It has been some time since our last reports (Q1-2018 and Q4-2017). That’s okay—we are strong believers in taking a long-term approach to investing. It’s well documented that overactive trading is detrimental to investors’ financial health, let alone their mental health. The best thing to do is often… nothing. Patience is a virtue.
Tech entrepreneur Naval Ravikant has said that “99% of all effort is wasted.” This principle applies doubly in the world of investing, where over-trading can result in real financial losses stemming not only from bad trading decisions, but also from trading fees. Just as it is in the best interest of the news media to stir people into a frenzy, so is it in the interest of the financial establishment, including the growing cryptocurrency establishment, to encourage investors to over-trade their accounts. The real beneficiaries of all that trading are the exchanges, brokerages, and market makers who collectively skim fees and take a percentage of every trade, in the same way that casinos take a percentage of all gamblers’ bets.
In fact, the main organizations making money from the cryptocurrency markets so far are those which are facilitating trading. We are reminded of a conversation with a top trader at a global investment bank in which he attempted to explain what it is exactly that investment banks do. “We are the casino,” he said. “Our clients are the gamblers.”
Make no mistake, the world is a giant casino. People are human and are strongly attracted to things with addictive power. We wonder what the world would look like without any businesses based on alcohol, caffeine, sex, or gambling. It would surely be a very different place.
Where we have advocated trading before is in the rebalancing of a carefully constructed portfolio. Rebalancing—or constantly buying low and selling high—is a way to harvest volatility. The burgeoning cryptocurrency markets are extraordinarily volatile, so there is an extraordinary opportunity to harvest volatility, which is a kind of wealth transfer from short-term trend-followers and day traders to rebalancers.
However, there are two issues with this approach. The first issue is taxation, because from a tax perspective, constantly selling winners and reinvesting the proceeds into losers is exactly the wrong thing to do because it maximizes realized gains. Thus, the effectiveness of rebalancing depends a lot on one’s tax jurisdiction. There is no point in rebalancing if the gains harvested must be paid to national governments and used to help them delay their inevitable bankruptcies.
In fact, simply spending the cryptocurrency itself is a taxable event in most jurisdictions. Germany is the exception, and that country has moved to recognize Bitcoin at least as legal tender. But in most other jurisdictions, buying a cup of coffee with Bitcoin would technically trigger a capital gain or loss. This is obviously an untenable situation, and very few investors would even have the ability to keep track of all such dispersals to comply with the tax reporting requirement.
The situation is even worse if you imagine a future world of micro-transactions where cryptocurrency users are spending the equivalent of one cent here and there to pay for various services like data storage. We joked that cryptocurrency investors should start dumping million-page Schedule D forms onto the front lawn of the IRS. If spending cryptocurrency triggers capital gains, then it is much better to just HODL and never spend it, but that would kind of defeat the purpose of it—cryptocurrency was originally envisioned to be a medium of exchange and not simply a store of value. This is just one of many ways in which cryptocurrency is pitted in a battle against governments, and in which government regulation is, as always, lagging far behind technological innovation.
On the topic of tax, we will mention here that the large capital gains realized by active cryptocurrency traders in 2017 are one possible explanation for the brutal cryptocurrency market sell-off that began in December 2018 and accelerated into the first quarter of 2018. Anyone wanting to take some profits out of the market at that time would probably not have wanted to sell until the new year so as to delay owing taxes by at least one more year. But knowing that many investors might sell out in January could in theory cause a sell-off in December, as investors willing to foot the tax bill sooner tried to get out before more widespread systematic selling began—and a sell-off starting in December is exactly what we saw.
The market peak also coincided with the launch of the Bitcoin futures trading that many market participants feared that would allow large-money interests to systematically short the market, thus driving it down. In reality, initial futures volumes were very low, but remember that markets are often driven more by fear and expectation than by actual events.
In any case, speculating on the causes of the sell-off is beside the point. Markets have a mind of their own (are they sentient?) and our job as long-term investors is to ignore the short-term fluctuations, however painful they may be. The history of cryptocurrency is fraught with huge sell-offs, so it is really par for the course.
We need to examine the market with a wider lens. The always-entertaining John McAfee put it succinctly: “Okay, people: Can we please get real? One year ago to the day, Bitcoin was at $2,560. Today it is over $6,000. That is a 140% increase. This year-to-year increase has been accelerating significantly. Stop the short-term thinking. Get real.”
Back to the topic of portfolio rebalancing, there is also an argument that rebalancing a portfolio of small tech startups is not a correct approach, given that tech startups tend to follow a power law distribution, meaning that a few companies (or coins in this case) come to dominate and the rest fail miserably. In such a market, the best approach is to diversify but to let the winners ride, instead of rebalancing out of them and into the losers. Of course, there are those “Bitcoin maximalists” who feel that Bitcoin itself is the only real long-term winner and that the ICO market is a land of empty promises.
The Bitcoin maximalists were not right in 2017, as the price-performance of Ethereum trounced that of Bitcoin itself and Bitcoin market dominance declined dramatically, but it remains to be seen if this trend eventually reverses. Bitcoin maximalist (and voracious carnivore) Saifedean Ammous published a book called The Bitcoin Standard, which makes a strong argument that Bitcoin improves upon the central banking gold standard, or in other words, that it is like Gold 2.0. The book was well summarized by a former advisor to the French prime minister.
However, gold bugs like Jim Rickards often point out that Bitcoin is not backed by anything real and is a far cry from gold. Gold is a very special element of the universe that is probably only produced in massively energetic neutron star collisions. We have a feeling that this debate will not be resolved anytime soon, which is probably a boon for Bitcoin, given that it is still just a small fraction of the size of the gold market.
Somehow we are reminded of the recent film Ready Player One. While the virtual world is certainly not a nirvana, it is pretty obvious at this point that it is ever-increasing in size and importance. This probably bodes well for virtual currency. But zooko from the Zcash project put it well when he said, “I’m a maximalism minimalist. The universe is always at least an order of magnitude bigger than what you can see.”
Of course, establishment economists such as The Financial Times‘ Izabella Kaminska have long argued that, as a currency, Bitcoin is even more untenable than gold. The argument is based around the idea that money supply should expand and contract fluidly as needed to maintain price stability and avoid dreaded deflation. In fact, Bitcoin could be even more deflationary than anticipated, given that approximately 5% of cryptocurrencies are irretrievably lost annually according to one estimate. That is a lot of forever-sunken gold. In any case, readers of The Financial Times might now be kicking themselves for having missed out on the entire blockchain revolution so far.
Keynesians aside, if gold and cryptocurrency are the two main contenders for a global store of value, then what about gold-backed cryptocurrency? There is an argument to be made that it would be the best of both worlds, but it’s not that clear. For one thing, gold-backed cryptocurrency reintroduces the need for trust. Bitcoin maximalists love the fact that Bitcoin is fully decentralized and trust-less (putting aside the fact that most mining is controlled by a couple of people in China). With gold-backed cryptocurrency, there is obviously a need to believe, or trust, that there is actually some amount of gold located somewhere and allocated to every unit of the cryptocurrency.
Moreover, while we have argued for real asset-backed cryptocurrencies in the past, it is far from clear how some of them would function practically. One major issue was well summarized in a recent tweet: “If I buy a tokenized house and lose my private key, have I lost ownership of my house? Can I never sell it again since I can’t technically transfer the key? Who can issue me a new key? Where is the real ownership ledger? What is the use of the token? Honestly wondering.”
We recently mused that the ideal global currency might simply be micro-shares of the global all-asset portfolio. One unit of the currency would represent a small ownership stake in every publicly tradeable asset in the world in proportion to the asset’s size. Thus it would be a recursive system where the currency itself would have an earnings yield, as opposed to cash or gold which naturally yield nothing, or which often actually have a negative yield in the form of inflation or storage costs.
Anthony Pompliano, or Pomp, is a big proponent of the idea of “tokenizing the world,” and is one of the most incessantly positive cryptocurrency commentators. But he recently decided to take a break from the negativity of the online world following a thread for which he was criticized for being over-enthusiastic about the potential of tokenized securities.
Many people pointed out that re-implementing existing securities in the form of tokens will not necessarily be as large of a wealth transfer event as the invention of a new gold-like asset (Bitcoin). But it remains to be seen how it all plays out. It is quite possible that the very concept of equity, or of shared corporate ventures, will be transformed by the advent of cryptocurrency.
Indeed, ICOs have recently overtaken other forms of fundraising even though they do not convey typical equity rights to investors. So it remains to be seen how ventures are funded and earnings shared with investors in the future. Remember that we are already living in a world where many of the leading tech stocks do not own much in the way of hard assets and do not typically pay out dividends to investors. Tech stocks are already quite “virtual” in a sense, and have already evolved a long way away from the more traditional idea of what a stock should be. This process is bound to continue as cryptocurrency continues to revolutionize Silicon Valley.
We take Pomp’s temporary departure from online commentary—just before the summer solstice—to have coincided with a low point for the market. Cryptocurrency’s most enthusiastic and incessantly positive commentator could not withstand the negativity and he surrendered. And while we generally shy away from all forms of market timing, as described above, our sources indicated that this year’s summer solstice marked a turning point not only for the crypto markets but also for the more general ongoing battle for control of planet Earth. We shall see.
We were very happy to see Pomp return to active commentary—on the Friday, July 13th new moon. The numerology of this date is a bit counterintuitive, since we are taught by Hollywood that only bad things happen on this date. But remember that Hollywood is well known to be chock-full of disinformation anyway, and the interpretation of dates and numerologies is much more complex subject than one might expect.
In other esoteric crypto news, John McAfee spent the summer solstice in a coma induced by apparent poisoning, but awoke thereafter in good spirits. Shortly thereafter, he was forced to avoid a live speaking appearance due to “credible death threats.” McAfee is planning to run again for U.S. president in 2020, this time on a cryptocurrency-based platform.
On the topic of security-like tokens or security tokenization, we will mention here that we are generally dividend lovers, and this is reflected in our affinity for proof-of-stake cryptocurrency systems. One view is that proof-of-work is an “absurdly inefficient” version of proof-of-stake, given that in either system those with a lot of money are capable of coming to dominate through investment—the only difference being that proof-of-work requires much more energy expenditure and the setup of warehouses, etc.
While we concede that Bitcoin may remain on top indefinitely, our general view that cryptocurrency will continue its evolution towards proof-of-stake platforms that offer tokenization and programmability, a process exemplified by Ethereum’s great success in 2017. In light of that, our favorite investment at the moment is Waves, a fully-functioning proof-of-stake system that is already technologically more advanced than Ethereum in many ways but which stills trades for a fraction of Ethereum’s price. In addition, the Waves platform already includes a fully-functional decentralized exchange allowing for the secure trading of arbitrary crypto-assets without restriction.
We list our portfolio of recommendations below in rank order of our preference for each investment at the current time. The order represents conviction, pricing/risk, and also a time preference, in the sense of some investments being more likely to mature sooner than others. While we have advocated for an equal-weight portfolio in the past, the rank ordering information below could, for example, be used to overweight higher-conviction positions.
Note that our first three positions are all blockchains which either already are, or have some plan to become, some version of proof-of-stake chains. Of further note is the fact that the top two positions are both using the Bitcoin Next Generation (Bitcoin-NG) consensus algorithm from Professor Emin Gün Sirer. As one of the world’s foremost blockchain academics, Emin’s new Avalanche consensus algorithm is also one to keep an eye on.
- Quantum Resistant Ledger
- 0x Protocol
- Basic Attention Token
- Swarm City
As a reminder, we are providing information to the public simply out of a desire share our views and the results of our research. The battle for control of planet Earth has always been a financial battle, and within the realm of finance, cryptocurrency is the latest battleground for control of the future.
There are actually some strange theories that Satoshi Nakamoto was a time traveler. We don’t put much stock into such ideas; however, there are many bizarre occurrences in the world of cryptocurrency that can perhaps only be explained as manifestations of the greater ongoing battle. These apparent attacks and counterattacks can give us some insight into the future, as they give us a glimpse of some of the possible futures that certain forces are attempting to either prevent or facilitate.
Of course, we take a position alongside the forces that we feel to be benevolent. This is our somewhat more esoteric idea of “socially responsible investing,” which is a topic of growing importance even on Wall Street. The only problem with social responsibility is that it is a very subjective concept. We are speaking here from the perspective of the Earth Alliance, a loose-knit collective of global organizations working for the benefit of humanity that includes the Asia-based White Dragon Society.