Please Stop Asking Jesse Felder About Bitcoin
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Introduction
Jesse Felder is a former hedge fund trader who is now the founder, editor, and publisher of the widely read financial blog and newsletter, The Felder Report. He is also the producer/host of the Superinvestors and the Art of Wordly Wisdom podcast.
We are longtime fans of Mr. Felder’s work, his podcast in particular (which just ran a great episode with Peter Atwater that we highly recommend).
Last week, Mr. Felder wrote a piece entitled “Please Stop Asking Me About Bitcoin”, which took on a topic near and dear to our hearts. Though admittedly bitcoin (BTC) fans, we are rarely mistaken for maximalists. We nonetheless feel compelled to rally in defense of an emerging asset that we believe was misrepresented in Mr. Felder’s post.
In Response to Mr. Felder
We cite specific quotes from Mr. Felder’s post below that are followed by commentary of our own.
The reason I don’t view Bitcoin as a legitimate investment is that I use an old school definition provided by Ben Graham. Because bitcoin provides neither “safety of principal” nor “an adequate return” it therefore can only be considered speculative. Furthermore, because bitcoin is not used as a medium of exchange nor provides any store of value, I can’t view it as a currency alternative either.
We appreciate Mr. Felder’s view here. Investors trained in the Graham and Dodd school will struggle to arrive at a value proposition for bitcoin. One of the challenges here is that traditional valuation metrics do not apply, making BTC off limits for those applying fundamental tools of analysis.
We therefore agree with Mr. Felder’s assertion that BTC is — for now — built more for speculation than investment. Where we diverge is that we are OK with that being the case. We believe crypto is an ideal asset class to trade given its volatility profile, fragmented market microstructure, and preponderance of retail participation. The resultant inefficiencies make crypto among the most alpha-rich environments around.
But maybe a speculative approach is called for anyway in today’s market environment? After all, the frenzy that has come to characterize crypto over the years has spilled over into traditional assets as well. This raises the question of whether price action might be at least slightly informed by large macro forces influencing all asset classes.
For example, the market backdrop for equities since 2008 has not been kind to value investors. Some combination of the Fed (e.g., easy money) and technological advancement (e.g., Robinhood) has allowed narratives to prevail over fundamentals (e.g., Tesla). Something is clearly amiss when companies see their stocks rally 200% following bankruptcy announcements.
Not surprisingly, some of the best investors of all time have struggled during this period, including the likes of Warren Buffett and Seth Klarman. Value investors love cheap valuations, predictable cash flows, strong balance sheets, and high dividends. But some of today’s most influential stocks — and best performing over the past decade — have included the likes of Amazon, Google, Netflix, and Facebook. None of these stocks pay dividends nor would any of them be considered cheap by most metrics, which means they went largely unnoticed by value investors.
It is here that we are reminded of one of our favorite Howard Marks quotes:
I would rather be an informed speculator than a conventional investor.
But an investment use case can also be made for BTC given that it has actually delivered on Mr. Felder’s preferred definition of what constitutes a good one, making it somewhat of a unicorn asset.
Safety of principal is interesting to contemplate here and is of course time frame dependent. For those taking a sufficiently long-term view, BTC has done just fine when it comes to capital preservation. Of course, the journey has been punctuated by periods of face-ripping drawdowns. But virtually everyone who adopted a buy-and-hold approach to BTC has at the very least preserved their capital on an inflation-adjusted basis. In fact, it has been reported that at least 95% of bitcoin supply was profitable at $11,400. That number is doubtless higher at today’s prices. It has been further estimated that BTC has been profitable on 99.8% of its trading days (as of the date of this publication).
Providing an adequate return requires a more nuanced discussion but here too BTC has largely delivered. As illustrated in the table below, it has been among the best performing assets in the world for most of its existence (come feast or famine!).¹
And thanks to its remarkably strong return profile, it has even proven competitive on a risk-adjusted basis over most time frames.²
We wonder if Mr. Felder could be closer to embracing BTC than he may realize. His past writing confirms agreement with the primary macro narrative that underpins much of the enthusiasm around bitcoin. He appears to prefer commodities relative to the U.S. dollar given inflationary concerns arising from all the money printing that is occurring these days.
But commodities are speculative instruments in that they do not generate cash flows, pay dividends, or offer adequate returns in all cases. This is where BTC can be viewed as a complement to such exposure, a view with which famed macro investor Stanley Druckenmiller appears to agree. His rationale for owning BTC is quite elegant in its simplicity: “Frankly, if the gold bet works the bitcoin bet will probably work better because it’s thinner, more illiquid and has a lot more beta to it.”
Mr. Druckenmiller’s comments were framed as a speculator citing inefficiencies rather than an investor praising fundamentals, but this may give Mr. Felder something to think about and perhaps lead to further exploration. (At the very least, he may find the consilience on display within crypto to be intellectually stimulating.)
There’s also the problem with hard forks. Bitcoin believers rely entirely on the idea that bitcoin is limited in supply making it far more attractive than fiat currencies that are being printed like mad by central bankers around the world. However, bitcoin has already hard forked several times, multiplying the number and type of bitcoins in circulation. In fact, if you put together all the hard forks Bitcoin has undergone since it was first created, the number of total bitcoins has actually grown faster than the number of dollars. That’s a fact.
This is an inaccurate portrayal of forks, which is ironic since it ended with such authority.
A hard (or contentious) fork occurs when a group of developers attempt to improve upon a legacy protocol by creating an offshoot. This is achieved by essentially copying the original’s open source code and editing it to create a version perceived by its creators to be better. BTC has technically had thousands of forks with only a handful proving remotely relevant for any meaningful period. The most notable among these forks is Bitcoin Cash (BCH), which itself was forked by Bitcoin Satoshi’s Vision (BSV). The only other fork that remains among the top 100 coins by market capitalization is Bitcoin Gold (BTG).
For the avoidance of doubt, forks result in the creation of completely new protocols rather than augmentation of a current one. And the resulting product — certainly in the case of BTC versions— is often deemed inferior by the market despite otherwise noble intentions. This is not always the case. In fact, the second-largest digital asset, Ethereum (ETH), is the product of a hard fork from Ethereum Classic (ETC). But that is more the exception than the rule.
Forking is therefore largely akin to first and second growth wines, where the latter might be passable in some form but typically pale in comparison to the main event. The difference is sometimes even starker where the forked coins more closely resemble luxury product knockoffs.
The ultimate giveaway here is that these coins have their own respective tickers, making each clearly distinct from the other. And these coins most certainly are not fungible. A trader looking to buy BTC would surely be disappointed to learn of an errant keystroke that mistakenly resulted in the purchase of BTG instead.
Mr. Felder’s note is therefore misguided in that bitcoin forks do not represent an increase in the amount of BTC, just as the launch of the XFL is not viewed as expansion of the NFL. Forks are simply the creation of quasi-copycat coins that have been tweaked in some manner. These forked coins are assuredly not BTC nor does any informed investor view them as such, including the creators of the new protocols themselves. And the market has voted with its feet by effectively rejecting all of the forked BTC projects given their relatively low levels of developer engagement and the fact that their collective market capitalization is orders of magnitude smaller than BTC.
While some manner of loose interpretation would allow that BCH, BTG, etc. could be viewed as inflationary to BTC, one would be hard pressed to find many within the crypto community who consider any of the forked coins a replacement for BTC itself. We see this as well with increasing levels of institutional engagement:
- Bloomberg headlines refer to BTC, not BSV.
- Paul Tudor Jones wrote about BTC, not BTG, as a potential hedge against what he called the Great Monetary Inflation.
- Ria Bhutoria of Fidelity Digital Assets has written multiple pieces about crypto, with BTC being the prominent feature in each while BCH has struggled to merit a mention at all.
The fact is there will only ever be 21 million BTC in the world. Approximately 18.6 million BTC have been mined thus far and its production will cease around the year 2140. Also worth noting is that BTC is currently growing its supply at a rate of just 1.8% per year, a small fraction of what we see across fiat regimes today. Add in the fact that nearly 4 million BTC are reported to have been lost and its attraction as an emerging store of value comes into finer focus.
For additional reading on this topic, one of the more insightful voices in the crypto community, Nic Carter, recently wrote a piece that provides a nice overview.
More importantly, as a store of value [BTC] has failed miserably countless times for countless cryptocurrency afficionados. Millions of dollars worth of bitcoin has been hacked even though crypto believers claim this is not possible. I’m not a fan of dollars but at least the $20 in my real world wallet can’t be stolen from the comfort of a hacker’s couch.
The Bitcoin network is among the strongest, most secure ever created. It has — in fact — never been hacked. While admittedly singular in focus, it has an extraordinary amount of computing power with hash rates (a key security metric) currently near all-time highs. And the nature of the underpinning technology itself — blockchain — was built upon notions of trustlessness, immutability, and cryptographic security.
Bitcoin’s security does not, however, extend to the many services that deal in BTC. An army of wallet providers and exchanges have sprung up in service of digital assets over the years, each representing a honey pot of sorts for hackers. Since the security of the protocol does not necessarily extend to the companies storing and handling BTC, it stands to reason that deficiencies may exist and therefore be exploited.
But to blame BTC for the security breaches of its user community would be akin to citing a hack on Citibank or Nasdaq as evidence of the insecurity of the U.S. dollar. Banks, credit card issuers, and most every other type of company are hacked all the time. Cyber theft is a worldwide phenomenon not reserved for crypto alone. For example, it is estimated that cybercrime losses will reach $6 trillion a year by 2021. This is more than 10x larger than the total market capitalization for all digital assets, suggesting the risk here extends well beyond crypto — and certainly applies to Mr. Felder’s fictional $20!
Speaking of which, that $20 in Mr. Felder’s wallet could most certainly be stolen in the physical world as well, where it is actually less secure than BTC. A mugger could make use of the physical bills contained within Mr. Felder’s wallet rather quickly and easily. And that activity would very likely be untraceable. However, in the (low probability) event someone were to be carrying their crypto wallet with them, it is unlikely a mugger would know what to do with it. And the victim could easily protect — and perhaps recover — their confiscated BTC simply by remembering their seed phrase and moving the coins to an uncompromised wallet. On the very slim chance that the mugger turned out to be an expert hacker, the stolen BTC could be easily traced and possibly retrieved until it made its way to a fiat offramp, at which point it would be lost amidst a vast sea of untraceable dollars.
Then there is also the fact that new cryptocurrencies are being created all the time, many of which may be technologically superior to bitcoin, in all of its derivative forms. Fiat currencies have value because the powers that be declare they have value; that’s what “fiat” means. How can we know that, without this sort of support, bitcoin will not be supplanted by a better cryptocurrency, perhaps one that has yet to be invented (or one created by the powers that be and vested with full fiat support)? We can’t.
This demonstrates misunderstanding of market structure and nomenclature. It is important to start by noting that, while there are thousands of digital assets in existence, only a small handful are technically considered cryptocurrencies (i.e., those seeking to perform a store of value function or serve as a medium of exchange). The overwhelming majority — both in existence as well as forthcoming — make no effort to be cryptocurrencies and therefore bear little resemblance to bitcoin.
Jeff Dorman of Arca has a thoughtful way of categorizing digital assets into four buckets: cryptocurrencies; decentralized protocols and platforms; asset-backed tokens; and pass-through securities. We reckon greater than 95% of all digital assets fall into those last three buckets.
Given its pioneering status and hold on the public consciousness, bitcoin is often used as a proxy for the whole digital asset ecosystem. Since BTC is a cryptocurrency itself, the term “crypto” took hold as a generic catchall for the space. While a convenient term, it ignores the variety of coins comprising the digital asset panoply.
So when it comes to cryptocurrencies strictly defined, bitcoin is really in a league of its own (even when accounting for its “derivative forms”, which is unnecessary for aforementioned reasons). It is of course possible that something could one day come along that aims to supplant bitcoin. But that would be a very tall task indeed. The folks behind BCH, for example, would argue that their version is already technically superior. But the market clearly disagrees and the odds of that ever changing seem extremely low.
Imperfect as it may be, BTC is the most battle tested of all digital assets. It has by far the strongest network effects and its brand recognition is growing stronger by the day. This does not preclude new entrants from seeking to improve upon BTC, but they will have quite the hill to climb in their striving.
In Summary
We sympathize with skeptical approaches to digital assets. This is an emerging space that is evolving in rapid and sometimes violent fashion. We believe crytpo has tremendous potential but confess it still has a lot to prove. Among other things, further maturation is required in terms of market infrastructure as well as practitioners.
Well-founded arguments should be properly considered whether for or against, and critical assessments should be held to the same standard as bullish testimonials. We believe Mr. Felder was operating under several misconceptions when coming to his bitcoin view. It is our hope that this rebuttal helps to elucidate things for him as well as his readers.
Footnotes
- Data reference information:
2. Sharpe ratio = (Annualized Rate of Return — Risk Free Rate)/(Annualized Monthly Standard Deviation). Risk Free Rate = 1%.
