Think Bitcoin™ Issue #37
Paradigm shift risk (why no one should have a 0% Bitcoin allocation); the fairness of Bitcoin's origin; Bitcoin is good for the environment; the real definition of inflation
Hey friends, welcome back to Think Bitcoin™ for issue #37. Special welcome to the new subscribers. I’m glad you’re here. As always, if you have any questions or comments, feel free to reach out. You can also find me on Twitter (@TheWhyOfFI) and connect with me on LinkedIn.
In this issue:
Long Reads: Paradigm Shift Risk (Why No One Should Have a 0% Bitcoin Allocation)
Content Round-Up: 3 articles, 1 Twitter thread, 1 podcast
As always, if you find this newsletter interesting or useful, please share it with others who might find it interesting or useful, too!
Long Reads
Paradigm Shift Risk (Why No Investor Should Have a 0% Allocation to Bitcoin)
“Successful investing is about managing risk, not avoiding it.” - Benjamin Graham
“You don’t need a weather man to know which way the wind blows.” -Bob Dylan
Every investor triages and assesses a universe of risk. Institutions and professionals use more sophisticated risk models than retail investors, but we’re all managing a complex of risks. Throughout this piece I’m going to focus primarily on retail investors, but the arguments I’ll make are applicable to professional investors, as well.
So let’s talk about retail investors and the known, oft-discussed risks to portfolios. If you’re a personal finance enthusiast (or ardent devotee) and/or you spend time in the personal finance space, you’re probably pretty familiar with some of the more salient ones like sequence of return risk, volatility risk, inflation, the risk of rising (and/or unforeseen) healthcare costs, and the risk of outliving your money.
Most retail investors approach these risks (and investing, generally) through a mean-reversion heuristic, which is generally backward-looking. What do I mean by this? Simply that it’s common to take a look at past returns, particularly recent past returns (like, say, the last decade or the last 40 years) and project that rate of growth and change into the future. Underperformance relative to this general trend is presumed to be temporary and reversion to the this general trend (i.e. to the mean) is typically expected.
This mean-reversion heuristic relies on a narrow set of data points, nearly all of which sit downstream of more important, foundational data points that, in contrast, tend to attract considerably less focus.
This creates some obvious issues. For starters, we can’t position for risks that we don’t foresee, whether willfully or unintentionally. We also run the risk of fighting the proverbial last war by relying so much on mean reversion and past results.
This is all a big wind-up to what I think is the biggest, most under-discussed risk to all investors right now, particularly retail investors. It’s what I’ll call paradigm shift risk. Unlike the effects of distress in a particular asset class or a period of temporary underperformance, which can certainly be quite significant, the effects of fundamental paradigm shifts are seismic and reshape the contours of markets in historic ways.
With respect to the present day and in the context of investing, we’re now uniquely situated astride multiple fault lines, while the edges of several tectonic paradigms brush up against each other, creating tension and energy, coiling to slip and reshape the very surface of our world. In economics, finance, geopolitics, and technology, old paradigms are starting to give way to new ones.
With respect to economics, we are reaching the end of multiple cycles and trends. The most obvious progression is that of Ray Dalio’s long-term debt cycle model. We can also think about it in post-Bretton Woods terms, which is to say the last 80 years of the dollar as the reserve currency, or the last 40 years of globalization and disinflation, spurred by opening up new labor markets and economies in other parts of the world. Now we’re looking at the countervailing trends of de-globalization, inflation, supply chain dislocations, and energy shortages.
We’ve been printing money at an accelerating rate and running up the debt, which has created a sovereign debt bubble (h/t Luke Gromen) that, unlike a stock bubble or a housing bubble, cannot be deferred or absorbed by a higher tier of the financial system. There are now almost no credible scenarios in which either of these currents will ebb or be curtailed for any sustained period of time without massive pain. Since massive pain is politically untenable, we can expect the less painful option to prevail: more printing, more debt, and more debasement of the currency.
With respect to finance, particularly personal finance, the 60/40 portfolio looks pretty shaky, the 40-year bull market in bonds is in question, and CPI is hitting levels unseen in half a century. Sacred cows of the personal finance space that have been effective guiding principles within the existing paradigm (think the 4% rule, indiscriminate index-fund buying) will likely face pressure during and through a fundamental change in this paradigm.
Many heroes and progenitors of personal finance like Warren Buffett and Jack Bogle (the inventor of the index fund) spent the majority of their own investing lives within the existing paradigm. One might quibble and note that Buffett was a very, very young investor during and through the WW2 years. One might also quibble that, given the stock market’s rise in the years since WW2, we can conclude that, regardless of whether Buffett was personally investing through that paradigm shift, his investing principles would have worked swimmingly.
However, this is the wrong analog. The U.S. came out of WW2 the undisputed global hegemon. Europe had just blown itself up and destroyed its financial position to wage war. In other words, the U.S. was an ascendent power and the ultimate winner of the last big shift. And this brings me to my next point.
With respect to geopolitics, we’re in a precarious moment. Unlike WW2, the U.S. is no longer an ascending power. We are a descending power. The world is devolving from a unipolar world, in which the U.S. exerts unquestioned dominance, to a multipolar world in which multiple powers have spheres of significant and competitive influence. The U.S. now is more closely analogous to England prior to WW2 than it is to itself during the same period. Which is why saying well, Buffett’s principles would’ve worked through WW2 so they would probably work through any similarly seismic paradigm shift, is inapposite. The more accurate analog would be to an investor in England pre-WW2, which should underscore the difficulty of stewarding oneself and one’s wealth through such a transformative period.
As a point of clarification, let me just state that I am not predicting a world war. But it’s inarguable that the monetary response to COVID-19 resembled wartime finance. Moreover, there is of course the Russia/Ukraine conflict, which remains unsettled and introduces a number of variables and uncertainties, all of which have massive geopolitical implications.
This progression from a unipolar world to a multipolar world also has implications with regard to reserve currencies and reserve assets, which is to say the global monetary order. Decades from now, when we cast our glance back to this time, it may be that the moment the world crossed the monetary Rubicon was when the West froze Russian foreign reserves earlier this year. After all, if a nation’s foreign reserves can be rendered not-money by countries with whom it falls out of favor, might nations rethink the types of assets they want to hold in their reserves?
As should be apparent, these paradigm shifts are all interrelated. They cause, exacerbate, and accelerate each other, creating a mosaic of challenges almost impossible to holistically (or even productively) address with governmental policy. All policy options have negative externalities. Do stimulus and we devalue the currency. Tax the shit out of the rich and (a) it wouldn’t be enough and (b) would lead to capital flight. Slow the economy down with rate hikes and tightening and we induce a recession and slam emerging markets, which of course creates social unrest and instability. Ramp the economy back up by expanding the money supply and we get asset price inflation, which warps markets and creates bubbles. Defend dollar supremacy at all costs and we live out Triffin’s Dilemma and harm our workers and our manufacturing capacity. Kill fossil fuels without a credible, workable energy alternative and we have an energy crisis, soaring gas prices, and dependence on energy-rich murderous dictators. Create a central bank digital currency and we live in Orwell land.
System change is what’s required and, more and more every day, it appears that’s where we’re heading.
With respect to technology, we now have Bitcoin, an innovation on the scale of the internet or the printing press, both of which indelibly altered the world. While the internet and the printing press both decentralized information/communication and sparked Cambrian explosions of ideas and applications, Bitcoin is a technological advance of money itself. It is forcing everyone paying attention to begin to re-examine what we mean when we talk about money. Ray Dalio himself spoke about this at Davos.
So we are at a pivotal point in history. We’re entering a liminal, transitional state between big paradigms, which could last several years and possibly a decade. It will be volatile throughout, as the world deconstructs and rearranges itself.
The risk is mistaking this volatility as mere volatility and not the rumblings or symptoms of meaningful structural transformation.
Economic and geopolitical doomsayers have been the proverbial children crying wolf for a long time, and the derision and dismissiveness they’ve garnered has been warranted. But we’ve also been lulled into a false sense of security and a precariously grounded faith in the idea that this time is never different. Sometimes it actually is different. And, historically, the conclusion of long-term debt cycles have been the times when things have been different.
The big, obvious question is how do we, as human beings trying to preserve value and wealth over time and space, approach a potentially momentous paradigm shift. It’s exceedingly difficult to predict or imagine precisely how a new global economic order will reconstitute itself on the other side a big paradigm shift. And it remains, of course, a possibility that we are not, in fact, on the cusp of such a shift. But more signposts, harbingers, and developments emerge every day (and every year) that evince a directional trend.
In this environment, there are a litany of reasons and ways in which Bitcoin is useful. Moreover, prognosticating into the future, there are a number of ways in which Bitcoin can play a vital role in reshaping any emergent new order. With respect to the former, many of the trends we’ve discussed are inflationary (though they will likely also cause episodic deflationary swoons). Fiat currencies will thus continue to bleed purchasing power. Moreover, geopolitical developments, particularly the continuing evolution from a unipolar, U.S.-dominated world to a multi-polar world competing for spheres of influence, continue to make the idea of a neutral reserve asset increasingly relevant. From a human rights perspective, many across the world are awakening to Bitcoin as a way to protect and grow wealth under double-digit inflation and/or authoritarian regimes.
As Bob Dylan said, “you don’t need a weather man to know which way the wind blows.” Which is to say, directionally we know where we’re going, even though we might not know what the final destination looks like.
And this is why no one should have a 0% allocation to Bitcoin. If you think there is a greater than zero percent probability that we are, in fact, in a transitional period of major paradigm shifts, then you should have a greater-than-zero percent allocation to the asset most directionally aligned with these big shifts. Successful investing, as Benjamin Graham said, is about managing risk and not avoiding it. Too many investors are avoiding paradigm shift risk and are very long on the the structural status quo, building proverbial Maginot lines in their portfolios.
Content Round-Up
1. “Is Bitcoin Fairly Distributed?” This is an article by Andrew Bailey, Associate Professor of Humanities at Yale-NUS College in Singapore, about the ways in which Bitcoin’s distribution, particularly its initial distribution, differs from that of other cryptocurrencies. Bailey explains how Bitcoin’s origin is unlike most (and probably all) other cryptocurrencies with respect to the fact that every bitcoin in existence (and every bitcoin yet to be minted into existence) has been paid for. There were no pre-mined bitcoins handed out or rewarded to insiders. In Bailey’s words:
“So Satoshi had to pay for his bitcoin, just like anyone else. He did not make magic beans out of thin air and hawk them at the local market. He bought them from nature, just like anyone else, and the price was energy. Mining has also been open to all since the network launched. So although bitcoin has early adopters, it has no insiders.” (emphasis mine)
One of the most common questions about Bitcoin that I (and all of us in the space) encounter is what distinguishes it from the surfeit of other cryptocurrencies. Summarily responding that everything else is a scam or a ponzi is not particularly coherent, productive, or persuasive. Which is why I like this article so much. It very clearly elucidates objective differences.
2. To anyone new to the idea that Bitcoin can help balance power grids and incentivize the build-out of renewable energy, familiarize yourself with Level39’s work. This Twitter thread is an opus. Don’t let under-researched, dubiously intentioned (and even more dubiously sourced) mainstream media hot takes on Bitcoin’s energy usage distract you from the truth, which is that Bitcoin can be a good thing for the environment.
3. “How Bitcoin Helps Survivors of the Prison Industrial Complex,” an article by Leigh Cuen about the financial discrimination and oppression that incarcerated individuals and folks coming out of incarceration confront. Cuen highlights how Bitcoin allows folks denied traditional financial access because of their criminal records to control their money and act as their own respective banks.
4. “Bitcoin and the True Meaning of Inflation,” an article by Steven Lubka. A couple of issues ago I somewhat briefly tackled the issue of what type of inflation Bitcoin hedges, and what we mean when we refer to inflation. And I was doing so because in response to all the mocking comments about Bitcoin not begin an inflation hedge, after all. This article is a masterclass in the different types of inflation, what inflation actually is and is not, and why Bitcoin does effectively hedge against actual inflation. Lubka includes useful examples to illustrate his points. Extremely clear and cogent. Highly recommend this to anyone struggling to comprehend how Bitcoin, the alleged inflation hedge, can be down while CPI can be over 9%.
5. “Taking Bitcoin to Africa with Bitcoin Mtaani,” an episode of the Nobcast podcast. Mary Imasuen interviews Guantai Kathurima (aka Master Guantai), a man on a mission to translate educational Bitcoin materials into multiple African languages to continue to advance Bitcoin across the continent. I first encountered Master Guantai through this great profile by Ayelen Osorio. It was both fascinating and inspiring to hear more about his story and his mission in this interview!
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 in two weeks,
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.
© Copyright Logan Bolinger, Think Bitcoin LLC