Three Reasons Why People Are “Investing” in Bitcoin
Adoption, perceived equivalence and incentives
Two and half weeks down, one more week to go for our hypothetical SEC employee. Time is flying by! The draft investor alert is due on Monday, June 26.
This week’s research has left you a bit dejected. A valuation guru says you can’t invest in Bitcoin; yet, one of the top business schools is teaching people the Fundamental Token Value (FTV) Methodology. A legendary investing duo secured their spots in financial history, but a superstar financial historian disagrees with them completely. The banker who leads the biggest bank is the person we trust with our personal finances, yet he and a top personal finance expert do not see eye to eye.
Then, there is the SEC, which finds itself in the middle of all of this.
“What have I gotten myself into?” It is becoming clear to you that finance theory alone won’t be enough to resolve this. If it did, literally the top finance people in the country would not disagree on something so fundamental. If Bitcoin, and crypto in general has become this polarizing, one needs to take a holistic view, thinking about history, logic, sociology and maybe even philosophy.
“What really is the narrative here?” you ask yourself. I know what is happening, but why is this happening? “If I had only three words (or phrases) to explain all of this, what would I choose?”
You close your eyes and let your mind go freely from one topic to another. You put the work in, it’s all there. Now it’s time to sort it out.
After a meditation-like session that only lasts a few minutes, but feels like a few hours, you’ve got your list:
Adoption, perceived equivalence and incentives.
Adoption
You remind yourself how Edelman explained the difference between a tulip bulb and Bitcoin:
That argument… It might have worked five or eight years ago. Today you look silly saying that.
Right. In other words, his argument is that there has been enough adoption, we are past the mania stage.
You wonder where he would draw the line. Is this one of those “I know it when I see it” moments, which is how the Supreme Court has characterized hard-core pornography? He thinks Dogecoin is a scam; in his mind, Bitcoin has surpassed some level of threshold and Dogecoin hasn’t. At the same time, if price is what matters when investing, as Edelman argues, then clearly some other coins may show, and in fact have shown, better price action, as in “Dogecoin to the moon.”
You realize the tension. Price is an objective thing, it is what it is. You can’t argue with it. The level of adoption, however, is not. Edelman elevates Bitcoin into an asset class and something you can invest in, based on both criteria. Acknowledging that Bitcoin does not generate any cash flows, he needs price to justify “investing” in Bitcoin. At the same time, that opens the doors of investing to tokens and even tulips, so Edelman knows that there needs to be another separator; something else that’d differentiate Bitcoin from the rest of the pack. Adoption fits the bill perfectly. “These two criteria, price and adoption, are hopelessly irreconcilable,” is your conclusion, as your imaginary dialogue between Ferguson and Edelman demonstrated.
For most people, the genesis of Bitcoin is the Halloween of 2008. This is when Satoshi Nakomoto launched his whitepaper titled Bitcoin: A Peer-to-Peer Electronic Cash System to the world. You have a different perspective on this. You think the story actually started more than 4000 years ago. “This is like Star Wars,” you say to yourself. “I enter the story in a particular time because that’s what the world shows me, but there is a whole backstory that comes out later.”
You are absolutely positive that in order to understand Bitcoin, one must first understand the ultimate adoption story.
In order to understand Bitcoin, we need to understand gold.
Is Bitcoin digital gold? The early narrative was clearly that. Damodaran listed it as one of three possible scenarios for Bitcoin and concluded that Bitcoin will be judged as a currency.
Of course, as Damodaran and Buffett remind us, one cannot invest in gold either. However, the narrative was successful. Gold has clearly shown it has staying power; it has a stellar reputation and it is viewed as a safe asset by even top economists. Bitcoin hid behind gold, which has been a longstanding confusion, and was able to get enough traction. When gold served its purpose, it was not useful to Bitcoin anymore…
Perceived Equivalence
Let’s go to Edelman again:
We all missed the opportunity to invest in Google, Amazon, Apple, back in the 1990s. We wished we had. Well, this is that next opportunity and we don’t want to miss this one.
Once the digital gold narrative took hold, something interesting happened. Bitcoin slowly morphed into more of a competitor for stocks. People started questioning the digital gold narrative; it wasn’t really holding up. Bitcoin wasn’t becoming money as some people had hoped.
No money, no problem! Or, should we say, Mo Money, Mo Problems?
The returns were stock-like. Gold generally does not behave like that. In the last 50 years, according to this chart (PDF), it topped 100% only once, back in 1979, when we had a pretty substantial oil crisis, high inflation and high unemployment. Bitcoin eclipsed that mark seven times in 13 years.
Gold, in people’s minds at least, competes with the S&P 500. Bitcoin competes with the hottest stocks du jour, Amazon, Google, Nvidia… take your pick.
Perceived equivalence... Bitcoin shook off the gold story and started running in a different direction. Gold was a good cover; it did its job by jumpstarting adoption, but it wasn’t really needed anymore. It was too boring and too stable, Bitcoin was now a “risk-on asset.” Why be gold, when you can become Google? You recall what Matthew McDermott, Global Head of Digital Assets at Goldman Sachs said:
And it doesn’t behave as one would intuitively expect relative to other assets given the analogy to digital gold; to date, it’s tended to be more aligned with risk-on assets.
This delightful 2021 article by Fortune, Your father’s stock market is never coming back, masterfully showed us how people think:
Millions of new brokerage accounts. Trillions in value transferred from taxpayers and the Federal Reserve into accounts at Robinhood and Coinbase. More money pouring in with every paycheck. Leverage, too, because this generation is truly fearless or (more likely) they haven’t had enough time to lose money yet. Either way, they decide what’s important to pay attention to and what’s irrelevant. If they choose to react to 10-word Elon Musk tweet rather than a three-hour Warren Buffett monologue, how will you stop them?
You recognize the two excellent points the article makes. First, if somebody never experienced pain, they are not (yet) incentivized to act differently. Second, if people don’t care about cash flows, then presumably they don’t care too much about people who have been historically good at estimating cash flows, like Warren Buffett.
With a Robinhood account, your first exposure to cryptocurrencies does not frame them as an unproven alternative to stocks. The two stand on equal footing. Coke and Pepsi. Feel like trading one or the other? Have at it, no difference. This is radically different from the experience of the Gen X and boomer investors … The generation creating the new conventions of the investing landscape views stocks and crypto coins as interchangeable.
“That,” you shout excitedly. “That is the ballgame.” If every tradeable is a financial asset and every trade is an investment, then the world of finance turns into a utopia that was unfathomable just a few years ago. Everything trades and nothing matters. What people are buying or whether they know what they are buying becomes pointless. It trades! That’s all that matters. If people can buy it, it means that somebody else can buy it from them and potentially at a higher price, so potentially they can become a zillionaire overnight.
The digital gold narrative started the adoption. From there, Bitcoin effectively achieved parity with stocks. The Tipping Point was reached. Everybody wanted a piece of the pie. Everything was in place for people to behave the way we expected them to behave because people respond to incentives, after all.
Incentives
As they say, “don’t pick up pennies in front of a bulldozer.” This applied to Bitcoin both financially and emotionally. Shorting it, if you could, because its intrinsic value is zero was a dangerous trade because, let’s face it, the market doesn’t care about intrinsic value. As Damodaran says, trying to reason with the market might be delusional.
The desire to belong is real, and not just financially. Even the otherwise resolute Warren Buffett uncharacteristically, decided to not be anti-crypto for one day, at the 2021 Berkshire Hathaway Annual Meeting:
I knew there’d be a question on bitcoin. I thought to myself, Well, I’ve watched these politicians dodge questions all the time, you know, I find it kind of disgusting, but they do it. But the truth is I'm gonna dodge that question because we probably got hundreds of thousands of people watching this that own bitcoin, and we probably have two people that are short. So we got a choice of making 400,000 people mad at us and unhappy, and, or making two people happy, and that's just a dumb equation.
Thankfully, it didn't last very long and Buffett continued to stand firm by his positions.
Thus, the path of least resistance is to go with the flow. Being truthful doesn’t bring you much. What’s the point? It’s much easier to jump on the bandwagon and get yours.
Go with the flow, they did:
Matthew McDermott, Global Head of Digital Assets at Goldman Sachs
But clients and beyond are largely treating it as a new asset class, which is notable—it’s not often that we get to witness the emergence of a new asset class.
Does this sound like a person who believes in Bitcoin as an investment opportunity? Or someone who is trying to make money on people that think Bitcoin as an investment opportunity? This is what Warren Buffett thinks:
Well, they probably think that lots of people are going to be very excited about, well, maybe already are, they think there is money to be made trading them. I don’t think they are expressing an opinion on the element of value. I’d be very surprised if the top partners at Goldman are selling their Goldman stock and putting it into Bitcoin.
Wharton
CoinTelegraph reported:
The six-week program costs $3,800, and the Ivy League university expects to attract thousands of students each year.
One thousand students would generate about $4 million. Five thousand students would translate to $20 million. Learners will ask how to value Bitcoin, and what are the instructors supposed to do? Tell them it cannot be valued? Nah. Fundamental Token Value (FTV) Methodology is the way to go according to Wharton.
Ric Edelman
What did he say about demand? Ah, yes:
Crypto is the most popular session at conferences like this. My room is standing room only as we talk about crypto. Because it’s the one subject nobody knows anything about and everybody is curious about it.
Right. So, a story is needed, and “You can only speculate on Bitcoin, but not invest in it” is not going to cut it. “The first new asset class in 150 years” is just a better line.
Jamie Dimon
I personally think that Bitcoin is worthless. But … I don’t care. It makes no difference to me. I don’t think you should smoke cigarettes either… Ok, that’s Jamie, now JPMorgan. Our clients are adults. They disagree, that’s what makes markets. So if they want to have access to buy or sell Bitcoin, we can’t custody it, but we can give them legitimate, as-clean-as-possible access.
This strikes you as the truth. He is very open about what he thinks Bitcoin is, but also capitalizes on the business opportunity. What is he supposed to do? Turn down business?
This stuff sells and it benefits not only sellers of speculation but sellers of all of the collateral stuff: consulting, knowledge, certificate programs, etc. Whether or not these people are capitalizing on the opportunity or truly believe it, it is hard to say. What is undebatable is that
Mankiw is right: People respond to incentives.
