Think Bitcoin™ Issue #20
Why Bitcoin (and the rest of crypto) is dipping; mental models that keep people from understanding Bitcoin; Bitcoin and progressive politics
Hey friends, welcome back to Think Bitcoin™. I hope everyone had a safe and restful Christmas and New Year. As always, if you have any questions or comments, feel free to reach out!
In this issue:
Headlines/Insights: Why Bitcoin is dipping; a switch in perspective that can help you understand Bitcoin
Content Round-Up: 2 podcasts
As always, if you find this newsletter interesting or useful, please share it with others who might find it interesting or useful, too!
Headlines and Insights
Why Bitcoin is dipping
If you read the last issue of this newsletter, which was published before Christmas, or if you follow me on Instagram, and/or got a chance to catch my interview with Ian Builds Wealth, you know that I’ve been flagging some short/medium-term headwinds for Bitcoin and for the crypto space as a whole. For the last 18 months or so, markets have been awash in liquidity, with the Fed implementing historically dovish policy while, simultaneously, the government enacted the largest fiscal stimulus we’ve ever seen. It has been an absolutely perfect storm for assets and asset prices. With interest rates held artificially low and the Cantillon Effect fully operative, a ton of the new and massive liquidity flowed into assets, including crypto.
Now, we have the Fed not only talking about tapering and raising rates; but also talking about normalizing their balance sheet. In other words, the historically dovish Fed has now swiftly turned hawkish in their attempt to fight what they now acknowledge to be decidedly non-transitory inflation.
So how does this affect Bitcoin? To radically simplify, when the Fed raises rates, they increase the cost of capital, i.e. the cost of borrowing. This means less borrowing and less growth. Raising rates also affects the discount rate used in discounted cash flow analysis of securities. This makes investors unwilling to pay as much for companies whose growth is primarily expected way out into the future (as opposed to the present). This harms really growthy high-flying tech stocks that, though currently unprofitable or not especially profitable, promise (or aspire) to be profitable down the road. This is why we’ve seen so many tech names get shellacked in the last couple of weeks.
These types of tech stocks, commonly referred to as growth stocks, are also generally “risk-on” stocks. A “risk-on” environment is one in which everyone’s feeling pretty optimistic about future prospects, the Fed’s monetary policy is accommodative, growth is abundant, etc. Investors have a higher risk-appetite in this environment, which leads them up the risk curve in equities. Usually in these environments the Fed is keeping interest rates low (or pegged to zero, as they have been for the last 18 months), so alternatives to equities are essentially nonexistent.
A “risk-off” environment means the Fed is tightening policy, which generally slows the economy down. The outlook is less rosy, and folks feel less optimistic. This leads many investors to de-risk their portfolios, which usually involves reducing exposures at the higher end of the risk curve and increasing defensive exposures and lower-beta exposures.
Bitcoin, as Robert Breedlove has said, is competing to become the ultimate risk-off asset (meaning the ultimate “safe” asset), but it is still presently perceived by many in the market to be very much a risk-on asset. It is certainly the safest and most established of crypto assets, but most investors (and especially institutional investors) still view it as a self-evidently risk-on asset. Beyond Bitcoin, crypto (generally) is universally considered a risk-on asset class.
So, with the Fed giving some signals that they want to end their accommodative policies, investors are rotating down the risk curve. It’s important to note the make-up of the current crypto market, too. In this cycle we’ve had the entrance of institutions and institutional investors. These players act and move predictably as macroeconomic conditions change. Unlike the true HODLers, many of whom are perfectly willing to white-knuckle it through inevitable bear markets, institutional investors can’t just eat 50% drawdowns. Their P&Ls close on a yearly basis. Staring Fed tightening in the face, it would be unsurprising if some institutions waited for more carnage before loading up.
I wholeheartedly believe that more institutions are and will be coming into the space. But institutions are much more concerned with timing markets than retail investors. And, given the outlook with respect to monetary policy, I would expect some of the savvier managers to wait for more pain before stepping in.
Now, the ultimate question is whether the Fed can actually pull tightening off and, if so, for how long. The Fed has attempted to taper many times in the last decade, and it’s always ultimately resulted in more expansion of the balance sheet.
(Chart credit Jim Bianco at Bianco Research)
If the Fed moves aggressively and swiftly, many expect broader asset markets and our debt-fueled economy to crack. The Fed could end up bumping us into a recession. The question is just at what level does something break and does the Fed then retreat and resume accommodative policy.
Right now, the Fed, politically married as it is to the Treasury Department and the Biden administration, appears justifiably to be more concerned with inflation. I think there are obvious political dynamics afoot here. The Democrats know they’re getting hammered over inflation, which is an issue that people really acutely feel every day. You feel it when you go to the grocery store, when you fill up your car, etc. And wages aren’t rising as quickly as CPI. They haven’t for decades. So CPI inflation remaining hot is a political nightmare for Democrats and will undoubtedly torpedo their chances of holding on to majorities in the House and the Senate if it remains at or near current levels.
Rising prices in food and gas is also the sort of thing that just makes people really angry. Rightfully so. Historically, this is the kind of populist angst that ends with people’s heads on sticks, people losing elections, people getting thrown out of office, general unrest, etc. So clearly there’s some brutal calculation going on: do we risk tanking asset markets and maybe flirting with a recessionary impulse by raising rates because wrangling (or at least appearing to wrangle) inflation is politically more important? Economic slowdowns aren’t great for most people, either, but, as of now at least, whether the Fed triggers a slowdown by tightening remains speculative (comparatively), whereas CPI inflation is very much real and present.
I think the Fed’s ideal scenario would be the inflation numbers significantly cooling off before they start raising rates, which would allow them to ease into it a little more and give them some more wiggle room. But if the upcoming inflation prints remain elevated, they will feel more and more pressure to accelerate their tightening, which increases the risk of something breaking, and generally makes a risk-off environment seem inevitable. Which is of course not great for Bitcoin and crypto.
If the Fed eventually has to step back in and rescue the economy that they had to break in order to control inflation, though, this would be incredibly bullish for Bitcoin.
So how do I feel? I feel short-to-medium-term cautious and long-term bullish.
In addition to the Fed tightening dynamics, there’s also significant unrest in Kazakhstan, where a significant amount of Bitcoin mining exists. The authorities cut the internet and, as I write, I don’t believe it has been restored. This led to a dramatic decrease in the network’s hash rate.
Remember, this happened after China banned Bitcoin mining, too. The network, ever resilient, recovered and had reached all-time highs again prior to this recent drop.
I’ll conclude with these heartening words from Ryan Selkis.
I’m not saying we’re in a bear market or about to be in one. But I’m saying buckle up, know why you own what you own, and remember you’re riding a wave of societally transformative technology that isn’t just going to go up in a straight line forever. There will be ups and downs, but if, as Paul Tudor Jones advises, you align the time horizon of your investments with the time horizon of your ideas, you’ll have an easier time weathering the volatility.
What Holds Many People Back from Understanding Bitcoin
Over the holidays I took a break from social media and pretty dramatically reduced my Bitcoin content consumption. I wanted to do this just to clear my head and create some space for new thoughts and perspectives to percolate. I ended up listening to a bunch of history lectures on Audible, which affirmed and crystallized a conception of Bitcoin I’ve been harboring and chewing on for a while.
Put simply, many people struggle to understand or fully grasp the historical sweep of Bitcoin because the lens through which they are evaluating it, the lens they have been trained and conditioned to employ, is that of “investment vehicle.” It’s no surprise, for instance, that most of the questions and reply-guy commentary I get on social media consist of some version of “it’s not a productive asset” or “it doesn’t create any cash flow” or “how can I make it create cash flow” or “it doesn’t have any ‘fundamental’ value” or “what are its historical returns and can we project those forward,” etc. In other words, folks tend to take traditional finance heuristics, to the extent that they understand them, and apply them to Bitcoin.
The purpose of these heuristics is twofold. One, they’re ultimately defensive at root, in the sense that they aim to reduce unknowns, increase predictability, and reveal problems. All of this is intended to, net-net, make an investment less speculative. These heuristics are the defogging button on your car windshield. No one wants to drive a car with no visibility. Similarly, very few people want to invest in assets utterly clouded with uncertainty and unknown risks.
These heuristics are useful in the domain of traditional and commonly traded investment vehicles. They were cultivated within a pretty orthodox paradigm of asset valuation and security analysis that everybody in the finance space, whether professionally/institutionally or merely in the personal finance space, is used to living in. The personal finance space, in particular, has more or less absorbed, wholesale, a watered down version of these heuristics, and is almost puritanical in its devotion to the paradigm itself, despite a comparatively minimal understanding of its underpinnings.
And herein lies the problem. When we become so entrenched in an existing paradigm, we come to view it as capital-R reality, immutable and inevitable. It becomes part and parcel of one’s worldview, of one’s understanding of his/her/their relationship to the world and to the economy. This creates two challenges: (1) it makes it harder to see the paradigm shift when it is initiated and (2) it makes the shift itself, experienced in real time and not through the perspective of distant hindsight, feel like a toppling of your worldview, which is something people obviously struggle with.
A few examples of historical paradigm shifts may illustrate these challenges more compellingly. Let’s start with Galileo. Galileo, as we all know, ended up in front of the Roman Inquisition. Why? He advanced heliocentrism, the idea that the sun (not the earth) was at the center of the solar system. This conflicted with the Bible and the teachings of the church, upon which consensus views were commonly based. Heliocentrism was a paradigm shift that had all sorts of downstream effects, many of which weren’t immediately appreciable. Looking backwards now, from posterity, we view this is as an obvious truth that should’ve been readily accepted. But actually existing through that paradigm shift would have felt markedly, significantly different.
I’ve also been thinking a lot about the Protestant Reformation and the Catholic Church’s slow response. Their delay, coupled with the invention of the printing press, allowed the ideas of the Reformation to propagate widely. By the time the Church meaningfully attempted to put the proverbial genie back in the bottle, it was too late. In Europe, the following centuries would be shaped, geopolitically and intellectually, by the emergence of Protestantism and its relationship with Catholicism. And guess what? It all started with one paper written by one person. (Do you see where my mind is going?)
Interestingly, there are some parallels here with the inception of Bitcoin. Martin Luther’s 95 Theses, like Satoshi’s white paper, kicked off a global paradigm shift of historical import. The U.S. government didn’t take notice of Bitcoin with any level of seriousness until 2021. Like the Catholic Church to Luther, they were slow to respond to the emergence of Bitcoin. The idea of Bitcoin was circulated via the internet, the most transformative tool for the distribution of information since the printing press, which itself was used to circulate Luther’s ideas.
The point of these historical illustrations is just to underscore that, if you’re struggling to wrap your brain around Bitcoin and why people buy it, perhaps it’s because you’re viewing it exclusively through the lens of an investment vehicle, which is to say within our current paradigm of traditional finance. If you step back and look at it with some historical perspective, as something that actually challenges our existing paradigms by presenting us with the promise of a new one, its significance and its potential is more easily appreciable.
Content Round-Up
As I noted at the outset, I’ve consumed less Bitcoin content the last two weeks, both intentionally, in an effort to clear my head and think some fresh thoughts, and also as the result of my wife and I moving into a new house. I will be back to my normal levels of consumption this week. In the meantime, here are two podcasts I enjoyed immensely last week.
1. “Bitcoin and the Black Experience with Dawdu M. Amantanah,” an episode of The Progressive Bitcoiner Podcast. In this episode, Amantanah discusses mistrust between the black community and the banking industry, justifiably based on historical (and also current-day) discrimination and exploitation. He further discusses the importance of education and financial literacy; consumerism vs. building wealth; and how fiat incentivizes overly-competitive behavior, moral shortcuts, and selfishness. Amantanah also offers his thoughts on the welfare state, which I won’t spoil for you; the importance of Bitcoin being unmanipulable with no single point of failure; and how the Cantillon Effect exacerbates wealth inequality.
2. “Progressive Values and Bitcoin with Nicole Dobrow,” an episode of The Progressive Bitcoiner Podcast. In this episode, Dobrow laments that the political Left isn’t getting exposed to Bitcoin through voices that they understand. She offers her own elevator pitch for why Bitcoin is good for the world (“Bitcoin has the potential to unite every global citizen of the world under a single monetary network, which puts every citizen in the world under equal standing”). She discusses the importance of a monetary network that no one government or country can dominate, what progressives miss about Bitcoin, why the Left needs better voices on Bitcoin, and why it’s dangerous for the Left to disavow Bitcoin.
Bonus/Miscellaneous
Recently I had the pleasure of chatting with Ian Group of Ian Builds Wealth (@ianbuildswealth) about why Bitcoin will eventually reach $1 million per coin and, more importantly, why Bitcoin matters globally, politically, and historically. We also discuss what to look for and expect from Bitcoin this year, given the ever-evolving macroeconomic environment. Check it out.
As always, thanks for reading! If you enjoyed it or found it useful, share this newsletter widely and freely!
“Civilization is in a race between education and catastrophe. Let us learn the truth and spread it as far and wide as our circumstances allow. For the truth is the greatest weapon we have.” -H.G. Wells
See you next week,
Logan
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DISCLAIMER: I am not investment advisor and this is not investment advice. This is not, nor is it intended to be, a recommendation to buy or sell any security or digital asset. Nothing in this newsletter should be interpreted as a solicitation, a recommendation, or advice to buy or sell any security or digital asset. Nothing in this newsletter should be considered legal advice of any kind. This newsletter exists for educational and informational purposes only. Do your own research before making any investment decisions.
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