Nick Maggiulli: Why I’ve Modified My Thoughts on Bitcoin
There is a point in any investor’s journey where they have to admit that they are wrong about something. In my case, I was wrong about Bitcoin and whether it would ever be considered a legitimate asset class. That realization became clear to me last month when the price of Bitcoin topped its high of $ 20,000 in December 2017. My previous belief was that Bitcoin would not beat these highs for many years, if at all. I didn’t think Bitcoin would go to zero, but neither did I think it would soon top its December 2017 peak.
Nick Maggiulli is the Chief Operating Officer at Ritholtz Wealth Management and the author of the finance blog, Of Dollars and Data, which first published a version of this article.
Now that it has topped that high by over 50%, I’ve found that Bitcoin isn’t the one-trick pony I thought it was. As Paulo Coelho wrote in “The Alchemist”:
Everything that happens once can never happen again. But anything that happens twice is sure to happen a third time.
Well here we are again. Bitcoin is on another spectacular bull run and investors are taking note. Now that Bitcoin has survived (and thrived) past its 2017 peak, many investors who used to take it as a joke are realizing that it isn’t. I am one of them.
I changed my mindset about Bitcoin, but not because of a lot of arguments from Bitcoin bulls. For example, bitcoin bulls claimed that bitcoin would be used as currency, that the US dollar would depreciate, and that the halving in May 2020 would increase the price of bitcoin. They were wrong in every way, but the price of Bitcoin is still going up.
What the bitcoin bulls found right was the increased adoption and ability of many bitcoin owners to hold (“HODL”) even when prices rose dramatically. These two effects (more demand from buyers and less supply from sellers) have helped boost the price of Bitcoin and cement it as a legitimate asset class within the investment community. As a result, Bitcoin has become a form of digital gold. You may not agree with this assessment, but if you still feel that Bitcoin is going to zero, reconsider your assumptions.
Why Bitcoin is staying here
The problem with the argument that Bitcoin is going to zero is that there are too many investors willing to buy it at a price well above $ 0. I remember speaking to many non-crypto investors before the recent price spike who said they weren’t going to buy Bitcoin for $ 10,000, but if it fell to $ 1,000-2,000 they would certainly step in.
Guess what? Now that the current price is over $ 30,000, some of these investors have likely increased the limit at which they would consider buying Bitcoin. Instead of buying at $ 1,000, these same investors are welcome to get closer to $ 10,000. And every time the price goes up in the future, these “mental buying limits” also go up, increasing the likelihood of Bitcoin’s future survival.
“But Nick, Bitcoin has no intrinsic value!” Guess what? Neither does gold with a market cap of $ 10 trillion! So if you want to argue against Bitcoin on intrinsic value terms, you must argue against gold as well. Because both the price of gold and the price of bitcoin are based on one thing and one thing alone – the belief that those assets will have value in the future.
See Also: Thinking About Durian – Why> 15% of My Net Assets Are in Bitcoin
And right now, the collective belief in Bitcoin is growing. The cult becomes a religion. But don’t just take my word for it. There are many articles (see here, here, and here) that discuss this increasing adoption in the investment community. And if this trend continues (as it likely will), it is even less likely that we will see a future without Bitcoin.
How will Bitcoin behave?
Now that Bitcoin stays here, you might be wondering how it will behave in the future. Will increased acceptance lead to higher prices? I have no idea! What I do know is that Bitcoin is a speculative asset class. Hence, we should look to other speculative asset classes as a guide to Bitcoin behavior. And I believe there is no better speculative asset to compare with than the early years of gold as an investment.
While gold has existed as a form of money for thousands of years, it was not until August 1974 that it became an investable asset class in the US. And in the six years after its reintroduction into the mutual fund (1974-1980), gold’s real value tripled (i.e. the yellow line below):
Source: FRED, Stockcharts
But it hasn’t worked so well since that tripling. While Bitcoin is unlikely to follow a similar path to gold, it is likely to exhibit similar behavior. This means that Bitcoin will continue to see a huge surge in price, followed by violent crashes that could last for years (and possibly decades) in the future. We’ve already seen this type of behavior with Bitcoin and I’m pretty confident we’ll see it again.
The difference between Bitcoin and Gold is that Bitcoin is still gaining acceptance among investors.
The difference between Bitcoin and Gold is that Bitcoin is still gaining acceptance among investors. Will it stay that way in the future? Who knows? However, if Bitcoin’s market capitalization were the same as gold, it would be worth more than $ 500,000 per coin. This is why some investors are so optimistic about Bitcoin.
There are still a few reasons to be bearish, however. Most importantly, Bitcoin is associated with some of the most speculative investing activities out there. This can be seen most clearly when comparing the price movement with the price movement of another speculative cryptocurrency – Dogecoin. While you may not have heard of Dogecoin, it is an alternative cryptocurrency (altcoin) that is kind of an inside joke on the internet.
And since the price of Dogecoin is a clear indicator of speculative behavior, we can use the correlation between Dogecoin and Bitcoin to get a better sense of how much speculation could occur in Bitcoin at any point in time:
Source: From dollars and data
As you can see, the correlation between Dogecoin and Bitcoin has been quite high for the past three years, with the most recent correlation being 0.8.
However, if we compare Dogecoin to gold, we see that the correlation between their prices tends to spin around 0:
Source: From dollars and data
This is just further evidence that Bitcoin is associated with speculative activity and will continue to behave like a speculative asset in the future.
Is there a right way to invest in Bitcoin?
Although I’ve changed my mind about Bitcoin, I haven’t necessarily changed my view of how to invest in Bitcoin. I believe the only prudent way to invest in this asset class without long-term negative effects is to not hold more than 2% of your portfolio in it. I wouldn’t recommend this approach to everyone, but it might work for some people. If you limit your exposure to 2% of your portfolio, you probably won’t get rich, but you are also unlikely to go bankrupt.
Why 2%? This was the allocation I received when I worked out the optimal portfolio in October 2017. Anything more than 2% increases the risk (per unit of return) to your portfolio, and less than 2% also reduces your return (per unit of risk) a lot. Of course, the optimal portfolio is the best solution for the past, not the future. In both cases I don’t see the damage in a 2% allocation, but please do your research first.
See also: Ajit Tripathi – Why I’m Long Crypto, Short DLT
The biggest risk I see to future ownership of Bitcoin is not a price crash (which is inevitable), but the possibility of a government ban on ownership. This may seem strange, but in April 1933 the US government banned the possession of gold bars / coins for all US citizens. The rationale for this ban is very different from a Bitcoin ban that could happen today, but with the recent complaint from the Securities and Exchange Commission against Ripple, I wouldn’t rule it out entirely.
After all, I could be wrong about many things that I have said today or in the past. But I don’t blog so that I can be “right”. I’m doing it so I can learn more about investing and get closer to the truth. As economist John Maynard Keynes (or Paul Samuelson) reportedly said:
When the facts change, I change my mind. What are you doing sir