Why isn’t Bitcoin coming to the rescue?

“The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.”

This could have been written yesterday, but it was actually written nearly 14 years ago, in the autumn of 2008.

And who wrote it? The man most regard as the greatest investor of all time, Warren Buffett.

His very next words in the piece are: “So… I’ve been buying American stocks.”

Why?

Buffett continues:

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense.

His central argument for buying stocks a year into one of the worst financial crashes of all time was this:

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497. …

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

We know now that he couldn’t really have picked a better time to publish.

The crash bottomed out a few months later, and anyone who bought when Buffett penned that piece would be up about 4X today, despite the current collapse.

What does any of this have to do with crypto today?

Well, it’s interesting for a number of reasons:

1. Buffett was entirely right.
2. At the time, people would have said he got it completely wrong.
3. His arguments against holding cash are more relevant today than ever, with double-digit inflation looming.
4. None of this matters to the average person… and that’s the key thing here.
5. All of this relates to what we’re seeing in crypto, and particularly bitcoin, right now.

Let’s unpack…

With the benefit of being able to see nearly 14 years into the future, it seems obvious Buffett was 100% correct. Like I said, anyone who bought off the back of Buffett’s words would be up about 4X today.

However, the stockmarket dropped another 24% in the four months following Buffett’s piece.

So, in reality, anyone who bought off the back of Buffett’s words would have been in dire straits four months later.

Of course, Buffett made it very clear he didn’t know what the market would do in the short term:

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month or a year from now.

His point was that the market would turn around long before anyone knew what was happening. And if you waited for confirmation, you would miss it:

What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

Moreover, if you were waiting for this turnaround while only holding cash, you’d be losing money the whole time.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. …

Those investors who cling now to cash are betting they can efficiently time their move away from it later.

And back then US inflation was “only” around 4%, today it’s 8.6%.

However, here’s the key thing: all of this is irrelevant to the average person.

Why?

Because when inflation is at 8.6%, no one is thinking about investing. They’re thinking about staying afloat. Especially when we’re arguably already in a recession, and people are losing work left, right and centre.

Add to this that the markets have done this since the start of the year…

And you can see why anyone in their right mind would be fleeing to cash.

The only people in a position to “be greedy when others are fearful” are the people who are already incredibly wealthy.

Essentially, they need to already have enough wealth that they can:

• Lose 20%-60% on their investments without it affecting other areas of their life.
• Know that if their expenses go up 10% every year it won’t ever affect their lifestyle.
• Have no fear of losing their income in a recession.
• Have a big pile of investible cash on hand.

So while Buffett’s advice is undeniably true, it’s also irrelevant for 99.9% of people.

And there’s honestly no telling how long these major crashes can continue to bite.

It took eight years for the S&P 500 to recover from the dotcom collapse, and then it immediately fell again in the 2008 financial crisis and took another six years to recover:

So, really, investors were underwater for 14 years after the dotcom bubble burst.

Who can afford to be greedy after 14 years underwater?

This brings us to the pivotal question: how does any of this relate to Bitcoin? (Especially as Warren Buffett famously hates it.)

Well, in theory, we’re living through the exact environment Bitcoin was designed to thrive in.

But in real life theories don’t always pan out the way they are supposed to, do they?

Remember, unlike traditional currencies, Bitcoin’s total issuance is capped (at 21 million Bitcoin).

So, in theory, over time Bitcoin will become more and more scarce and through the forces of supply and demand, its value will go up.

Decreasing supply + equal or increasing demand = increasing price.

This should make it the ideal inflation hedge.

As I wrote in my feature: What does inflation have to do with Bitcoin anyway?

There are two main reasons people argue Bitcoin can be a better hedge against inflation than stocks.

1. Bitcoin is decentralised.

Stockmarkets are essentially a representation of how well a country’s businesses are performing.

If that country’s economy starts to suffer, people will lose faith in its businesses, pull their money out of the stockmarket and stock prices will fall.

Because bitcoin is decentralised, it isn’t tied to the fortunes of any one country. It is independent and global.

Which leads us onto the next point…

2. Bitcoin is completely separate from the financial system.

One of the big ideas behind Bitcoin is that it isn’t tied to the financial system.

Central banks’ monetary policies can’t affect Bitcoin because it operates in its own financial system.

This is mainly because there will only ever be 21 million Bitcoin in existence. That’s written into its code and no Central Bank anywhere in the world can change that.

So, no matter what happens to any given country’s inflation or economy, Bitcoin will – in theory – be unaffected.

This is arguably one of its main purposes.

After all, it was born out of the 2008 financial crisis. And its first ever transaction had the following headline written into its code: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”

Whether that was its creator, Satoshi Nakamoto’s intention or not, it is one of the main reasons many people hold it today. As an insurance against our current financial system.

Sounds great. But let’s just take a look at that chart again:

Hmm, something’s not right here, is it?

Shouldn’t Bitcoin be up there with WTI (oil) making its holders an (unrealised) fortune?

Instead, Bitcoin has lost more than any other asset.

What went wrong?

The narrative changed.

Back in the 2010s, Bitcoin really was seen as an alternative currency, and alternative to the fiat money system.

Today, that narrative has changed to “store of value”. But really people see it as a risky asset that could make them rich.

For example, between March 2020 and March 2021, the S&P 500 gained about 70%. An absolutely incredible return for a major stock market.

However, over the same timeframe, Bitcoin gained more than 1,000%. Wow.

Two months later, however, Bitcoin had dropped 50%.

And four months after that, it had doubled again.

Then two months after that it was down 50%.

You get the idea…

By this point, everyone knows how volatile Bitcoin is, and they invest accordingly… which is why it’s behaving just like a risky tech stock.

From the (admittedly anti-crypto) New York Times:

[Bitcoin’s] convergence with the Nasdaq [America’s tech-focused stockmarket] has grown over the course of the coronavirus pandemic, driven partly by institutional investors like hedge funds, endowments and family offices that have poured money into the cryptocurrency market.

Unlike the idealists who drove the initial enthusiasm for Bitcoin in the 2010s, these professional traders are treating the cryptocurrency as part of a larger portfolio of high-risk, high-reward tech investments. Some of them are under pressure to secure short-term returns for clients and are less ideologically committed to Bitcoin’s long-term potential. And when they lose faith in the tech industry more broadly, that affects their Bitcoin trades.

“Five years ago, people who were in crypto were crypto people,” said Mike Boroughs, a founder of the blockchain investment fund Fortis Digital. “Now you’ve got guys who are across the whole span of risk assets. So when they’re getting hit over there, it’s impacting their psychology.”

In fact, Bitcoin has lost so much value since last November that it’s wiped out 80,000 “Bitcoin millionaires”.

But what’s going to be interesting to watch going forward is if Bitcoin really does start to behave in the way it’s “supposed to”.

Over the longer term will its thesis win out and will it actually become its own independently functioning financial system?

Will it become the “insurance against an economic collapse” it was always touted to be?

Or will it continue to rise and fall with all the other risky assets people like to invest in?

Personally, as usual, I have no idea.

But It’s sure going to be interesting watching it all play out.

What else is going on?

None of these stories really fit in with today’s narrative. But they are all worth being aware of, so I’ll just link them here.

• UK consults on new DeFi tax rules
• EU agrees on comprehensive cryptocurrency regulations
• Grayscale sues the SEC over its Bitcoin ETF

Okay, that’s all for this week.

Thanks for reading.

Harry

PS Next week we’re going to be looking into what could become the biggest crypto story of 2022 – the spectre of Mt Gox. And there are also rumblings of Celsius getting ready to dump $500 million Bitcoin on the market.

Full disclosure: At time of writing, I held the following cryptos: Ethereum, IOTA, Radix, Mina Protocol, Aleph Zero.

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