|  | | | | How did Bitcoin get to $70k? |
| Bitcoin is one of the more intriguing investment stories in recent memory and maybe of all time. As the cryptocurrency bellwether, and perhaps even the “reserve currency” of the crypto universe, it is the one we feel makes the most sense to keep tabs on, given that crypto itself represents questionable terrain for a serious investor.
Fundamental investors, ourselves included, do not like to engage in idle speculation. They like investments that are linked in some way to the generation of cash. They do not like investments based on psychology, the “greater fool theory,” or guesses about what someone else might be willing to pay at some point in the future.
The late Charlie Munger, whom we admittedly but justifiably quote often, was one of the greatest fundamental investors of all time. He never hesitated to express his aversion to Bitcoin. |
| | Sometimes I call it crypto “crappo.” Sometimes I call it “crypto-****". It’s just ridiculous that anybody would buy this stuff… It’s totally absolutely crazy, stupid gambling. - Charlie Munger, 2/16/2023 |
| | Bitcoin generates nothing, but is in fact itself generated, through some energy-intensive digital procedure (described as “mining”) that few people can effectively explain and probably few Bitcoin investors really grasp.
Bitcoin is similar to gold in that gold’s lack of utility (setting aside niche applications) resulting from its inertness as a metal is paradoxically the source of its value as a store of value. Gold works as money because gold is very good at one thing—simply existing, with a relatively fixed supply.
But gold exists in the physical realm, and its scarcity is based on nature, not computer code.
Political dimensions
From a political standpoint, Bitcoin is both offensive and attractive. It is offensive in that it has many of the characteristics of a scam. Even worse, it is notoriously used as a means of payment in a wide array of illicit and truly harmful activities, from drug dealing to terrorism. |
| | Bitcoin itself is a hyped-up fraud, it’s a pet rock. - Jamie Dimon, JPMorgan CEO, 1/19/2023 |
| | At the same time, Bitcoin represents a source of individual freedom, in that it largely exists beyond the reach of political and legal authority. In theory, bitcoin ownership or trading can be outlawed, similar to how gold was confiscated by the federal government in the 1930s. The Chinese central bank in fact banned Bitcoin and other forms of crypto in 2021.
But unlike gold, Bitcoin lacks a physical presence, which makes confiscation difficult even to conceptualize. And because Bitcoin is owned through passwords rather than official personal identity information, transaction activity in Bitcoin is nearly impossible to track.
Bitcoin as a mode of commerce represents an opportunity to take ultimate control over the economy out of the hands of government and central banks. For the same reason the CCP hates it, many libertarians (or individuals with libertarian inclinations) truly love it. |
| | [Bitcoin] is an opt-out from the broken financial architecture created by the U.S. Federal Reserve system…. I think the existence of Bitcoin holds the dollar’s feet to the fire to make sure that it can’t be manipulated in a way that people don’t just opt-out and go in the other direction… - Vivek Ramaswamy, 11/15/2023 |
| | From the vantage point of a skeptic of centralized government, Bitcoin functions as a sort of check or balance against what could become, or perhaps already is, an abusive monopoly of the money supply. Vivek’s point is that a little competition is healthy and disciplines the Fed.
Our personal interest in investing in Bitcoin began in 2022, after the steep sell-off, when the pendulum of sentiment started swinging toward the “pet rock” thesis on Bitcoin and away from the digital gold thesis.
The onset of the interest rate tightening cycle sucked the speculative froth out of markets and sent crypto into a tailspin, along with a large swath of the tech sector. Sam Bankman-Fried was exposed as a fraud, and the entire structure of the global crypto trading system appeared at risk of unraveling.
Some of the largest businesses involved in the crypto economy looked like they were on the verge of collapse. Coinbase (COIN) is among the leading custodians and trading platforms for cryptocurrencies. From a peak in late 2021, its share price fell more than 80% in a matter of months.
Grayscale Bitcoin Trust (GBTC) was at the time a closed-end fund and among the largest investment vehicles in the world that had direct ownership interest in Bitcoin. Its sole purpose was to own Bitcoin and give stock market investors an avenue to own Bitcoin indirectly through ownership of shares of the GBTC trust.
Ever since its 2015 listing, GBTC had traded at a premium to the underlying value of its Bitcoin holdings because it was one of the only ways investors could obtain Bitcoin exposure through the stock market. Back then, investors seeking Bitcoin exposure would otherwise have to acquire some form of direct ownership through a crypto exchange or other platform, which was cumbersome and involved various risks.
Investors, including institutional investors, poured money into GBTC largely because of this convenience factor and the belief that the manager of the trust, which used Coinbase as a a custodian, was a relatively large and reliable counterparty.
Cathie Wood’s ARK Innovation ETF (ARKK) had been among the largest holders of GBTC. As money flowed into her fund and others, it was redirected into GBTC, which supported the premium valuation.
In the first few years of its existence, the premium investors were willing to pay for a share of GBTC versus the underlying net asset value (NAV) of its Bitcoin holdings was substantial, at times exceeding 100%. Conceptually, this is like paying someone $1,000 for an envelope that contains $500 worth of euros. You would likely only consider doing this if there were some difficulty associated with buying euros directly and you strongly believe euros would rise in value.
Even at the end of 2020, just prior to the distress in the crypto market that would arrive in 2021, the premium was at times over 40%. |
| |  | | | The volatility Bitcoin experienced in 2021 and again in 2022 then led to a funny confluence of crypto speculation and value investing.
As reflected in Munger’s comments above, value-oriented investors often have a natural allergic reaction to an investment that is based on something that is entirely intangible and that does not produce cash flows. At the same time, the essence of value investing is to buy a dollar for fifty cents. Value investors (Buffett and Munger among them) scour the market for these mispriced bargains.
As the harsh sell-off in growth stocks bottomed in late 2022, and funds like ARKK were dumping their GBTC shares to meet redemptions, Bitcoin itself reached a low of about $16,000, versus its 2022 high of $66,000.
In the fourth quarter of 2022, GBTC was trading at a nearly 50% discount to NAV. So not only was Bitcoin down some 75% from it recent peak, this investment vehicle that owned Bitcoin could be purchased for about half the value of its underlying Bitcoin holdings.
Nothing beats a double discount
To the extent Bitcoin was “cheap” at the time, this scenario represented what value investors sometimes refer to as a “double discount.” The underlying asset was marked down, and the entity which housed it was further marked down. Among the concerns investors had at the time was that the entire edifice of crypto investing would collapse. So there was an element of fear that the manager of GBTC, Grayscale, would be forced to liquidate its Bitcoin holdings, or that its custodian Coinbase would collapse and leave investors in GBTC with an uncertain claim to those assets.
Ironically, in retrospect, the outlook for GBTC from a structural perspective was brighter than ever. Legal efforts were underway by the crypto industry to allow a trust like GBTC to convert into an Exchange Traded Fund (ETF). This meant there could at some point be continuous liquidity for the underlying assets, similar to stock ETFs like SPY or QQQ.
If GBTC could convert into an ETF, the NAV discount would disappear. In that scenario, even if Bitcoin didn’t rise in value, an investor in GBTC could nearly double his money if he had purchased GBTC when the discount was at its widest levels.
Even in late 2022, as litigation proceeded, many if not most observers felt the Securities and Exchange Commission (SEC) would ultimately approve the creation of Bitcoin ETFs. The anticipation of this event in late 2023 led to a reduction in the NAV discount of GBTC and simultaneously drove up the value of Bitcoin. Bitcoin investors figured, correctly, that Bitcoin would ultimately benefit from a brand new wave of buying demand as Bitcoin ETFs hit the market. |
| |  | | | The surge in Bitcoin year to date (up over 65% as we write) can be predominantly explained by the SEC’s actions with respect to the formation of Bitcoin ETFs.
Not only do these ETFs create more opportunity for investors to own Bitcoin, it puts the federal government in a difficult position if it ever chooses to clamp down on Bitcoin. After all, it was a federal agency, under pressure from the courts, that just paved the way for mom and pop investors to buy and sell interests in Bitcoin just as they do common stocks.
Bitcoin has truly gone mainstream. Should libertarians rejoice? Or has the government simply put itself in a position to control Bitcoin’s fate by integrating it within its regulatory apparatus? We don’t know, and no one else does either, but it will be fascinating to watch.
More importantly, should you own Bitcoin?
In addition to GBTC, there are a number of other ETFs that have been created that provide low-cost exposure to Bitcoin. Our preference, as always, is to make investments when sentiment is bad and long-term upside is underappreciated. The risk-reward opportunity that was available in late 2022, when the price of Bitcoin itself was down sharply and the NAV discount applied to GBTC was at wide levels, is long gone.
GBTC is now up nearly 700% from its absolute bottom. Having converted into an ETF, there is no longer any NAV discount.
That being said, we still own a small amount. The most attractive quality of Bitcoin is that there really is no way to define a ceiling in terms of where it may trade one day as the crypto landscape evolves.
Bitcoin could well end up being as worthless as a pet rock, but in that worst case scenario, an investor loses 100% of his or her investment. At the same time, one can imagine scenarios, even if it’s just a function of runaway speculation, where Bitcoin trades at multiples of current levels, even after the most recent run.
We are not at the moment recommending the purchase of Bitcoin or Bitcoin ETFs and may never. But it is not entirely irrational to maintain some small exposure here, given the asymmetry of potential outcomes. Bear in mind, it is a wildly volatile financial instrument and, for better or worse, highly sensitive to political developments, technological developments and market psychology.
No one should ever purchase any crypto-related investment without being fully prepared for short-term and potentially permanent losses. Even if the long-term trajectory is up, if history is any guide, the journey will be treacherous. |
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