 13% | 25% | GLD |
| High Yield | 0% | 4% | 3% | 6% | -1% | HYG |
| Emerging Market Debt | -2% | 5% | 2% | 13% | 1% | EMB |
| Bank Debt | 0% | 2% | 2% | 4% | -2% | BKLN |
| Industrial Materials | -2% | 14% | 11% | 10% | 16% | DBB |
| USD | 1% | -4% | -4% | -2% | -7% | DXY |
| Volatility Index | 45% | -14% | -13% | -43% | 66% | VIX |
| Oil | 7% | 17% | 1% | -17% | -68% | USO |
Source: TradingView. As of 1/31/21.
This Isn’t About GameStop
I would guess that most of the folks reading this have a pretty good understanding of what happened with GameStop stock over the last two weeks. If you don’t (or even if you do), I would highly recommend this short episode of “The Breakdown” by my friend Nathaniel Whittemore. He does such a good job of unpacking the foundations of why this is important, that I honestly couldn’t do a better job myself. So if you haven’t already listened to it, do that now, and then come back here.
What is written here is meant to be a continuation of the general explanation given by Nathaniel. As I see it, 1) this is an astonishingly unique and pure populist event; 2) the significance massively transcends “a short squeeze on GME”; 3) this has the potential to be a really big deal; and 4) it remains to be seen what we, the people, are going to do about it.
This term. Populism. It’s been getting thrown around a lot lately, right? And by lately, I mean the last 4 ½ years or so.
Source: cfr.org. June 29, 2016.
Side note, imagine getting the “Council on Foreign Relations” to write a paper about rising populism… But I digress. Populism is defined as “a political approach that strives to appeal to ordinary people who feel that their concerns are disregarded by established elite groups.” Hmm. That feels relevant right now, doesn’t it? There certainly seems to be a growing group of Americans that feel this way, right? Disregarded by established elite groups. Disenfranchised, in different words. It was that feeling that put Trump in the White House in the first place, right? In 2016 just enough people felt disenfranchised while just enough people didn’t like Hillary that we elected a reality TV star with a real odd way of conducting himself as President just to see if, hey, maybe something will change.
Things changed, to be sure. And despite this new Trump guy being plenty unpalatable, the change seemed to be just enough net positive that America was likely ready to give him another four years to see if, hey, maybe some things will change a little more.
Then Covid hit. The whole country shut down. And this happened to job loss.
Source: St. Louis Fed. As of January 23, 2021.
And continued unemployment did this.
Source: St. Louis Fed. As of January 16, 2021.
And Fat Nixon was just really, really bad through the whole thing. A bad leader, a bad decision maker and a bad communicator. Just bad enough to get just enough people to vote for the opposition, who most people didn’t really like that much in the first place, that Trump was kicked out of office and Republicans lost control of the Senate to boot.
Over the course of 2020, this underlying issue - that the system in place isn’t working for an increasingly larger portion of Americans - got much worse. Rich folks, by and large, had a really, really good year in 2020. How good? According to Oxfam, American billionaires saw their net worth increase by $4 trillion since March 2020.
This is the “K-shaped recovery” we’ve been hearing so much about. It’s plenty painful. But only painful for the folks least able to bare it.
Source: CNBC. As of January 1, 2021.
Source: CNBC. As of January 1, 2021.
Source: CNBC. As of January 1, 2021.
And in the meantime, the monetary and fiscal polices we chose to enact on the back of Covid?
Source: St. Louis Fed. As of January 17, 2021.
Source: St. Louis Fed. As of January 18, 2021.
Well, all those did was make asset prices go up. A lot.
Source: TradingView. As of January 31, 2021
That’s an important point in all this. Our current set of monetary and fiscal policies make asset prices go up. A lot. They don’t cause all that much headline CPI price inflation yet, especially in the face of so many deflationary forces. But they kinda make all asset prices for the most part go up. Some asset prices more than others, but they all kinda go up. Which is why it has been deemed “the everything bubble”.
In fact, those policies deeply distort price discovery as its normally understood in free markets. Because these are not free markets at all. These are administered markets. Markets which are heavily under the influence of the monetary and fiscal policies which surround them. Policies enacted by men and women, in some cases elected and in some cases appointed, who have career histories and allegiances and leanings and motivations. The policies they have enacted are a clear signal to the market – stocks only go up.
Enter WallStreetBets and their everyman leader, Dave Portnoy. This group of the little guys collectively correctly realized early on into Covid that the current slate of monetary and fiscal policies deeply distorts asset price discovery. Even more ingeniously, they found an incredible way to profit from these distortions, even with their comparatively tiny investment sizes. For ONCE. The little guy found a way to win too sometimes.
Sometimes the little guy’s bets lined up with Wall Street.
Source: TradingView. As of January 31, 2021.
Source: TradingView. As of January 31, 2021
Sometimes those bets didn’t line up with Wall Street.
Source: TradingView. February – June 2020 shown.
Source: TradingView. As of January 31, 2021.
Until one day, the little guy’s *very* good bet lined up diametrically opposed against some very well-connected members of Wall Street’s *very* bad bet. And that was the day the little guy won. Sort of. Temporarily.
Source: TradingView. As of January 31, 2021.
The GameStop event was an astonishingly unique and pure continuation of the populist movement that has been firmly in place since at least 2016. This show of populism was importantly bipartisan - neither associated with the left nor the right. That’s a big deal. And it was *smart*. Really, really smart. And highly profitable, at least for some.
Perhaps the most important aspect of this populist uprising was that it was firmly challenged by the status quo in a manner so obviously FOR the big guy and AGAINST the little guy. Robinhood and many other online brokerages restricted the buying of GME, AMC and others but allowed continued selling in those same names. So the big guy could do what he wanted but the little guy couldn’t. These online brokerages also drastically reduced the maximum number of shares able to be held by individual accounts, blocking the ability for the little guy to buy any more of these heavily shorted stocks. Janet Yellen, who was paid $810,000 in speaking fees by Citadel, one of main hedge funds wrapped up in this situation, will not recuse herself from overseeing this situation. There was a dog and pony show of statists that appeared on CNBC, Bloomberg and other mainstream news outlets – denouncing WallStreetBets actions as unacceptable market manipulation that must be stopped. The CEO of Robinhood delivered one of the least convincing explanations possible. Elizabeth Warren called for all markets to somehow trade only on fundamentals, whatever that means.
Except that’s just it. GME, AMC and others are trading just as much on fundamentals as the $17 trillion of negative yielding debt worldwide. The same fundamentals that are driving TSLA, APPL, AMZN, AAL or anything else. TSLA trades at 28x TTM revenue. APPL trades at 26x EBITDA. AMZN trades at 94x trailing earnings. AAL trades at 343x forward earnings. All of these metrics, without exception, are made possible by the current regime of monetary and fiscal policies. GameStop, and WallStreetBets rallying around it, is also made possible by those same exotic monetary and fiscal policies. All of the above is simply a function of the distortion in free market price discovery caused by the largest monetary experiment in human history – quantitative easing while simultaneously running increasingly larger deficits on top of increasingly untenable debt levels.
The wealthy figured this out a number of years ago. So when they had the chance in March 2020, they doubled down on that bet when they saw the price-distorting safety net the Fed and Treasury threw out for asset prices. Not a safety net for jobs. Not a safety net for the bottom 50% or even the bottom 90%. A safety net for asset prices. And when the little guy figured out how to bet on that safety net at the expense of a handful of hedge funds, those hedge funds that lost money called in back room favors and got the whole thing shut down. That is where we find ourselves.
This situation and its potential effects are analogous to Bitcoin as it relates to monetary and fiscal policies. Bitcoin is an emerging, speculative store of value – an insurance policy against monetary and fiscal policy irresponsibility. It is competing against gold, which had a 5,000 year and $10 trillion head start. In order to force increasingly more people to consider an alternative SoV like Bitcoin as an insurance policy, monetary and fiscal policies need to be increasingly more egregious. It’s not enough that those policies are already bad – they need to be getting worse. The eventual outcome needs to be increasingly viewed as inevitable to more and more people. That serves as the motivation to demand a better way, and the willingness to push for it.
The same is true for unchecked centralized power failing the people. In order for the people to demand change, that unchecked power must continue to fail, and fail in increasingly more grand fashion. It must fail more egregiously. It must fail more publicly. It must fail an increasingly larger percentage of the population. It must fail Democrats and Republicans. That serves as the motivation to demand a better way, and the willingness to push for it.
This is not about a short squeeze on GME. This is about unchecked power failing the people. Wall Street. Politicians. Big Tech companies. Power tends to corrupt and absolute power corrupts absolutely. The founding fathers of this country were willing to die to fight against this. It was the single factor most considered in the establishment of the structure of the republic of the United States of America. It’s why there were so many checks and balances built into the governing documents of this country. And the erosion of these checks and balances over time was the thing the founding fathers were most worried about with regards to the future success of this nation. Our nation.
Decentralization has the ability to deliver a better way – a drum I’ve been banging for years but many others were banging for many years before me. If you’re worried about a social media platform banning certain users for speech that the executives find unbecoming, you can build a decentralized social media platform on top of smart contracts. If you’re worried about a computer processing platform banning certain users for speech that the executives find unbecoming, you can build a decentralized computer processing platform on top of smart contracts. If you’re worried about an exchange making up rules to benefit only the very wealthiest few market participants, you can build a decentralized exchange on top of smart contracts. This is why decentralization matters. And these are the motivators to have decentralization more widely adopted, and the willingness to push for it. That has the potential to be a really big deal.
It remains to be seen what we, the people, are going to do about it. For those of us all the way down the rabbit hole, our sights are uniquely set on identifying these abuses of power by unchecked centralized authority. It’s what so many of us are dedicated to fighting against. The status quo, understandably, works hard to obfuscate these abuses of power from the everyday person. As Henry Ford said, “it is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” But from time to time, and increasingly more frequently, these abuses of power spill out of the back rooms and into plain sight. GameStop is one of those times. The event itself was ubiquitous last week. Not every American understands all the minutiae of the GameStop situation – gamma hedging and brokerage VARs and short interests – but nearly every American realized last week that the little guy was being screwed by the big guy. Increasingly, this is becoming the zeitgeist of our time.
Crypto, and more broadly decentralization, stand as a technological platform with the potential to drive societal change for the good. That’s true for social media platforms. That’s true for computer processing platforms. That’s true for exchanges. That’s true for money. “Potential” is the key word here. Decentralization delivering a better world is in no way a foregone conclusion at this current juncture. It remains to be seen whether decentralization will deliver on all, some or none of its potential to make the world a better place – to curtail the abuses of unchecked centralized power that plague our society at so many levels.
Goals without action are merely dreams. So what are we, the people, to do about it? As for myself and my colleagues, our minds are made up and our feet have moved to action. We will spend our lives working to deliver on the potential of decentralization to make the world a better place. That’s why we named it Ikigai.
The Basics of Assessing The Risks To A Bitcoin Investment
| Symbol | January | Q4-20 | Q3-20 | Q2-20 | Q1-20 | 2020 | 2019 | % ATH |
|---|---|---|---|---|---|---|---|---|
| BTC | 14% | 169% | 18% | 42% | -11% | 303% | 92% | -2% |
| ETH | 78% | 105% | 59% | 69% | 3% | 469% | -3% | -57% |
| XRP | 124% | -9% | 38% | 1% | -10% | 14% | -45% | -82% |
| BCH* | 10% | 31% | 5% | -1% | 26% | 71% | 30% | -89% |
| EOS | 12% | 1% | 9% | 6% | -14% | 1% | 0% | -86% |
| BNB | 18% | 27% | 90% | 22% | -8% | 172% | 123% | -19% |
| XTZ | 41% | -9% | -7% | 46% | 20% | 49% | 192% | -36% |
| XLM | 138% | 71% | 12% | 64% | -10% | 184% | -60% | -78% |
| LTC | 4% | 169% | 12% | 6% | -5% | 202% | 36% | -77% |
| TRX | 18% | 2% | 61% | 41% | -13% | 101% | -29% | -88% |
| Aggregate Mkt Cap | 29% | 122% | 32% | 44% | -5% | 301% | 51% | -30% |
| Aggr Alts Mkt Cap | 65% | 56% | 58% | 45% | 4% | 274% | -1% | -60% |
Source: CoinMarketCap. As of 1/31/21. BCH includes SV.
This section is normally titled “Market Update – Liquid Crypto Asset Investing”. It’s where we typically unpack charts and quantitative data to help frame the current crypto market environment and shares some of our thoughts on where that market might be heading.
Based on some of the occurrences in January and some of the questions I’ve been receiving, we’re going to do something different here this month. Those occurrences I speak of are primarily the chorus of Bitcoin naysayers that spoke up in January - namely Erik Townsend and Mike Green discussing Bitcoin, Nic Carter and Mike Green debating Bitcoin, and Ray Dalio publishing a paper on Bitcoin.
Erik and Mike are firmly Bitcoin naysayers. Dalio is a bit more neutral but still falls short of actually supporting a Bitcoin position at this time. Each of them, along with the typical casts of characters like Peter Schiff, have their various reasons to not be bullish on Bitcoin. A number of those reasons are invalid or unfounded to the degree that I won’t address them here today, just for the sake of time. Yet others I find to be valid risks to a Bitcoin investment. Below is a list of those risks:
1. Governments, especially the US, will not allow Bitcoin to become too successful before somehow shutting it down, or regulating/taxing it into oblivion.
2. While the blockchain may have proven secure to-date, the digital infrastructure around the blockchain is at risk for cyber-attack.
3. While Bitcoin’s supply is capped, it could hard fork in the future, so the supply isn’t really capped.
4. New competitors to Bitcoin could come along and be deemed superior to Bitcoin, as Google was deemed superior to Ask Jeeves.
5. The future demand for Bitcoin is difficult to estimate and thus, even while the future supply may be known, you cannot confidently establish an expected future price.
6. Tether is insufficiently transparent while being of systemic importance to Bitcoin and there are many allegations of improprieties against Tether regarding its past and current reserves.
7. Bitcoin is a bad commodity because you have constant counterparty risk in the form of miners. If the global internet collapses or for some reason all miners decide not to verify transactions on the Bitcoin network, Bitcoin cannot operate.
8. Bitcoin’s price is volatile.
9. Bitcoin is used for illicit activities.
There is some real validity in this list! Allow me to briefly address each one:
1. Governments, especially the US, will not allow Bitcoin to become too successful before somehow shutting it down, or regulating/taxing it into oblivion. Plenty of validity here. Why would the government allow BTC to grow large enough to begin to compete against the sanctity of the US dollar as the world reserve currency? Well, the government is made up of actual human beings. Americans with constituencies, personal networks and career histories. While it’s easy to forget, these are elected officials who were put into office by American voters, or they are appointed by elected officials who were put into office by American voters. As we all know in America, those who have the power and the money have the ear of elected officials – this is how our democracy works in America right now. To the extent that those in possession of the ears of elected officials also own Bitcoin, their influence serves as a buffer of protection against government shutdown or heavy-handed regulation/taxation. BlackRock. Guggenheim. MassMutual. Fidelity. Harvard endowment. Yale endowment. Stanford endowment. Michigan endowment. Stanley Druckenmiller. Bill Miller. PayPal. Cynthia Lummis…. Get where I’m going with this? Yes, it’s a risk. No, it’s not a foregone conclusion.
2. While the blockchain may have proven secure to-date, the digital infrastructure around the blockchain is at risk for cyber-attack. Also valid. Make no mistake, if Coinbase was hacked for $20bn of Bitcoin tomorrow, it likely wouldn’t kill Bitcoin forever, but price would go down a lot and wouldn’t come back up for quite some time. Yet, Coinbase has never been hacked. Neither has Kraken. Or Gemini. Or a number of other exchanges. Hacks have become meaningfully less frequent over the last several years as exchange infrastructure has improved. This risk has significantly diminished over the last several years, it doesn’t carry the weight it used to. But it’s still a risk.
3. While Bitcoin’s supply is capped, it could hard fork in the future, so the supply isn’t really capped. Also valid. I would be surprised if at some point in the next decade we don’t go through some sort of sequel to the BCH hard fork event of 2017. You could imagine a scenario in 2028 after the block reward is cut to 1.56 where miners decide the inflation rate is too low and attempt a hard fork that increases the total supply from 21 million to something higher. It could very well happen and will be worth paying close attention to, should it occur. But as the saying goes, if you come at the king you best not miss. BCH has lost 95% of its value vs BTC since the hard fork occurred. Those that bet on BCH were on the receiving end of that 95% underperformance. That serves as sharp reminder. It’s certainly a risk, but Bitcoin will likely survive a hard fork should one ever occur.
4. New competitors to Bitcoin could come along and be deemed superior to Bitcoin, as Google was deemed superior to Ask Jeeves. Somewhat valid. From the perspective of general technological evolution, when was the first thing ever “the thing”? So I get why some folks might make that assumption. I can say with a high degree of conviction that Bitcoin will not be usurped by any crypto asset currently in existence. Few cryptos can even present a credible claim as a SoV at all, and they are deeply inferior to Bitcoin in every way that matters. So if Bitcoin were to become Ask Jeeves, the Google hasn’t been invented yet. What would that look like? What characteristics would a crypto have that would deem it superior to Bitcoin? Fully private transactions? Government isn’t going to let that fly. More inflation? Less inflation? Why should there be any more or less? Faster block times? We’ve been through this debate before. Price stability? How, and stable against what? A more equal distribution? How, and why? When you start to really pick holes in these arguments, they struggle to hold much water in my opinion, but it is a risk.
5. The future demand for Bitcoin is difficult to estimate and thus, even while the future supply may be known, you cannot confidently establish an expected future price. Ok. Well, you have the hardest supply schedule in human history, so you’re already starting with more certainty on that side of the equation than you’ve ever had with any other asset before. What is the demand for any asset? I get that Bitcoin is a new asset class. We’ve never had anything like it before. It has characteristics of currencies and commodities but isn’t exactly either. Projecting future demand for anything that has no comparison is inherently difficult. But 11 years on into this experiment, we have learned a number of things about the demand for Bitcoin. We know that it exhibits a high degree of network effect. We know it is highly reflexive. We know that its fixed supply has a relationship to the actual and projected changes of the supply of the asset in which it is priced – namely US dollars. Uncertainty abounds when assessing the future demand for Bitcoin, but we’re certainly not flying entirely blind. The price will be what the market will bear, considering all the factors. Just like with anything else. There’s risk there, but you take it level by level.
6. Tether is insufficiently transparent while being of systemic importance to Bitcoin and there are many allegations of improprieties against Tether regarding its past and current reserves. Totally valid. Tether is very important and not very transparent. They’ve done plenty of shady stuff in the past. They are currently embroiled in a legal battle with the NYAG. This has been ongoing since April 2019. There continues to be periodic updates on the status of that court case and those updates will continue. While under active investigation by the NYAG, Tether has created more than $20 billion of new USDT. Tether has also banned 256 Ethereum addresses from interacting with USDT. The CTO and general counsel have been on several podcasts recently, firmly standing by the legitimacy of Tether and its reserves, and promising increased transparency this year. Reading between the lines of the comments from Tether officials, I believe the most likely outcome will be a fine and continuation of business as usual. There is certainly risk to this situation, but the FUD tornado has reached a fever pitch here.
7. Bitcoin is a bad commodity because you have constant counterparty risk in the form of miners. If the global internet collapses or for some reason all miners decide not to verify transactions on the Bitcoin network, Bitcoin cannot operate. Ehh. If the entire internet goes down, every aspect of the world is in big trouble. We’re talking about a Mad Max type of scenario. If that were to play out, how good do you really feel about your bank account, or your stocks, or all the gold being held in a big warehouse somewhere? And regarding miners specifically refusing to verify transactions on the network, they have always been, and will always be, entirely economically incentivized to provide compute. It is the beauty of Bitcoin’s mechanism design that compels them to verify transactions on the network for profit. No other reason. Why should that ever change? If you’re pricing these risks very highly, you have them mispriced in my opinion.
8. Bitcoin’s price is volatile. Yes it is, although the realized volatility has declined through Bitcoin’s history and the expectation is that it will continue to decline. I agree that Bitcoin’s current volatility doesn’t make it a great medium of exchange right now. Bitcoin is too good at being a store of value right now to be a good method of exchange right now. No one wants to be the Bitcoin pizza guy. Gresham’s Law. And that’s ok, because the world really needs a good store of value right now. Bitcoin’s price volatility means you need to consider your position size and consider your hold period. Over most any time period, Bitcoin’s volatility has just been up. It was down 52% in a 24-hour period in March 2020, but it was flat from the end of Feb to the end of April 2020. Over any four-year period in Bitcoin’s history, a portfolio of 90% cash and 10% Bitcoin has outperformed the SPX. Size it right and hold it for a while. You won’t mind the volatility.
9. Bitcoin is used for illicit activities. This is true. Although according to Chainalysis, the total amount of crypto being used for illicit purposes was less than one half of one percent of all transactions, or $10 billion. This is slightly less than the $10.4 billion of FINES paid by banks in 2020 ALONE for AML/KYC breaches. So yeah, crypto gets used for bad stuff sometimes. The government is keenly aware of this and doing what they deem necessary to rein it in. But it’s a tiny percent of total crypto transactions, and illicit crypto transactions are a tiny percent of total illicit transactions. Good ol’ USD def the market leader there. So the notion that crypto is only used for illicit purposes simply doesn’t hold water.
I say this often, but it bears repeating - there is a tremendous amount of risk present in a Bitcoin investment. Layers of risk. Systemic risk. Opaque risk. Unknowable risk. Whales. Miners. Tether. Tether court cases. Podcasts about Tether. Blog posts about Tether from anonymous sources. Counterparties. Price manipulation. Regulation. Exchange hacks. Custody hacks. User data hacks. Project hacks. Global macro. Hard forks. Bitmex death spirals. Stop runs. Exit scams. Other scams. Scammers. Aggressive market makers. GBTC NAV trade unwinds. SIM swaps. Code bugs. Trump tweets. False rumors. True rumors. Tech obsolescence. Rehypothecation. Forced sellers. Legal actions. Liquidity crunches. Market illiquidity. Brad Sherman. Satoshi’s million Bitcoin. Exchange order glitches. Bad data. President Xi. And that’s not remotely close to an exhaustive list. However, Bitcoin is up like 11 million percent over its history, so you’ve been really well-compensated for the risks you’ve been exposed to. IF THERE WERE NO RISKS PRESENT TO A BITCOIN INVESTMENT, THE PRICE OF BITCOIN WOULD EXCEED ONE MILLION DOLLARS.
There are many risks to any investment. There is risk to buying the 2-year Treasury. There is risk in Muni bonds. There is risk in APPL stock. Risk in TSLA. Risk in real estate. Risk in fine art. Risk in funding your own startup. There are also expected returns associated with any investment. For the 2-year Treasury that expected return is just barely above zero. For Muni bonds a bit more. For TSLA stock the expected return is more, and so on. If an investor is willing to bare what they perceive as more risk, all else equal they will demand a higher return. Very simple.
That is the concept of “risk-adjusted returns”. You run through all the risk factors of an investment, dozens or even hundreds of risk factors, then you assign a likelihood of each risk materializing and a projected return should that risk materialize. If I buy TSLA today, there’s a chance Elon dies tomorrow. Stock would be down 90%. One in 20 million chance it happens. -90% x 1/20,000,000 = a really small probability-weighted outcome. If I buy TSLA today, there’s a chance they miss earnings. Stock would be down 15%. 20% chance it happens. 15% x 20% = -3% probability-weighted outcome. But I may also think there’s a 40% chance TSLA beats and stock would be +10%. 40% x 10% = 4% probability-weighted outcome. So you do this with dozens or hundreds of upside and downside risk factors that end up being the foundation to establish a base case, downside case and upside case for your investment and then you decide whether to pull the trigger and in what size. If you’re actively managing the TSLA position, you take and new information every day and act accordingly.
This is precisely how to approach an investment in Bitcoin. You take those nine risks I addressed above, and the couple dozen more I listed, plus dozens more. And you assign a likelihood of outcomes and expected price reaction in each outcome. If you assign a 0% probability to all those risks, your expected market cap for Bitcoin should be at least $30 trillion (market value of all Treasuries in existence) and likely $100 trillion or more. Without any risk, your base case is Bitcoin is the world reserve currency, the dominant store of value and the collateral foundation for the global financial system. But there are risks, so that’s not your base case. Your base case is something else. Those are risk-adjusted returns. We believe a passive Bitcoin position presents an exceptional risk-adjusted return opportunity. We believe an actively-managed Bitcoin position presents even more so.
What I find most annoying about these Bitcoin naysayers’ stance, is how disingenuous their approach is. How intellectually dishonest it is. From what I can tell, they are throwing this very basic approach of probability-weighted outcomes out the window and taking an all-or-nothing approach. “Because Tether risk exists, therefore I cannot ever own any Bitcoin”. That is an inferior approach to assessing any investment. If you told me these guys went through that probability-weighted exercise and arrived at a base case, upside case and downside case that doesn’t warrant the deployment of any capital, I’d say ok. I’d disagree with that assessment and I’d want to hear them unpack it, but that is their conclusion to make. But that doesn’t seem to be the situation at hand in these cases. So be it. People are right and wrong every day. That’s what makes a market. But I urge you to be thoughtful in your approach to assessing the risks present to a Bitcoin investment. Hopefully this helps.
Closing Remarks
The crypto ecosystem carried over its truly torrid pace of development from the end of 2020 into the first month of 2021. We do this all day every day, and even then, we have our hands full keeping up. It’s not just crypto moving at lightning speed either, the rest of the world saw major developments in January as well.
Less than a month ago, protestors stormed the US capitol and overthrew security forces, looting and vandalizing the building and fighting with officers - eventually leading to five deaths. Less than two weeks ago, WallStreetBets faced off against large hedge funds over GameStop, and were winning the battle of the short squeeze until the rules of the game were changed so the little guy wouldn’t win. Worldwide daily Covid deaths reached new highs in January while more than 100 million vaccines were delivered. The United States has a new Democratic President and a new Democratic Senate while Washington continues to work towards passing a $1.9 trillion Covid stimulus package.
The beginning of 2021 brings hope, albeit with a bit of a rocky start. Hope for change. Change requires action. After all, “the world can only be grasped by action, not by contemplation.” Action requires the motivation to demand a better way, and the willingness to push for it. Motivation and willingness come from inspiration. This is where we find ourselves in February of 2021 - amidst inspiration to find the willingness and motivation to move to action and call for change that will lead to an improvement over the way things are right now. We are here for it.
“Fear is only as deep as the mind allows.”
– Japanese Proverb
Travis Kling
Founder & Chief Investment Officer
Ikigai Asset Management
P.S.
Included below is an incomplete list of memorable tweets from the last month. Twitter is not investment advice and my views could easily be wrong. That being said, like it or not, Twitter matters for crypto. I have no interest in being a talking head for a living and babbling about on Twitter is a long way away from being a good steward of investor capital. However, this is a community with open-source software in its DNA, and participants want to crowd-source the truth. We believe we have built a team and a process that will produce these truths more quickly and more clearly than our competitors. We are shepherds of this technology. Answers to fundamental questions about this asset class are not currently clear, so having a public platform to share your views with the community is important. After all, you’re helping shape the future :)
1. Ikigai Asset Management is the trade name for a collection of advisory and consulting businesses operated by Travis Kling, Anthony Emtman, and their team.
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