What’s at the bottom of The Crypto Rabbit Hole? (Part 2)

In Part 1, I explained that I was late to crypto because what I saw at first glance (a speculative frenzy) had put me off.

But I was wrong. Things get more and more interesting as you go further down the rabbit hole.

Please bear in mind that I am not trying to persuade anyone else that they should buy crypto. I don’t want to encourage uninformed gambling.

So DO NOT BUY CRYPTO based on what I say. Always do your own research.

The ethical case for cryptocurrencies

Let’s start with the moral and ethical case for better money.

If you are reading this you are probably a pampered westerner. But imagine if you can an immigrant from Ecuador working hard picking fruit in California and sending money back to their family in South America. The wire transfer fee could be something like 9% of the money transferred. That means they work 12 months a year and get paid for 11 months a year: the rest goes to the banks.

Crypto transfers can fix that problem and transfer money anywhere in the world safely, instantly and with minimum fees. That’s a significant improvement for a lot of people in North America and Europe.

Now consider that billions of people across the world do not have the $ or € or £ as their base currency. They live in Africa or Asia or South America under brutal authoritarian dictatorships, often without access to the banking system, and without access to stockmarkets or reliable stores of value. How are they supposed to save and build wealth when their cash wages can quickly become worthless?

Those governments steal money from the population by confiscation, corruption and/or debasing the currency that they have monopoly power over…they print more and more of it to fund wars, vanity projects and their own offshore bank accounts.

The lack of reliable payment infrastructure and stores of value keeps people in the developing world dirt poor. Cryptocurrencies can fix this problem by removing governments monopoly over currency issuance and bank transfers.

The Magic Money Tree

The whole money thing worked well enough in the West for the past 40 years (1980 – 2020) if we ignore the global financial crisis (which we shouldn’t).

The domestic payments system works, inflation stayed low, held down by globalisation and technological progress and cash / government bonds acted as a reasonable store of value over the short and medium term. Over the long term, not so much.

Then came CV-19 and governments lockdown strategy. It doesn’t matter whether their response was right or wrong…it was what it was…but 10 years of relative austerity (which never eliminated the annual extra borrowing, let alone paid off a single penny of debt) were blown away in a matter of weeks.

The public finances are shot and The Magic Money Tree is now being shaken down harder than the owner of a pizza restaurant in Al Capone’s Chicago. Something is gonna get broken.

We can guess what governments playbook will be. In 1945 Britain had run up huge debts to fight the second world war.  Government debt to GDP peaked at 240%. Over the next 35 or so years, governments ran policy to keep real interest rates low and engineer inflation. In 1974, retail price inflation peaked at 26%. Unpleasant as this was, it worked.  Government debt to GDP fell below 30% in the early 2000s. It’s now back over 100% and rising fast.

The implied yield to maturity on the Vanguard UK Gilts (Government Bond) ETF (VGOV) is currently about 0.9%. With inflation at 1% or more, this means that with every day that goes by, the real value of your bonds is shrinking like an ice sculpture at a party.

When the facts change…what do you do?

Before 2020 you could argue that crypto was a solution in search of a problem. But now it’s pretty obvious that the world now needs a safe store of value that can be transferred instantly and cheaply in a digital world. Being digital means cryptocurrenices are easier to store and transport than gold.

Bitcoin is hard money that can’t be printed: only 21 million Bitcoins will ever be issued. It doesn’t matter what your political views are…the investment case for crypto got a whole lot stronger from March 2020 onwards.

US inflation just hit 4.2%. It’s not clear whether governments will be consistently able to engineer “the right amount” of inflation in the consumer price index. But they have already created asset price inflation. Ever since 2009. the price of hard assets has been rising: stocks, property, gold, art and cryptocurrencies.

So I think you can make a good ethical and economic case for cryptocurrencies (wire transfer and new financial system architecture) and a decent investment case for them as part of an inflation hedging strategy.

Yes, this is gambling

There is also a case for some intelligent gambling on crypto. Several years ago smart people like Nassim Taleb and were suggesting having say 1 or 2% of your portfolio in Bitcoin as part of a “barbell strategy” (very low risk assets such as T bills combined with high risk assets like venture capital and crypto).

Ethereum (ETH) can now be seen as an early stage venture capital play on a new fintech software platform on which the world of decentralised finance is being built. Buying ETH allows you to play the network adoption effect if you’re prepared to hold for months and years. High risk, high potential reward.

Even Ben Graham, The Original Gangsta of Value Investing (and Warren Buffett’s mentor) accepted that there was such a thing as intelligent speculation. To do this with crypto, you have to recognise the huge volatility, never use leverage and size the bet appropriately. Only gamble with money you can afford to lose.

Asymmetric returns

To make rational bets, you need to understand the concept of Expected Value.

If I offered you a heads versus tails coin toss where you win £110 for calling it correctly and lose £90 for calling it wrong… …would you take that bet? Or would you say that all gambling is immoral?

Personally, I would take that bet because it has an expected positive value. (50% x 110) – (50% x 90) = £10

Here’s the financial argument for crypto:

  • It absolutely could go to zero…you turn £100 into £0; but
  • It could 10x or 100x…where you turn £100 into £1,000 or £10,000

The downside is limited to what you paid…the upside is uncapped. The principle is the same with equities: but consider the relative risk : reward ratios of these asset classes. Yes Bitcoin is risky but here are the annualised returns 2011-2021:

  • Cash ($) : 0.5% per year
  • US equities : ~14% per year
  • Bitcoin : 224% per year

I’m a great advocate for getting rich slowly but that’s only because getting rich quickly is generally impossible or involves illegality or insane risks. If I could find a series of bets with strongly positive expected values that would get me rich quickly…you better believe I’d back up the truck baby.

If I was in my 20s, stuck in a mediocre job market and thinking I might never get on the housing ladder, I’d probably gamble on crypto…limited downside, unlimited upside. I’m not recommending it but the odds are way better than other forms of gambling.

The horse has bolted

Yes, this is a bubble. Yes, lots of punters will get rekt (as the lingo goes). Traders gonna trade and it’s not my job or your job to save them.

But, if you look beyond the short term noise, big changes are coming. For one thing, crypto is going to disrupt the old banking order.

Some of the the banks are fighting this. I’m told that HSBC have been shutting the accounts of people who’ve tried to buy crypto. Last week an over-zealous member of the fraud team at Lloyds bank froze my entire account when I tried to send some money to my Coinbase account (Coinbase is a large crypto exchange and as good a place to start as any). This is the problem with a single point of failure. If you only have one bank account, they can turn off your ability to function in the world with the flick of a switch.

Ten minutes later I had opened a Revolut bank account online and it’s brilliant. The user interface is slick and simple and you can hold multi currencies £/$/€ (including cryptocurrencies) seamlessly and easily. Fifteen minutes later I had bought £100 of ETH on the Revolut app (the % fees are higher than Coinbase but it’s super-easy for small amounts as an initial experiment). It’s a crypto-friendly bank account built for the digital age.

The crypto horse has bolted and will not be put back in the stable now. Blockchain technology will change the world in all sorts of ways that are not immediately obvious. I think that cryptocurrencies will help keep banks and governments around the world more honest in the future. Crytpo will speed up money transmission and make financial services faster, cheaper and fairer for 7 billion people. But it’s still early days and it’s gonna be a wild ride.



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13 comments

  1. Good post Barney!

    I would highly recommend Coinbase Pro, fees are 0.5%.

    Revolut charges something like 2% for buying, and does not give the best conversion rate either AND you don’t get access to control the crypto keys, which is critical, if anything happens to revolut your coins are gone.

    I have coinbase pro, i build up my monthly buys on the exchange and then send it all to the Coinbase Wallet, which is a separate hot wallet app, non-custodial wallet (i.e. the coins live on the blockchain directly). This is the way to really manage it and hold full control.

  2. Check out LocalBitcoins – buy direct from rated sellers, KYC hoops and funds held in escrow. Then transfer your coins out to a hardware wallet.

    FIAT—–> LocalBitcoins——> Ledger —–> Tesla. Ok maybe not the last part. The whole process soup to nuts about 10 mins.

  3. Lee Ourand · · Reply

    I’ll grant you that cryptocurrency is maybe a better financial system than is available in some of the worst run countries in the world. But that may not be as great an argument as it seems at first blush—they’re still absolutely awful currencies. They’re slow (Bitcoin can only handle ~7 transactions per minute), they’re hyper volatile, they’re unsafe (for most reasonable definitions of unsafe), and they can’t really be used anywhere—virtually nobody accepts Bitcoin for anything. Even Tesla has pulled the plug on the ridiculous idea of accepting them. Further, I suggest it’s a lot more difficult for people in hard-hit countries to actually buy cryptocurrencies in their local currencies, and then actually do anything with them. It’s a hand-wavy argument you’re making. There are absolutely problems that could be solved. Crypto technically solves none of them—and the ones it does solve are purely coincidental and could be solved in myriad other ways, much more efficiently.

    You state that:
    > Crypto transfers can fix that problem and transfer money anywhere in the world safely, instantly and with minimum fees

    No. They cannot. Bitcoin transactions, for example, on average take 10 minutes. They can take several hours or more. While that’s not terrible for the example you’re referring to (transferring money internationally), it’s pretty lousy for much else. As for transaction fees, Bitcoin currently costs ~$15/transaction. Not terrible, but certainly more expensive than using a service like Transferwise. And safety? I guess it depends on what you mean by this, but I think by *most* people’s definition of safety, cryptocurrencies are absolutely and ridiculously unsafe. If someone scams you of your money? You’re toast. There’s no affordance for getting it back. If you forget your password? Game over. Your money is gone. It’s the wild west of money. Completely unsafe for anyone not completely diligent and really knowledgeable about cryptographic fundamentals.

    As for Asymmetric returns, what couldn’t you say that about? Penny stocks, playing the lottery, etc. all have asymmetric upside. It doesn’t mean they’re wise investments.

    > One thing that I know is that crypto is going to disrupt fintech and the banking system.

    We see this all the time. “CRYPTO IS GOING TO CHANGE THE WORLD!”. Yet, no one has presented a single example of it doing anything. Every non-cryptocurrency example I’ve ever seen has been clearly not using a blockchain, and the company was riding the hype through some clever marketing. Hot tip for identifying this: if the project involves tracking products in a supply chain? Definitionally not blockchain. Blockchain is *only* relevant in trustless systems. When the project involves the physical world—you know, where property rights exist—blockchain does not and cannot be applied.

    Blockchain is *neat*. It’s neat in much the same way a Segway is neat. And just like when the Segway was revealed, there is muuuuuch undue hype around it, and I’m confident will be looked back at with similar “heh. Remember when we all thought that dumb nonsense was going to change the world?” Blockchain has been in use now for ~12 years. We haven’t seen a single use-case for it beyond mass-adopted speculation. If there’s one revolution Blockchain has brought us, it’s an impressive new financial scam. I suspect in the coming decades, the term “ponzi scheme” will be replaced with “satoshi scheme” for the brilliance of inventing a decentralized way of scamming people out of their money in exchange imaginary internet numbers. We live in interesting times.

      1. Lee Ourand · · Reply

        I would not assume “digital money” == “blockchain-backed cryptocurrency”. There’s virtually no reason for a government to use a blockchain for a digital currency. Just to reiterate: blockchain’s raison d’être is to permit untrusted readers and writers to a (very slow) database—to transact in an system lacking trust. To accomplish that, there are many tradeoffs that are ultimately detrimental. Again, speed, no undoability, easy loss via losing one’s passphrase, etc. Solutions to these problems would necessarily defeat the purpose of blockchain (e.g., centralization, storing passphrases, etc.)

        I agree with the thought that a digital currency may one day come to fruition and solve lots of problems. I very much doubt that currency will rely on a blockchain database.

      1. “it’s probably nothing…” 😂

        1. 😀 haha!

      2. Lee Ourand · · Reply

        Yeeep. And this one squarely fits into my second example: “the company was riding the hype through some clever marketing”. What benefit does EIB gain by issuing bonds on a blockchain (whatever that even means?). Is there *trust* involved in the bond issuance system? Are there laws enforceable by the EU around bond payments? Right…

        1. The EIB stated that the innovative approach will help the market and its participants by reducing the number intermediaries involved along with the fixed costs. The technology is also being called upon to improve market transparency by increasing participants’ abilities of seeing trading flows and identifying asset owners.

          https://blog.aaxpro.com/en/2021/05/03/eib-issues-e100m-digital-bond-on-ethereum/

  4. David · · Reply

    Tether is the dog not barking. Read up on how it is being used to manipulate the price of btc.

  5. good luck with the experiment. i agree wholeheartedly about trying to find something to juice the average tracker returns. growth stocks did the trick for me. my 30x gain in $SHOP made up for any losers i bought in relatively equal amounts. of course i bought those growth shares back in ’16 when nobody was looking before they took off. then the FOMO folks piled in at the end of last year AFTER the huge run-up. i only hope they can smartly average into either growth or crypto if that’s their thing.

    i hold zero bonds and have preferred share etf’s in their place. if i’m gonna take the risk in need the 5% yield!

  6. I’m not overly worried about inflation. First, there’s the fact that this month’s year over year figures for inflation in the US (unadjusted CPI 4.2%) are based on a comparison with last April, which no one would argue was a normal month:

    https://www.thewealthadvisor.com/article/inflation-figures-are-grossly-inflated-heres-how

    Second, although the magic money tree is watered with cash printed / loaned into the economy, it is also pruned by taxing much of that money back out of the economy, so that the money supply stays relatively stable.

    Third, my portfolio already contains an adequate hedge against inflation in the form of stocks. I don’t need a stake in crypto for that.

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