We may be adding bitcoin to some of our portfolios. While exciting and topical, to us it's just one more non-correlated market. Like all markets we're agnostic and will trade both long and short. At present it looks like the trend is down and we may be getting short. If the price trend reverses, we will be long.
We are concerned however with certain myths being bandied around about bitcoin.
1 - It’s an inflation hedge
First and foremost, there’s not enough data to support any conclusions given the less than 10 years of price history. That said, from the data that does exist we find this argument flawed especially if you are considering it as a hedge.
There’s been three extended bull market runs in bitcoin:
The first two bull markets produced the largest returns, and both coincided with a deflationary environment. The last bull market run, occurring in the recent inflationary environment, has been the smallest of the three. Since inception bitcoin has performed stronger in deflationary environments.
More importantly though, as a quantitative fund manager we can’t help but notice that the r (correlation) between margin debt and bitcoin is quite strong (86%) whereas the correlation between bitcoin and most inflation metrics is close to zero.
As such, the data suggests that speculation and “FOMO” are the largest drivers of bitcoin returns, not inflation.
2 - Limited Supply
Given the omnipresence of recency and confirmation biases, we understand the rationalization of bitcoin as an inflation hedge, even if flawed. The limited supply argument however we take strong opposition to. For example, consider the theory put forth by Cameron Winklevoss, founder of Gemini cryptocurrency exchange:
We have no idea how much gold is available elsewhere, especially on asteroids and other planets in space. Barely worth a comment on this, other than for comic relief. We are at least decades away from any attempts at commercialized asteroid mining, a time frame much longer than even the longest-term investors.
More importantly however, the “limited supply” argument on bitcoin is heavily flawed. For any company that wishes to transact in bitcoin the physical amount they hold is irrelevant. What is important, rather, is the notional amount. Tesla didn’t decide they needed 43,000 bitcoins but rather they wanted $1.bn dollars’ worth of bitcoin. Even the announcement and headlines themselves were in fiat dollar, not bitcoin.
For a commodity however, the opposite is true: a physical amount is required. To build an electric car you need an average 183 pounds of copper. For an i-phone an average 0.034g of gold. To drive a Jeep from Toronto to Calgary, an average 525 liters of gas.
For any commodity, you need a physical amount to satisfy an economic function. Thus, supply is fundamental to its value. For bitcoin this does not hold.
Whether one holds one, one million, or one hundredth bitcoin is irrelevant to its economic function. Further, the decimalization of bitcoin beyond millionths goes well beyond stocks, bonds, currencies, and other traditional assets. For example, most currencies are bounded on the low end by one hundredth (or pennies). Stocks are generally bounded by one. Bitcoin has no such lower bound. Whether Tesla own one, one million, or one millionth of bitcoin is irrelevant to its economic function.
Finally, as we’ve recently seen, it’s entirely possible that Bitcoin, with its heavy toll on the environment could easily be replaced by another crypto currency. Commodities on the other hand, even fiat currencies, are much more irreplaceable. Whereas it has taken decades just to begin the shift from fossil fuels energy dominance to renewable energy, bitcoin dominance within crypto was tested with just a couple tweets.
Dominance within currencies, too, has historically withstood decades, if not centuries of attacks.
Technically there may be a limited supply of bitcoin, but there isn’t a limited supply of crypto currencies: no limited supply of ideas. The thesis that the limited supply of bitcoin supports any sort of valuation is fundamentally flawed.
3 - An institutional Asset Class
Another argument that we find deceiving is the notion that bitcoin is an institutional asset class. As of writing we have yet to meet a single large institutional investor that has added or has plans of adding bitcoin or crypto to their strategic asset class allocation.
Will institutional investors invest in bitcoin, or are they investing in it? Definitively yes, but almost exclusively through other asset classes: private equity, venture capital, hedge funds, and CTAs. It is not an institutional asset class in its own. To be clear, they are investing in:
Companies (stocks, bonds) with exposure to bitcoin, just like they invest in any other companies.
Fund managers (hedge funds, CTAs) that actively trade crypto currencies, both long and short.
It’s unlikely that bitcoin and crypto will ever become part of institutional investors’ asset allocation. Very few (we’d estimate less than 5%) large institutional investors have asset class allocations to currencies or even commodities. Rather they invest in fund managers and commodity trading advisors (CTAs) that actively trade these instruments, both long and short. Many of the largest institutional investors (CalSTRS, HIERS, Illinois SURS, etc.) have specific strategic asset allocations anywhere from 4 – 10% to CTAs, but 0% specifically to crypto currencies. We see no indication that this will change.
Banks are getting involved with crypto, just like they get involved with any business they can generate transactional revenue from. There are also ETFs now for bitcoin, but there are also ETFs for psychedelics (PSYK) and marijuana (HMMJ). There’s even the FOMO (“fear of missing out”) ETF that recently launched.
These are topical, speculative industries and themes, not institutional asset classes.
4 - Democratization of finance and financial liberalization
Finally, crypto is often flouted as the democratization of finance or some sort of financial liberator. Most of these arguments have some merit but in regards to blockchain, not bitcoin. Blockchain may solve many fundamental problems in the developing world, for example complexities around identification, banking, and the availability of credit. But bitcoin, with transaction fees that went north of $50 this year, was acceptable for perhaps the purchase of a Tesla, but not for a grocery or gas bill. Its practical use beyond a speculative asset in the developing world is really limited to a store of value which, with 30-day volatility that has been north of 100%, is risky and inefficient at best.
To date if anything bitcoin has led to increased inequalities and concentrations of wealth. For the democratization of finance we find it ironic that over 80% of bitcoin mining takes place in closely held companies in communist regimes with poor human rights and free speech records.
Bitcoin mining by country 2021
Further, the actual user base for people transacting with bitcoin, not speculating in bitcoin, is estimated to be a mere 8 million people: a small fraction of the number of investors speculating in bitcoin’s price.
Final Thoughts
As mentioned, we may be adding bitcoin futures to our portfolio shortly. Like cotton, crude, and canola; we’re agnostic in our positioning. When Bitcoin is trending up, we will be long, when it’s trending down, we will be short.
We’d prefer another bull market in bitcoin. Long trends tend to be much more profitable than short trends. Long trends are more orderly and longer lived whereas short trends tend to be brief and highly volatile. The break-out of the commodity bull market for example has led to a return to double digit commodity trend following returns, consistent with commodity trend following returns from 1970 - 2010. A bitcoin bear market, like the 2010-2020 commodity bear market, poses more challenges.
Regardless of what we hope for, we’ll trade based off price action and trends. Given its ubiquity in financial news and the fact that we’re beginning to trade it, we wanted to provide some clarity around what we believe are widely purported myths:
Bitcoin, while previously strong as inflation increased, performed stronger in deflationary environments. Speculation is likely the largest driver of BTC, not inflation.
With decimalization and high availability of substitutes, limited supply arguments lack merit.
Crypto is not an institutional asset class. Institutional investors are either investing in companies with exposure to crypto, or fund managers and CTAs that trade cryptos.
So far it is more likely that bitcoin has increased concentrations of wealth and inequalities.
This is by no means a complete analysis on the merits of owning bitcoin. Rather it’s an attempt to highlight some of the misconceptions, or myths, that we frequently see in headlines.
Like any other investment, if you’re going to invest or trade in bitcoin or other crypto-currencies, understand what you’re investing in, and why. If you can’t do that, seek assistance from an experienced and reputable financial professional, or email us at info@auspicecapital.com
Sources
https://mobile.twitter.com/hedgopia/status/1395013790069006339/photo/1
http://siteresources.worldbank.org/INTGDH/Resources/GDH_CompleteReport2011.pdf
https://www.mecmining.com.au/top-5-uses-of-gold-one-of-the-worlds-most-coveted-metals/
https://www.statista.com/statistics/1200477/bitcoin-mining-by-country/
https://www.cnbc.com/2021/05/13/why-elon-musk-is-worried-about-bitcoin-environmental-impact.html
Disclaimer below
IMPORTANT DISCLAIMERS AND NOTES
Futures trading is speculative and is not suitable for all customers. Past results are not necessarily indicative of future results. This document is for information purposes only and should not be construed as an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice. Auspice Capital Advisors Ltd. makes no representation or warranty relating to any information herein, which is derived from independent sources. No securities regulatory authority has expressed an opinion about the securities offered herein and it is an offence to claim otherwise.
QUALIFIED INVESTORS
For U.S. investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, is only available to Qualified Eligible Persons “QEP’s” as defined by CFTC Regulation 4.7.
For Canadian investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, is only available to “Accredited Investors” as defined by CSA NI 45-106.