I spoke at a conference this week and one of the first questions from the audience was about Bitcoin and my thoughts on cryptocurrencies as an asset class.
My go-to phrase to sound intelligent (even though I have no idea) on this one is “Bitcoin may not be the ultimate winner in all of this but the blockchain technology is going to be revolutionary.”
To be honest I really don’t know what the outcome of all this cryptocurrency stuff will be. I still don’t totally understand the intricacies of it but judging by everything I’ve read and heard no one really understands it all.
I am fascinated by it all though. It provides yet another great study in behavioral psychology.
I’ve seen a few people try to provide a formula or ratio to try to value Bitcoin and the like, which is utterly ridiculous. This is the basic formula for cryptocurrencies:
a new and exciting technology + a group of true believers + a sexy narrative + an insane price rise = crypto market value
There’s no way to gauge this kind of thing through traditional metrics as there are no fundamentals. But that won’t stop people from trying. This thing could already be a huge bubble that could pop at any moment for any number of reasons. Bitcoin has already had three separate instances where it fell 85% or more in the past.
While market crashes make for an interesting case study I’m more interested in what could take this bubble to the next level. I love trying to understand the psychology behind massive market bubbles. I’m not saying it will happen but human nature being what it is, you can never rule it out.
One of the arguments for a sustained rise is the idea of scarcity since the supply of Bitcoins is capped at a certain number of units. Supposedly the total amount of gold ever mined could be melted down and it would only fit into an Olympic-sized swimming pool. Yet the price for an ounce of gold is basically constant for the last 2,000 years.
The example I once read is an ounce of gold bought a nice men’s suit in the time of Jesus and does the same today. There are plenty of scarce resources that don’t go up in value simply because of their scarcity.
Another argument is if Bitcoin can just become a certain percentage of all investable assets it will be worth much more than it is today. If everyone just owns 3% of this is will be worth trillions!
This is a lazy argument. It’s like your college roommate’s dumb business ideas when they would tell you they’re going to start their own whiskey brand or t-shirt company or something. If I can only gain a 1% market share I’ll be rich!
Like no one’s ever thought of that before.
I like to look at these things through the lens of an asset allocator. In terms of asset allocation decisions, I see two scenarios that could potentially send Bitcoin into the stratosphere and make this a ginormous bubble.
The obvious answer here is if the owners of Bitcoin move beyond tech people and millennials. If big-time institutional money makes an entrance things could get interesting. Because of the way institutional capital is deployed this is not a foregone conclusion. The allocators of capital at the endowments, foundations, pensions, and family offices make portfolio decisions in a verrrrrry slow and methodical way.
Portfolio changes in these funds are like turning around a battleship because of the politics and career risk involved. It will probably take decades for pensions to get involved but I wouldn’t be surprised if some nonprofits in the endowment world decided to dip their toe in the water.
The question is: What could cause these institutions to get involved?
The obvious one is that Bitcoin continues to rise and institutions get a bad case of FOMO. But my guess is it’s much easier to look past the huge rise in price on Bitcoin when everything else is rising, even if the gains aren’t nearly as large.
My hypothesis is we could see an influx of capital into this space if it turns out to be a diversifying asset during the next stock market downturn. If stocks get hit hard and Bitcoin continues to rise, or just doesn’t fall, I could see this scenario getting the attention of some endowment funds. While these funds were once some of the most innovative in the entire investment industry, many of them have resorted to fighting the last war over the past decade.
If there was evidence that Bitcoin acted as a diversifying asset during a substantial stock market meltdown I’m guessing that could be enough to perk up the ears of some institutional investors. And once a few pull the trigger the herd mentality would kick in because there’s so much peer pressure among these funds.
I would also assume that the endowment community would be much more comfortable paying 2&20 to a crypto hedge fund (an oxymoron if there ever was one considering you can’t hedge anything in this space) instead of simply buying Bitcoin on its own because that’s how they roll.
Will this happen? Who knows. No one really knows anything at this point because all of this stuff is still in its infancy. My only prediction on Bitcoin is that it will continue to be wildly volatile which is what makes it so interesting from a psychological perspective.
Volatility invites human emotions into the equation and crazy things can happen when people make emotional decisions.
Further Reading:
Bitcoin, Stocks and the Fear of Missing Out
Now here’s what I’ve been reading lately:
- Lessons from over a decade managing money using quant strategies (Validea)
- 2017 best of financial blog awards (RiversHedge)
- The law of reversed effort (Dan Egan)
- How Dr. Suess used constraints to create his greatest book (James Clear)
- More hustle isn’t always the answer (Growth Lab)
- 50 book recommendations from Ramit Sethi (iwillteachyoutoberich)
- Just own the damn robots (Reformed Broker)
- How market panics occur (NY Times)
- Advice for aspiring traders (Irrelevant Investor)
