It Can Be Sunny AND Cold In the World of Crypto
It Can Be Sunny AND Cold In the World of Crypto
Bitcoin ETF Approvals and Asking The Wrong Question
Happy New Year everyone!
The recent big news is the SEC’s approval of 11 Bitcoin Spot ETFs. Almost immediately, Brian Armstrong, Coinbase’s CEO was featured on CNBC where he presented his vision:
There are certainly a couple of notable missteps here. The first one comes from Andrew Ross Sorkin when he said (around the 1:42 mark):
There are going to be people who have wanted to get access to the Bitcoin world to invest in Bitcoin…
Isn’t that interesting? One of the smartest and most articulate journalists of our times thinks one can invest in Bitcoin. By the way, did you notice how Brian Armstrong didn’t call it that? It almost feels as if he was instructed by his lawyers to refrain from calling it an investment. Maybe he read our amicus brief. In any event, you know our views on this: You cannot invest in Bitcoin, you can only speculate on it, for the simple reason that it does not produce cash flows.
On that note, SEC Chair Gary Gensler’s X posts miss the mark as well:
Financial historians will wonder why some consensus has emerged in the early 21st century around the idea that one can invest in Bitcoin. Hopefully, this book will help them understand how and why that happened.
The second misstep: The moment Brian Armstrong makes reference to the security or commodity debate (around the 5:28 mark):
I think it’s pretty clear at this point that we do need new laws on the book, to clarify some of these outstanding issues around what’s a commodity, what’s a security...
This whole security or commodity concept, of course, is a myth. It is absolutely amazing that this myth continues to be perpetuated despite repeated warnings from current and former CFTC commissioners. Gensler’s statement missed the mark on this one as well. He stated:
Importantly, today’s Commission action is cabined to ETPs holding one non-security commodity, bitcoin. It should in no way signal the Commission’s willingness to approve listing standards for crypto asset securities. Nor does the approval signal anything about the Commission’s views as to the status of other crypto assets under the federal securities laws or about the current state of non-compliance of certain crypto asset market participants with the federal securities laws. As I’ve said in the past, and without prejudging any one crypto asset, the vast majority of crypto assets are investment contracts and thus subject to the federal securities laws.
It is clear what Gensler is trying to do here. He is trying to contain the “damage” to Bitcoin only. The problem? His hunch that the investing public is hurt by crypto is correct, but we don’t think he fully grasps why that is the case.
In any event, Armstrong paints a vision of Bitcoin being the future of money. We think that ship has sailed, in fact it was never even built. Noah Smith over at Noahpinion agrees. Now it is about creating more demand, and what’s the best way to do that? Calling Bitcoin an investment!
The American public is on the verge of extreme disappointment…
To hear the other side of the story, CNBC also interviewed SEC Chair Gary Gensler:
The video is a must-watch in its entirety, but the following is where things went wrong. Here is Joe Kernen (around the 3:55 mark):
The question I wanted to ask you…Let’s take the continuum. Let’s take the rat poison, Beanie Baby, Jamie Dimon, Charlie Munger vs. we had yesterday on our Coinbase CEO. Did you hear him make the case for Bitcoin? It was almost a symphony to Bitcoin bulls, Chair Gensler. The proof of work, akin to gold, every monetary aspect we’ve had for thousands of years is represented perfectly, and Tom Lee, there has never been a mistake on the blockchain out of trillions of transactions. You understand it, you taught at MIT. Which is it? Is it a Beanie Baby in your view, or is it something that has inherent value that is going to be part of the financial system decades from now. Which is it? (emphasis added)
We are convinced that the most important money-related problems occur because we are not asking the right questions. Joe Kernen frames the problem as one of two choices, but this is not a real choice! These two things can be true at the same time! On that note, if two things can happen at the same time, it’s not very meaningful to refer to it as a continuum or spectrum. Kernen is bound to get the wrong answer here because he is asking the wrong question.
Let us try to explain by using an analogy. Imagine you are visiting Chicago. It looks like a perfect day with clear blue skies with the sun shining, yet it’s five degrees outside and with the windchill, even lower. While you desperately try to put your gloves on, your phone rings:
FRIEND: Hey! How is Chicago?
YOU: I’m having a great time, thank you!
FRIEND: Awesome! How is the weather? Is it freezing cold? Or is it sunny? Which one is it?
YOU (surprised): Both.
FRIEND: What do you mean?
YOU: I mean both. It’s very sunny, not a cloud in sight. But it’s 5 degrees. Windchill is negative 10. So, yeah, it’s sunny, but it’s also very cold.
Cold and sunny do not sit at the opposite ends of the spectrum, cold and hot do. Sure, the sun being out is associated with warmth, but it can absolutely be cold and sunny at the same time. It can’t be cold and hot at the same time. Your friend could have said, “Is it freezing cold, or is it actually hot?” That’s a legitimate spectrum question. The way it is framed, it is not.
While slightly more subtle, Joe Kernen is making the exact same mistake. We are not convinced that Bitcoin can ever be the future of money, but for the sake of the argument, let’s just accept the possibility. That sunny future doesn’t imply that it also won’t be cold for an “investor.”
We covered Howard Marks in a previous post. He also had a piece in the 6th edition of Security Analysis. After acknowledging some uneasiness with the conclusion that Graham and Dodd would be ruling out his dealings with “speculative-grade assets” as investments, he came to a somewhat similar realization:
Then it dawned on me that Graham and Dodd were saying one thing and I was reading another. They didn’t mean that something shouldn’t be bought—but rather that it shouldn’t be bought, to use their phrase, “on an investment basis.” Today people attach the word “investment” to anything purchased for the purpose of financial gain—as opposed to something bought for use or consumption. People invest today in not just stocks and bonds but also in jewelry, vacation-home timeshares, collectibles, and art. But 75 years ago, investing meant the purchase of financial assets that by their intrinsic nature satisfied the requirements of conservatism, prudence, and, above all, safety. (emphasis added).
This is a very important passage that we are sure is overlooked by many. It also doubles as being the perfect tool that shows why Kernen’s question is not framed correctly.
On the left-hand side of the “continuum," namely rat poison, Beanie Baby, Jamie Dimon and Charlie Munger, there is a central collective thought that the act of purchasing Bitcoin is speculation. More precisely, it’s what we call Type 2 speculation, namely buying an asset that is not designed to generate cash flows in the first place. It is not an investment. We aren’t saying that people should not speculate with Bitcoin. We are saying that they should understand that they are not buying it as an investment. Further, if you believe that the purpose of the securities laws is ultimately to provide the investing public with full and fair disclosure, there is not a single disclosure more important than telling the public that they can not buy Bitcoin as an investment. This is precisely what brings crypto (including Bitcoin) into the regulatory perimeter of the SEC.
Is blockchain a good technological opportunity? Probably. That possibility does not lead to a conflict with the conclusion that Bitcoin is not an investment. Blockchain having potential in commerce is akin to seeing the sun, but that does not negate the fact that it can also be cold for a Bitcoin “investor.”
Consider this additional comparison: America was a great opportunity for most of the 20th century, which is precisely why I moved here 20+ years ago. Of course, I knew this even when I was a kid. I come from a country where 60%+ inflation persisted and the small amount of money I made from various jobs did not hold up well. So, what did I do? I rushed to the nearest foreign exchange booth and bought USD, because that represented a better store of value. So for all the people out there arguing Bitcoin is a better store of value than USD, I know what you mean. In fact, that decision served me well. Partly, it was those purchases that allowed me to support my girlfriend’s (now my wife) post-graduate studies here in the U.S. The rest, I blew on what I thought was an investment in Intel, but that’s a story for another day.
I am skeptical though, because an entire country was and still is behind the fiat. All the infrastructure, institutions and innovation effectively guaranteed that the USD was going to continue to appreciate against the local currency where I lived. Perhaps the implicit idea is that a digital universe is almost like a new country forming, and the native cryptocurrency that makes commerce happen in that digital universe will continue to appreciate against the local currency. In a way, the presumption is, I think, that the roles have reversed. USD, once celebrated as the world’s reserve currency, might become like a third-world currency and Bitcoin becomes the new USD. We are now doing exactly what you had done, you might say, and once the transformation to digital is complete, maybe the Bitcoins purchased today, might support our significant others.
One problem with that thinking is the USD is legal tender (in the U.S.) and Bitcoin isn’t. Another problem is that it’s still not clear that Bitcoin will win that competition, but it seems to be in the leading position now. An even bigger problem is that what holds up Bitcoin is people’s willingness to buy it, there is no sovereign government that has control over it (though El Salvador made it legal tender). Equally importantly, despite the libertarian narrative, I’m not convinced that a large enough number of people are actually worried about the USD that much, they just want, as Damodaran put it, to supercharge their returns. Are we sure that the “store of value” narrative isn’t simply fodder for speculators who fancy themselves as investors? If those people leave, what else is left?
In any event, one could hold the opinion that the demand for Bitcoin tomorrow will be much greater than what it is today for whatever reason. Assuming we fully buy into the fixed supply narrative of Bitcoin (Jamie Dimon doesn’t), by basic laws of supply and demand, Bitcoin’s price would likely rise. If that is your thesis, you could speculate and buy Bitcoin, I suppose. But, that is not an investment thesis, and you are not investing.
