by Tristan Borges Solari 5 months ago
The financial markets as we know them are increasingly erratic. Investors are becoming disillusioned to a market rising indefinitely. This is nothing new in the history of financial markets, as investors have had to realize time and again that in a system of ever-expanding monetary policies and never ending debt bubbles, you cannot seek higher and higher returns and not be the bigger sucker. The conditions we face today make for particularly ambiguous conditions. Market participants signal for greater uncertainty and indicators point towards a recession. The Volatility Index displayed below displays just how volatile the market expectations are of the S&P 500 index options, with the past economic downturns highlighted in grey.
Are things different this time? In a way, yes and in many ways they aren’t. We are once again witnessing an overheated market, propped up by an astronomical amount of debt, the likes of which we’ve never witnessed before. The Federal Reserve has slashed rates to near zero, it has just over $6.5 trillion on its balance sheet and America’s workforce has taken a hit, with 26 million people claiming their jobs have been lost in the United States and over 2 million in Canada.
Your portfolio has likely taken a hit as well. A conservative investor seeks returns through a diversification strategy that would allow for higher returns with a relatively low amount of it. This lower risk portfolio would be mainly made up of assets such as bonds, ETFs and a smaller percentage allocated to some equity or commodities.
Gold has for a long time been used as a hedging mechanism allowing for investors to escape uncertainty and turmoil. It is known for maintaining its value over time. The fact that it's very scarce, it’s difficult to replicate and its durability have allowed it to emerge as the superior form of money and has maintained its status for millenia. Moral hazard is implied in the very existence of fiat. Those in control of fiat supply can further fund any venture they deem reasonable to pursue. They can also bail out virtually anybody, thus encouraging reckless behavior and speculation.
Although we are now under a fiat regime, gold maintains its presence and value because people want it and because it is scarce. It is both a monetary metal as well as a commodity. Despite its many positive attributes, it is cumbersome to use for our expenditures and it is costly to store and protect.
We are also facing today what could be the greatest recession of our lifetime. Here is a quote from Ludwig von Mises, famed economist from the Austrian School of Economics, that illustrates the end of a boom cycle like we are seeing today:
“(An economic) boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis… (a) depression follows in both instances.” Mises, L.v. (1940), Interventionism, p.40
So far, we are seeing an ever-increasing credit expansion, with no stopping in sight. Banks around the world are printing money one way or another in order to keep stimulating the economy. The thing is, with an ongoing epidemic, many businesses have slowed down and millions of people are out of work. Individual debts aren’t being paid, mortgages aren’t being collected, we aren’t consuming as much and lack of revenues and mounting insecurity have people holding onto cash and exiting markets. Soon, many will be defaulting on their loans, further putting pressure on businesses that won’t be able to attract customers that have any money to spend. The effects of inflation will be nuanced across the globe. Some countries with a stronger currency that know demand internationally, such as the United States, might barely feel it at all. On the other hand, the precarious situation we are in would lead to people hoarding cash in an attempt to prepare for greater uncertainty in both the financial and the job markets. We might not witness inflation, but instead head straight into a depression as spending capabilities of individuals are hindered. There is a way to protect against all of this, whether we spiral into inflationary territory or tumble head first into a depression.
This opportunity has existed since 2008, when a pseudonymous actor, named Satoshi Nakamoto, released the first scarce digital asset of its kind. There is no overarching authority that controls it or censors its use. It is incredibly scarce. It has a predictable issuance policy and actors across the globe dedicate an enormous amount of resources in order to secure. Bitcoin, having sprouted during the last great recession, will now prove itself to be the ultimate safe-haven asset during the next one. It is possibly the most revolutionary monetary and technological breakthrough of our time and every investor should seriously consider studying it, it might just save them.
Bitcoin is made up of a network of computers communicating with one another, continuously fact-checking and verifying that the status of ownership of the bitcoins in circulation is true. This is not due to a common sense of altruistic participation. Each user is personally incentivized to be their own verifier of truth. What they are each verifying is that they are truly the owners of their respective Bitcoin keys. The digital gold is in their hands and they won’t be fooled into receiving any fugazi bitcoins as well.
Bitcoin’s monetary policy allows you to own an asset that doesn’t get debased over time. The supply limit remains at 21 million units and its inflation rate corresponds to a programmed diminishing supply. You are effectively holding onto an asset that increases in purchasing power over time relative to its total supply. As of early May 2020, the yearly inflation rate present in Bitcoin will be 1.8%. It will then be a scarcer asset than gold, which in comparison has an inflation rate of about 3%. When actually owning the asset, you also have the benefit of transacting without being censored. If you are communicating your transactions directly to the network and are in custody of the keys tied to the funds, no intermediary can get in your way and stop you or confiscate your funds.
Similar to gold, it is scarce, difficult to forge and durable (many ways to protect your keys). Unlike gold, it is truly borderless, being digital in nature, is censorship and confiscation resistant, supply and authenticity of bitcoins are verifiable, it is easy to transact securely and inexpensive to transact.
Bitcoin is another important asset that now exists that can help investors diversify from systemic risk. Bitcoin is an all in one bearer asset, risk-free asset and currency asset.
I’ve created the following portfolios using the Dow Jones Industrial Average ETF Trust (DIA) as a representation of the performance of the Dow Jones Industrial Index and the iShares Core U.S. Aggregate Bond ETF (AGG) as a representation of the U.S. investment-grade bond market in order to illustrate that even just having a small percentage allocated to Bitcoin can greatly improve your overall performance. The portfolios have followed a quarterly rebalancing schedule.
Table 1: Asset Weight Allocations for Portfolios
The allocations differ based on the level of risk one is willing to undertake when seeking to achieve superior returns. What’s interesting as well is the correlation between the above-mentioned asset classes. Bitcoin has low correlation with these other assets, making it not only a novel investment opportunity, but also one that presents important diversification implications. It has also been demonstrated in an extensive risk exposure analysis by Liu and Tsyvinski that Bitcoin has low exposure to traditional asset classes.
Below you will find how these portfolios have performed over time with quarterly rebalancing in order to maintain the desired weights of each asset. Portfolio 4, with the largest allotment in Bitcoin, has earned an impressive cumulative return. However, this is also the one that has presented the highest risk and the lowest reward per unit of risk undertaken. Bitcoin has definitely played an important role in improving the overall performance of every portfolio. So far, it is the best performing asset of the decade. Holding onto Bitcoin has been profitable 3853 days out of a total of 4134 days (93.2%).
As with all investments, risk is always an important factor to take into consideration since there can never be a guarantee that you’ll obtain a positive return. There is the preconception that Bitcoin is extremely volatile. This isn’t necessarily false and has often been a concern for many investors. It is still a relatively young asset, only being in its eleventh year of existence. However, the investing landscape around Bitcoin has drastically changed throughout its lifetime.
The institutionalization of Bitcoin has been ever increasing, with much more mature companies investing in it and dedicating resources to improving access for institutional investors. Companies such as Bakkt offer physically delivered daily and monthly futures as well as monthly options. The Avanti Financial Group charter would permit it to engage in a range of payment, custody, securities and commodities activities for institutional customers that use Bitcoin. Other companies, such as KNOX, offer high-grade custody services with insurance for up to 100% of held value. The Greyscale Bitcoin Trust (GBTC) and the 3iQ Global Cryptoasset Fund also exist for investors seeking investment vehicles invested in and deriving value from the price of Bitcoin. You can find a thorough analysis of this phenomenon in our blog post about institutionalization.
Volatility is nothing new. What are the advancements being made in order for Bitcoin to grow into a mature asset class. The events that have occurred over the past two months have served to put into question what the viable thing to do is in times of greater uncertainty. Even assets such as oil have failed to adhere to our conceptions of stability. Markets are irrational, and that won’t be changing anytime soon. We could hope for some sense of return to normality, but then again, was what we were witnessing pre-Covid normal? If achieving higher highs through balance sheet manipulations or employing fiscal strategies without actually creating any sustainable value is what’s normal, do you really want to return to that and risk having a greater implosion later on?
You could look at the above graph and tell yourself that if Bitcoin is becoming less volatile compared to the S&P, the markets might be in big trouble. If Bitcoin, this internet-native currency that only some folks on Twitter seem to understand, isn’t as wild as the ultra-established S&P, then this must be a precursor to dark times.
I don’t see it that way. There is no going back to “normal”. If anything, what we thought to be normal should be avoided at all costs. This has only led to greater interventionism on behalf of governments worldwide, bailing out left and right in order to try and maintain levels of return only realizable with exceedingly excessive accumulation of debt beyond the level debts could reach on the free market. The spread of the virus has only been the catalyst to the numerous policies implemented to serve the constant appetite of governments for additional revenue and spending capabilities.
Money is the underlying factor to our interconnected economies. The US dollar has a comparative advantage thanks to its history of dominance in the bank reserves worldwide and to a relatively more responsible past fiscal policy. Its view by others as a more desirable currency and its increased demand might serve to abate inflation for now, thus encouraging further money supply expansion strategies.
It is naive to believe that we will just be able to “restart” once this pandemic subsides. Habits, both spending and living wise, have changed. Many have lost their jobs and companies that are still operational are realizing that their employees are more productive working at home or that they don’t need such a big workforce. Actions have been taken in the name of self-preservation, but we will have to live up to the consequences that would take the form of decreased economic output. What we are seeing now is quite similar to what we have witnessed in the beginning of 1929, a Bull trap.
The delayed effects of such policies will nonetheless be felt by individuals and portfolios alike. Bitcoin serves as a vehicle to improve your returns, as we’ve seen with the analysis conducted above. It is also a hedge against inflation due to its predetermined supply emission and total maximum supply policies. Ultimately, owning Bitcoin serves to protect your purchasing power. With citizens in several countries cowering under fear from the threat of an invisible enemy, they willingly delegate further responsibility over their lives to their heads of state.
There is increased surveillance of peoples and their activities. More control is flowing into the hands of government officials, some even granting themselves unlimited and ultimate power. It is times like these that the games of human interaction have reverted to the basics. The economic game, as described by Jack Hirshleifer, in which we attempt to profit by working within the rules is severely hampered. The political game, usually constrained by an existing constitution or other conceptions of legitimate behavior, where individuals seek profit by changing the rules to their own benefit, is slowly prevailing. The final game of human interaction is as basic as it can get. It is subject to no constraints. Only raw power and conflict prevails.
We are less safe now than ever. Bitcoin allows you to retain what little bit of freedom you have left under such circumstances. You get to retain control over your wealth. You get to safekeep the value you have worked to generate and pass it along to your children. Avoid having your wealth erode away at the whims of governments not knowing what else to do but print more money and castrate you through inflation.
I suggest you learn as much and as in depth as you can about how Bitcoin works. Do your own research and due diligence. If you need help with that, give us a call. We can assist you every step of the way, from figuring out proper capital allocations and doing research reports, to buying and securely storing your first bitcoins. We are a team of privacy, security and Bitcoin experts at your disposal that have already helped investors secure over 300 bitcoins.
Stay up to date on Bitcoin by signing up to our newsletter!