Bitcoin: Bubble or Anti-Bubble?
<p>The following analysis summarizes my current thinking about Bitcoin and Crypto Currencies. Like <strong>Frida Khalo</strong>, “I don´t want you to think like myself. I want you to think”. The analysis is quite comprehensive but certainly not exhaustive and tries to be as objective and unbiased as possible, mindful of my own biases and blind spots. Whether we agree, disagree, or simply “agree that we disagree”, I hope the arguments will help you reach your own conclusions and avoid herd mentality and manipulation in one direction or the other.</p><p>Let’s start with some simple definitions:</p><p><strong>Bubbles </strong>are <strong>artificially </strong><em><strong>expensive</strong></em><em> </em><strong>assets</strong> driven by a false belief known as a <strong>misconception</strong>. They reflect situations where “the emperor has no clothes” and will collapse “a matter of when, not if”.</p><p><strong>Anti-bubbles</strong> are <strong>artificially </strong><em><strong>cheap</strong></em><strong> assets</strong> driven by a <strong>misconception</strong>. They are a mirror image of the bubble that, in addition to offering extreme <strong>value</strong>, provide an <strong>effective hedge</strong> against the bubble.</p><p>As two expressions of the same process, the eventual implosion of the bubble and explosion of the anti-bubble will happen at the same time and are driven by the same catalyst. Like an anti-virus or an anti-missile, anti-bubbles are by construction an effective defensive mechanism against bubbles. </p><p><strong>If we want to find bubbles and anti-bubbles, look for the misconception behind them. That simple.</strong></p><p>The question: is Bitcoin a Bubble or an Anti-Bubble? is not that simple, as there are multiple forces and beliefs and misconceptions in both directions.</p><p>I have divided the analysis into two main sections. The first one discusses “The Problem” and “The Enemy”. The second discusses “Bitcoin, the solution”. Each section is structured in bullet points to help diagonal reading where the title summarizes the idea, and the rest of each paragraph elaborates the idea in more detail. </p><p>Let´s start with <strong>“The Problem”</strong> (Fiat Currencies, Asset Bubbles, Inflation) and <strong>“The Enemy”</strong> (Central Banks and Governments), which I have discussed in previous contributions. If you are familiar with these ideas, please feel free to skip directly to the following section “<strong>Bitcoin, the Solution</strong>”.</p><p>- <strong>Debasement of Fiat Currencies.</strong> I think, by now, most of us agree that there is a large problem with fiat currencies due to a relentless and unsustainable abuse of monetary and fiscal policies without limits. The new chapter of the saga has introduced MMT (“Modern Monetary Theory” aka “Magic Money Tree”) a short-term patch that does not solve problems, but rather 1) delays problems (via debt), 2) transfers problems (via currency and trade wars), 3) transforms problems (from bubbles into inflation) and overall, 4) enlarges problem to systemic levels that invariably lead to the paradigm shift that seeks to transforms bubbles too big to fail into inflation and fiat currency debasement. This argument favours “Anything, But Fiat”.</p><p>- <strong>Central Bank Independence</strong>. The essence of the Fiat Currencies problem is the lack of Independence between the Government (Executive and Fiscal Power) and Central Banks (Monetary Power). Without Central Bank independence, money can and will be printed ad infinitum to finance the Government spending and debt. As Ben Hunt from Epsilon Theory would say “they are not even pretending anymore”, referring discuss today´s obvious lack of independence. The old Latin adage, “Quis custodiet Ipsos custodes?” (“who polices the police?”) directly applies here, and the reason why Voltaire rightly claimed that “paper currencies eventually converge to their intrinsic value: paper”. This argument favours independent and decentralized money and positions the Fed and entire set of Central Banks and Governments as “The Enemy”.</p><p><strong> </strong>- <strong>From Risk-Free-Interest to Interest-Free-Risk. </strong>Amongst other aberrations, monetary policies without limits have resulted in negative interest rates in cash and negative nominal yields in fixed income and credit (<em>pay</em> interest for lending your money, an oxymoron), which are plain and simple financial bullying that penalizes prudent behaviour, like saving. Once upon a time, we could invest our savings in AAA Government Bonds, like the 10-year German Bund, that would pay us 5% Nominal Yield per annum. The Nominal Yield was by then much higher than the then prevailing inflation, resulting in Positive Real Yields on our savings. The textbooks referred to this as Risk-Free-Interest a concept on its way to extinction, if not extinct already, due to the aberration of abusive monetary policies such as Negative Nominal Interest Rates. This argument, once again, reinforces the argument “anything but fiat”.</p><p><strong> </strong>- <strong>The Desperate Search for Yield</strong>. Savers prefer to buy bread with their fixed income than sell their fixed income to buy bread. A corollary most savers prefer to <em>increase risk</em> to achieve their desired target yield than <em>reducing yield</em> in order to achieve their target risk. That is, we are building the house from the roof. A warning on excessive risk-taking and bubbles.</p><p><strong> </strong>- <strong>The Duration Bubble</strong>. The transformation of risk-free-interest into interest-free-risk has multiple dimensions, but it all starts with artificially low interest rates. The Desperate Search for Yield described above has incentivized or worse, forced, savers to lend for longer and longer periods for lower and lower yields. A snowball effect that has resulted in, amongst others, negative nominal yields for 30-year German Bunds, which is equivalent to an unsecured loan to the German Government where you give them 100 Euros today for zero interest during the entire life of the loan and receive <em>less</em> than 100 Euros at maturity. As crazy as it is and sounds, negative nominal yields are now the norm, not the exception. A “rational” explanation for this behaviour is the risk deflation, a major misconception in my view that I will discuss in more detail later.</p><p><strong> </strong>- <strong>The Credit Bubble</strong>. The duration bubble is the epicentre of the problem but not the problem itself. What I mean by this is that Central Banks can print and lend infinite amounts to their governments via Quantitative Easing without creating any apparent distortion or clear short-term catalyst, as has been the case in Japan for decades. The problem with the duration bubble is that it naturally expands into credit markets. Look for example at the 10-year Spanish Government Bond, where the negative nominal yields sadly do not reflect the fundamentals of the economy but rather the combination of artificial demand from money printing and Complacent Desperate Search for Yield. A relentless process has expanded and snowballed into by lending for longer and longer to weaker and weaker credits for lower and lower yields, spreading to Investment Grade, High Yield and Emerging Markets. All the same trade.</p><p><strong> </strong>- <strong>The Equity Bubble</strong>. Artificially low interest rates contribute to artificially high valuations in equities via multiple fronts. The scope of this note is Bitcoin, so I won’t dwell in too much detail on all of them, but I will mention how artificially-low interest rates (duration bubble) and artificially low credit spreads (credit bubble), complacent expectations about the future (growth), artificially low volatility (anti-bubble), PE high multiples (equity duration), complacent expectations about inflation (anti-bubble) or taxes (along with death a certainty, according to Mark Twain) all contribute to higher present values of cash flows and valuations.</p><p><strong> </strong>- <strong>The Liquidity Bubble</strong>. Private credit and private equity markets suffer from similar dynamics where investors seek to capture the liquidity premium in illiquid investments.</p><p><strong> </strong>- <strong>Complacency</strong>. Despite the multiple red flags, the markets can get used to anything from Trillions and Trillions of dollars at negative nominal yields to Tesla’s $ 850 billion supported by a PE of 1700. As one of my favourite quotes goes, “market is forward-looking but somehow never sees it coming”. Therefore the Desperate Search for Yield has transformed into the <strong>Complacent</strong> Desperate Search for Yield.</p><p><strong> </strong>- <strong>There Is No Alternative (“TINA”). </strong>I could go on into multiple other pockets of artificial valuations and excess, but by now I think I have made the point that “Houston, we have a problem” with asset bubbles everywhere. The “Mother of All Bubbles” or the “Everything Bubble” is by now a well-known problem, but many investors argue that “there is nowhere to hide” and participate in the Bubbles arguing “There Is No Alternative” (TINA). Not necessarily true. As Marco Aurelius wisely taught us “remember you always have the option of having no option”.</p><p><strong> </strong>- <strong>Bubbles Too Big to Fail</strong>. The past decades of “transformation of risk-free-interest into interest-free-risk” have created a series of synchronous bubbles without precedents. In my view, the size of these bubbles is so large that they are not Systemic and Too Big to Fail whereby the normalization of monetary policy is by now Science Fiction. Think about what would happen if nominal interest rates were to “normalize” to, say 5%. Clearly, the entire House of Cards would collapse. The Wealth Effect would vanish. And thus, why we are caught in a vicious cycle of artificial valuations and monetary and fiscal policies without limits. This is like the Hollywood movie where the bad guy is the policeman.</p><p><strong> </strong>- <strong>Financial Stability</strong>. The idea that we can solve problems via money printing and debt is wishful thinking. As discussed at length in other contributions, monetary and fiscal policies without limits do not solve problems, but rather 1) delay problems (via debt), 2) transfer problems (via currency wars and trade wars), 3) transform problems (via inflation), which altogether do not solve but simply 4) enlarge problems.</p><p><strong> </strong>- <strong>The transformation of Bubbles Too Big to Fail into Inflation, or worse, Stagflation</strong>. Central Banks, whose primary mandate is Financial Stability has created the greatest Bubble in Financial History. As Mike Meyers said, “the bad guy is the good guy of his own movie” and as Mervyn King discusses in his latest book Radical Uncertainty, Central Banks responded with no clear understanding of the problem nor the true consequences of their actions. They have just been trying to keep their head above the water, perhaps, just perhaps, acting in good faith to avert the imminent collapse of a problem caused by the previous guy (or girl), but whose actions are only exacerbating the problem further for the next guy (or girl) and future generations. A musical chairs game that has seen how Central Bank and Ministers of Finance switch sides, as it has been the case with Lagarde in Europe or Yellen in the USA (and that now has even brought them to the top of the Executive Power, as it may be the case with Mario Draghi in Italy) which is clear confirmation that the exit plan in inflation.</p><p><strong> </strong>- <strong>Deflation vs Inflation Debate</strong>. Yes, there are many powerful deflationary forces in the system, including unemployment, weak economic activity, technology, aging demographics, overcapacity, malinvestment. There is however one single inflationary force that more than offsets all of them: Money Printing. As I always say, inflation is not about the value of bread going up, it is about the value of the money with which you buy bread) going down. Inflation at the end of the day is 100% a monetary process. This argument wars against holding cash, fixed income, or credit instruments because they are short inflation. The 100 USD or EUR that your 30-year bond payback will not buy you much.</p><p><strong> </strong>- <strong>Inflation, The Frog in Boiling Water</strong>. Relentless money printing will invariably lead to inflation. The response from the market will depend not only on the actual level of inflation but also on inflation expectations. As a frog falls in boiling water it will jump out, but well known that if we throw a frog in mild water.</p><p><strong> </strong>- <strong>Inflation, the Anti-Bubble. </strong>Given<strong> </strong>the size of the bubbles, it is clear in my mind that the only wait out of this mess is inflation. Inflation hurts savers as the 100 USD or EUR that you will receive in 10, 20 or 30 years will buy you nothing. Inflation benefits those with debt as repaying the 100 USD or EUR of principal will cost you nothing.</p><p><strong> </strong>- <strong>The Anti-Bubbles of the Monetary and Fiscal Policies without limits</strong>. I have discussed at length why I believe Volatility, Inflation, or Gold are in my view clear Anti-Bubbles. For a more detailed analysis on the concept and contrarian investment framework, you can refer to my book, “The Anti-Bubbles: Opportunities heading into Lehman Squared and Gold´s Perfect Storm” (BEP, 2017) or selective contributions to the media including Financial Times Insight Column “Gold´s Perfect Storm”, Wall Street Journal “The Return of Inflation”, Real Vision TV, Hedgeye TV, the Felder Report, MacroVoices, just to name a few.</p><p>Having discussed “<strong>The Problem”</strong> (Fiat Currencies, Asset Bubbles, Inflation) and “<strong>The Enemy”</strong> (Central Banks and Governments), I now discuss what I understand are the key arguments, beliefs, and misconceptions supporting the narrative “<strong>Bitcoin, the Solution</strong>”. </p><p>- <strong>Blockchain and Crypto are game-changer technologies</strong>. I am a big believer in human ingenuity and the transformational power of technology. My first book, “The Energy World is Flat: Opportunities from the End of Peak Oil” (Wiley 2014) is a tribute to my fellow engineers and game-changer technologies. Whilst I am not an expert on Blockchain nor Crypto, I recognize the merits of the technology and its potential to disrupt multiple industries. I do however believe that there is a potential flaw in logical thinking that concludes that 1) “because we have a big problem with Fiat Currencies” and 2) “Cryptocurrencies are a game-changer technology”, therefore we can conclude that 3) Bitcoin is the solution. The logical jump is not obvious and, in my view, ignores key considerations set forth below.</p><p>- <strong>Governments will never give up Seigniorage</strong>. For those not familiar with the concept, Seigniorage describes “the profit made by a Government by issuing currency, which is given by the difference between the face value of a note (say €500) and the production costs (say €0.01)”. Seigniorage applies to coins (cost of metal), notes (cost of paper), and digital (no cost). Seigniorage gives Governments a “first-mover advantage” in the inflation game as they get to print and spend first. Abusive monetary policies result from the lack of independence between Central Banks and the Government, as discussed in the previous section, The Problem.</p><p><strong> </strong>- <strong>PayPal and Tesla now accept Bitcoin as payment. </strong>One of the catalysts for the strong performance in 2020 was the inclusion of Bitcoin as valid payment in platforms such as PayPal. More recently, Tesla has announced the purchase of $1.5 Billion of Bitcoin and the acceptance of Bitcoin as payment. The large increase in valuation of Bitcoin (now around $ 1 Trillion) and the acceleration of adoption by different platforms and firms is an effective by-pass to Central Bank Fiat currency and it surely gaining attention at both the Central Bank and Governments.</p><p><strong> </strong>- <strong>Governments can rule Crypto Illegal Tender</strong>. A decentralized currency that bypasses the Central Bank and Governments will not be tolerated. Governments will do, literally, “whatever it takes” to maintain their control and privilege of Seigniorage, which could easily include making Crypto-Currencies illegal tender. The risk of a sudden prohibition in payment platforms or firms is easy to implement. Look at the recent episode with GameStop and the Robinhood trading platform, where the rules of the game were changed in the midst of the squeeze. Something similar could happen with PayPal or Tesla, anytime. The risk is binary, and the exit door is narrow, so be careful. <strong>Change in Narrative</strong>: <strong>From Crypto “Currency” to Crypto “Asset”</strong>. It is not surprising in my view that some prominent promoters of Bitcoin, like Michael Saylor, CEO of MicroStrategy, are trying to change the narrative from “Currency” to “Asset”, in some way trying to avoid direct conflict with the Fed. Wishful thinking in my view.</p><p><strong> </strong>- <strong>Terrorism and Money Laundering: The Convenient Excuse</strong>. Central Bankers and Governments will never admit that Bitcoin or Crypto are a threat to their Monopoly of Money and Privilege of Seigniorage. Instead, they are more likely to use the simplest and most convenient excuse: the illicit use by Terrorists and Money Launderers. Janet Yellen has already raised this point shortly after her recent appointment suggesting “lawmakers curtail the use of Bitcoin amid terrorism concerns as cryptocurrency transactions were used mainly for illicit financing". Similar to Lagarde in Europe. A trend that I think will continue and poses a major binary risk. A similar approach was used to get rid of high-denomination notes, such as €500, where part of the rationale to eliminate large-denomination notes was to fight crime and money laundering, but there was also another hidden argument: physical money is the primary obstacle to negative interest rates as physical money can be stored at zero interest rates, and thus the smaller the denomination of the note, the harder to store large quantities of money.</p><p>- <strong>Systemic Risk: Bubbles are NOT a Zero-Sum Game</strong>. Bubbles should in principle be “zero-sum games”. The recent run-up and down in Game Stop is a good example of a zero-sum game bubble, where some prominent Hedge Funds lost billions, some “Redditors” and traders made a lot of money by “buying cheap and selling expensive”, and many other Redditors missed the exit window and will be holding the bag, stuck, as “patient long-term investors”. The transfer of wealth in Game Stop was a handful of billion dollars, life-changing for those involved, but largely irrelevant for global markets. But the size of Cryptocurrencies is now so large that could pose <strong>Systemic Risk</strong> (an event that could trigger severe instability or collapse an entire industry or economy). During the 2008 Global Financial Crisis, Banks became "<strong>Too Big To Fail</strong>". At the time of writing this note, Bitcoin alone has surpassed the $1 Trillion valuation which, to put things in context, is somewhat comparable to the first round of quantitative easing (“QE”) in 2008 that was needed to contain and reverse the collapse. During QE1 the Fed purchased $1.25 trillion in mortgage bonds, $200 billion of debt issued by government-sponsored mortgage companies Fannie Mae and Freddie Mac, and $300 billion of long-term US Treasuries. Altogether less than the market cap of Bitcoin and Tesla today and potential another angle why the Government and the Central Banks should be monitoring potential risks to Financial Stability.</p><p>- <strong>Bitcoin is and will be Taxed</strong>. The fact that cryptocurrencies are decentralized does not mean that the Government will not go after your profits. Don´t be naïve. They will. As Mark Twain said, “there are two certain things in life: death and taxes”. Indeed, the greater the problem with fiat, the greater the risk of taxation. The reason we have a problem with fiat currencies is debt and therefore greater the debt problem, the greater their need to tax both directly via taxes and indirectly via inflation, also a tax. The measure will most likely be populist and well received by the average person. To make things worse, Janet Yellen has allegedly raised the idea of <strong>taxes on unrealized gains</strong>. In my opinion, this is the single most dangerous comment from a Central Banker or Government in years as <strong>Taxes on Unrealized Gains = Tax Wealth Effect = Prick Bubble</strong>. A shot in the foot for the Government as it would immediately prick the Ginormous bubble they have created and are trying to milk. Whatever may be the case, just make sure are you put money aside and plan for the taxes for realized or unrealized gains on Bitcoin.</p><p>- <strong>Government Digital Currency is bad for Crypto</strong>. Do not fool yourself. Central Banks embracing their own version of digital, or cryptocurrency is not good news for Bitcoin. Quite the opposite. The adoption of full digital currency (eliminating paper money and coins) gives the Central Banks even more control over money and additional benefits, such as introducing negative interest rates or printing infinite supply instantly. The benefits of Seigniorage are particularly large for the Reserve Currency, currently the USD. Other Developed and Emerging Market currencies, such as the Euro or the Japanese Yen, or the Chinese Yuan are no real challengers to the Reserve Currency status. A decentralized global currency presents an interesting intellectual solution, but it is against the common interest of all Sovereign countries to lose control of their monetary policy.</p><p><strong> </strong>- <strong>The Intrinsic Value of Money is Zero</strong>. This is a loaded question. In essence, the argument is that money on itself has no value and is just an intermediate step between goods and services. I am aware of other interpretations (such as the value of the USD is the present value of the tax receivables) but in my opinion fiat currencies are an act of faith in the issuer of the currency (The Central Bank) and its “boss” (The Government). The USD has had that trust for centuries. The Argentinian Peso or the Venezuelan Bolivar do not have that trust. Either way, whether the Central Bank and Government will abuse their position of power and dilute our purchase power via money printing or now, the fact is digital and crypto money can be created out of thin air and thus why in my view they have zero intrinsic value. Real assets, such as gold or real estate, are different as they cannot be printed out of thin air.</p><p><strong> </strong>- <strong>The Scarcity Fallacy: 21 million Bitcoins vs 21 million Cryptos</strong>. There is no scarcity in cryptocurrencies. You can create a perception of scarcity by framing the discussion around “there are only 21 million Bitcoins” (which is true) but it misses the point that “there are 21 Million different cryptos” (which could be created out of thin air).</p><p>- <strong>The Inflation Hedge Fallacy. </strong>The Scarcity Fallacy directly translates into the Inflation Hedge Fallacy, as <strong>Digital Assets </strong>are NOT <strong>Real Assets</strong>, they are... Digital Assets! As discussed with Daniel Lacalle over Twitter on this point, we must differentiate between 1) <strong>Ability to Print</strong>, where it is clear you can NOT print physical assets such as gold or real estate, but you CAN print digital assets, and 2) <strong>Scarcity</strong>, where some physical assets will be more scarce than others (Gold vs Copper vs Iron) but digital assets are NEVER scarce. As a result, I believe Real Assets are much superior inflation hedges than Digital Assets, and strongly disagree with the narrative from Bitcoin Fundamentalists that argue “gold is useless old money”, as I discuss in detail during my recent newsletter “The Revenge of the Old Money”. On that note, I discuss <strong>Gresham’s law, “Good Money” and “Bad Money”</strong> and how the race to inflation has two phases. The first one, where money printing is taking place without awareness and “bad money replaces good money” and a second phase where inflation expectations drive a process where “good money replaces bad money” that eventually leads to Voltaire´s “paper money reverts to its intrinsic value: paper”. We must remember that inflation is not about the value of assets going up. It is about the value of MONEY going DOWN. To the limit, as Fiat Currencies converge to zero (as it was the case with the Venezuelan Bolivar) everything is an inflation hedge to some degree or another. </p><p><strong> </strong>- <strong>The “There Can Only Be One” Narrative</strong>. To reinforce my point on Scarcity Fallacy, look at the “joke” that Elon Musk is playing by pumping <strong>DogeCoin</strong>, the “dog of cryptos”, effectively challenging the fundamentalist argument “there can only be one”, which in my view is central to the success of Bitcoin because, ironically, the success of alternative cryptos such as <strong>Ethereum, Cardano, XRP</strong> or even <strong>DogeCoin</strong> could accelerate the demise of the entire group. It is not surprising that aggressive promoters of Bitcoin, like Michael Saylor, are attacking “anything non-bitcoin”, including other cryptocurrencies such as Ethereum, which he argues “are centralized competitors and are not done with the functional architecture yet”.</p><p>- <strong>The Bitcoin Monopoly Fallacy</strong>. As Daniel Lacalle and I argued in our book “The Energy World is Flat” (Wiley, 2014), “Consumer’s don´t crude oil. They need cheap, abundant, reliable, clean transportation”. I believe the same applies to money. Andrew Bailey, Governor of the Bank of England recently said at digital currencies panel at the Davos World Economic Forum that "digital innovation in payments is here to stay, but cryptocurrencies in their current state are not likely to be the final settling point, as businesses, consumers and regulators look for digital currencies that are stable, safe and well-designed before fully shifting away from traditional currencies like the pound and dollar". The argument of evolving technology was also raised by Ray Dalio in his recent note. The monopolistic and static argument “there can only be one, and Bitcoin is the one” (which could have been taken from the Highlanders’ movie) is critical to the Bitcoin narrative, which expands with other quotes such as “24 hours. 360 degrees. 100 percent. 21 million Bitcoin” (bitcoin standard). “I will HODL bitcoin for 100 years” (prisoner’s dilemma), “World’s Best Collateral” (new gold), “Tax and fees kill almost all other assets” (decentralized outside of the system) which discuss and debunk throughout this note. </p><p><strong> </strong>- <strong>The Value Fallacy: BitCoin, DogeCoin, AppleCoin, TeslaCoin, YouNameItCoin. </strong>How about<strong> </strong>Apple launching its own cryptocurrency, AppleCoin? The idea is that anyone to wants to buy an Apple product would need to pay with AppleCoin. How much would that be worth? Today´s market folly would probably assign billions despite being created from thin air. And how about TeslaCoin or WallMartCoin or MicrosoftCoin or YouNameItCoin? A value creation miracle? I don´t think so.</p><p><strong> </strong>- <strong>Network Effect application to Money and Store of Value. </strong>The Network Effect<strong>, </strong>also known as <strong>Demand-side Economies of Scale, </strong>is the phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products. Typical examples are Telephone or Uber. Network effects different from supply-side economies of scale, which describe decreasing average production costs. Network effects are the demand-side equivalent of economies of scale whereby customer's willingness to pay increases with each new consumer. In my opinion, it is not clear that <strong>Network Effects necessarily apply to Money or Store of Value</strong>. The price of the USD or Gold or Bitcoin or Ethereum in my view is not impacted by Network Effects but rather good old-fashioned supply and demand, which bring us back to the Value and Scarcity Fallacies (framing "Bitcoin has limited supply") and Inflation Hedge Fallacy (framing "Bitcoin is the only alternative to Fiat and will have unlimited demand", which misses the point that everything (not just Bitcoin) is an inflation hedge when the value of fiat converges to zero.</p><p>- <strong>Metcalfe’s Law </strong>states that "the value of a network is proportional to the square of the number of participants in the network". This model has been used to predict the exponential growth in the valuation of Bitcoin and other crypto currencies, but in my view, <strong>the narrative confuses Utility and Price</strong>. Even for the telephone, we can argue that the <strong>utility </strong>increases <strong>exponentially </strong>with each incremental user (true) but that does not necessarily translate into consumers willing to pay higher prices, let alone exponentially higher prices.</p><p><strong> </strong>- “<strong>Bubble, Ponzi Scheme, and Environmental Disaster”. </strong>Agustín Carstens, Head Bank of International Settlements, described Bitcoin as “Bubble, Ponzi, and Environmental Disaster”. His considerations imply that <strong>Bitcoin Mining is not ESG compliant. </strong>An important consideration for Corporate and Institutional investors, as Environmental, Sustainability, and Governance (“ESG”) considerations are in my opinion not a fad and will continue to push ahead in full force with deep implications for both firms and their investments. The recent surge in prices is partially supported by Tesla´s recent $1.5b purchase and expectations that other institutional and corporate clients will follow, which confirms the thesis but also leads to some “front running” from the retail and traders. Whilst Goldman Sachs in a recent report was more skeptical of the relevance of these potential inflows, we must remember that Desperate Search for Yield and Returns already pushed some institutional investors into CDOs in 2008. We all know what that worked out.</p><p><strong> </strong>- <strong>The “HODL” Crypto Prisoner’s dilemma</strong>. The prisoner's dilemma is a paradox in decision analysis in which two individuals acting in their own self-interests do not produce the optimal outcome. As a result, both participants find themselves in a worse state than if they had cooperated with each other in the decision-making process. The narrative of "HODL" (incorrect spelling of HOLD, originating from a tweet from a Bitcoiner during a sell-off, now adopted as the “cry of war”) tries to address this issue. The idea is to create a cult where new members buy but never sell, and whereby some other members, such as “Bubble Traders” such as Paul Tudor Jones or Stan Druckenmiller have zero emotional attachment to their investment and will happily dispose of their investments at the optimal time, leaving the HODLers holding the bag.</p><p><strong> </strong>- <strong>Paul Tudor Jones “The Fastest Horse in the Race against Inflation” </strong>Paul Tudor Jones, the legendary investor, in his newsletter from May 2020 “The Great Monetary Inflation” discussed various alternatives in what he called “the race against inflation”. A strong supporter of gold and real assets, he advocated for non-traditional hedges such as Bitcoin. His approach “looking for the fastest horse in the race at any point in time” is extraordinarily powerful. I do not know how much he bought nor at what price, but Bitcoin was trading under 10k at the time the newsletter was published. </p><p><strong> </strong>- <strong>Paul Tudor Jones, Druckenmiller, and other “Masters of Bubbles” will not HODL</strong>. In addition to Paul Tudor Jones, there has been a growing number of legendary investors and traders such as Stan Druckenmiller, a disciple of George Soros, the master of Bubbles who coined the concept of Reflexivity (“fundamentals drive prices but prices also drive fundamentals”) who have also embraced the merits of Bitcoin. Once again, will not BUY and “HODL” Bitcoin, he will TRADE it. He has been very vocal on the entry. Not so sure he will be so public or vocal on his exit. What is for sure is that he will “exit first and tell later”. </p><p><strong> </strong>- <strong>Fear Of Missing Out. FOMO. </strong>As the adage goes, “be careful when you follow the masses. Sometimes the m is silent”. There was a fascinating social experiment in Holland, I believe, where lottery tickets would win by community area. That is, the winner is not a number that means nothing, but rather a number that represents a neighbourhood, a community. The caveat is that only those in the neighbourhood who bought the ticket would get the price. This simple method exploits FOMO as, in the event of winning, your neighbours will be rich, and you will not. Fascinating. Similar for the markets, the rapid expansion across neighbours, work colleagues, friends, or relatives can become a powerful driver of behaviour. His push to get corporate adoption reminds me of 2008, when some institutional investors bought CDOs fooled by siren songs (from investment banks and rating agencies) to sailors (institutional clients). If things go wrong, well, we all lost together and, as we say in Spanish “malo de muchos, consuelo de tontos”, which we could translate along the lines of “evil for many, consolation for fools”.</p><p><strong> </strong>- <strong>Manias are a double-edged sword</strong>. Timing the markets with certainty is impossible. As Jim Rogers said, “Manias first destroy those that go against it, and then those that go with it”. Even if we knew with 100% certainty that a bubble will eventually be worthless, it would still leave us with THE problem of TIMING. As Keynes wisely said, “Bubbles can remain irrational for longer than I can remain solvent”, which I complement with “bubbles tend to last longer and go further than anyone anticipates, they also tend to collapse a faster and deeper than anyone expects”. On the way up it is all fun and giggles because no-one seems to lose (those who bought low and sold high locked-in their profits and are happy, and those who bought high and enjoying even higher prices). In a bull market everyone feels rich, a phenomenon known as <strong>Wealth Effect</strong>, which can lead to complacency and excess. For those paying attention to the price action, I would argue that <strong>Bitcoin price action resembles more Tesla than Gold</strong>, which is ironic as Tesla has now bought $1.5b of Bitcoin, effectively reinforcing that correlation even further. Tesla´s $850b market capitalization with 1,700 Price Earnings ratio has no historical precedents and has widely polarized market participants between those who, like me, believe it is a bubble and those who do not. The large disconnect in prices between Bitcoin and gold in my view an additional warning signal of momentum-driven buying, which could be exposed as/if/when the trend changes.</p><p><strong> </strong>- <strong>Risk of Fraud, Cyber-attack</strong>, <strong>and Implementation Considerations</strong>. Ray Dalio raised this point as a key consideration in his note, which I agree with. Whilst Bitcoin is positioned as “<strong>unhackable</strong>”, there are multiple weak links in the chain that could be subject to cyber-crime and/or fraud. There have been plenty of examples already involving exchanges and a whole host of complex processes involving efforts to take it out of the system which in my view pose enormous challenges for adoption. Moving on to other technical and <strong>Implementation Considerations: </strong>The report from the BIS from July 2018 (https://www.bis.org/publ/arpdf/ar2018e5.htm) raises some concerns about <strong>Scalability</strong>. “At the most basic level, to live up to their promise of decentralized trust cryptocurrencies require each and every user to download and verify the history of all transactions ever made, including the amount paid, payer, payee, and other details. With every transaction adding a few hundred bytes, the ledger grows substantially over time. Thus, to keep the ledger’s size and the time needed to verify all transactions (which increases with block size) manageable, cryptocurrencies have hard limits on the throughput of transactions”. The report also argues currencies are<strong> inadequate for everyday means of payment</strong> as “to process the number of digital retail transactions currently handled by selected national retail payment systems, even under optimistic assumptions, the size of the ledger would swell well beyond the storage capacity of a typical smartphone in a matter of days, beyond that of a typical personal computer in a matter of weeks and beyond that of servers in a matter of months. But the issue goes well beyond storage capacity and extends to processing capacity: only supercomputers could keep up with verification of the incoming transactions. The associated communication volumes could bring the internet to a halt, as millions of users exchanged files on the order of magnitude of a terabyte”.</p><p><strong> </strong>- <strong>Speculation and Extreme Volatility likely to Continue</strong>. The market is extremely polarized between those who believe Bitcoin is worthless and those who believe each bitcoin will be worth millions. Even taking a completely agnostic stance that assumes a 50/50 even chance, we know for sure that the volatility will be extreme, which is yet another limiting factor for adoption. Ray Dalio summarizes bitcoin as “as a long duration option on a highly volatile asset where we can lose 80% of its value”.</p><p><strong> </strong>- <strong>Speculation via Bitcoin Futures</strong>. The development of a futures and options market is arguably a natural step in the development of any underlying but is a mechanism that can turbo-charge speculation. To a certain extent, those who buy bitcoin in exchange for full payment in cash have their downside limited to their investment and could HODL their bitcoin all the way to zero. On the other hand, investors buying Bitcoin via leveraged futures are incurring much greater risk and will have to post margin to keep their positions.</p><p><strong> </strong>- <strong>Speculation via Bitcoin Options</strong>. Full of confidence from their successful “trading”, some investors will sell put options as a way to generate some premium thinking “I will happily buy it there”. More often than not, the focus on the premium instead of risk will result in larger notional they cannot afford. Buying options is risky but at least the worst-case scenario is the loss of the premium. Selling leveraged options is the quickest path to bankruptcy. I have seen this movie already in 2001 and strongly recommend against selling naked leveraged options.</p><p><strong> </strong>- <strong>Convexity is greatest from low prices</strong>. The exponential nature of bubbles makes Bitcoin and other cryptos a very “convex asset”. Clearly, the higher the price the lower the convexity and the greater the downside, and thus why people like Elon Musk try to pump DogeCoin from 0.01 instead of buying Bitcoin at 40,000.</p><p><strong> </strong>- <strong>Risk of False Diversification</strong>. I think this is obvious, but I will make the point anyway. If you are investing in a “diversified” basket of crypto currencies, you are NOT diversified. It is just ONE trade. If the perception of diversification leads to leverage, this could be fatal as the combination of higher volatility and polarization of correlations can produce larger than expected losses.</p><p><strong> </strong>- <strong>Bitcoin, Striker or Defender? </strong>I often use a football/soccer analogy where I categorize investment strategies as “strikers”, “midfielders”, “defenders” and “goalkeepers” as a function of how they are expected to behave during risk-on and risk-off market conditions. The narrative of Bitcoin is, in essence, a defender against a weak USD and inflation, but the concern is how much speculation is driving markets and how that could lead to force liquidation during periods of high volatility and stress. At the end of the day, it is the behaviour and not the label that determines the role you play in a portfolio.</p><p><strong> </strong>- <strong>Optimal Strategy</strong>. I have been asked many times what I think about Bitcoin and how I would trade it. I do not invest in it neither at a personal, not professional level, but my answer has generally been, “I think it is a bubble, but I also think it is likely to go up from here”. My recommendation was to buy 2 Bitcoin at x, and Sell 1 once the price doubled, resulting in a “free Bitcoin”. That works best at lower prices of course. At current prices, there is much more two-way risk. The danger, as with every bubble, is to grow in overconfidence and increase the size of our trading to levels that could and will ultimately result in greater losses than we could anticipate or afford. For those “new traders” who have not traded through 2001 or 2008, I just recommend prudence and discipline. It is going to be a wild run.</p><p><strong>Conclusion</strong></p><p>I believe we have a Big Problem with Fiat Currencies, Asset Bubbles, and Inflation. I also believe that Blockchain and Crypto are great technological innovations that have the potential to disrupt certain industries. I do however believe that Bitcoin and Crypto are quickly becoming a clear enemy of the Central Banks. The old adage warns us to “Never Fight the Fed” as we know they will do “whatever it takes” to keep their monopoly over fiat money and the privilege of Seigniorage, and thus why investors should be ready for additional regulation, taxation, or even outright prohibition as illegal tender. In addition, I believe the thesis and narrative have fundamentals flaws, including the Scarcity Fallacy or Value Creation Fallacy, and thus why, overall, my personal conclusion is “<strong>Bitcoin is 80% Bubble and 20% Anti-Bubble</strong>”.</p><p>Just my personal opinion. Nothing personal. The analysis is comprehensive but not exhaustive and subject to my own biases and blind spots. Whether we agree, disagree, or agree that we disagree, I hope the analysis will complement your own and help you reach independent conclusions.</p><p> </p><p> </p>