Volatility Is A Bitcoin Investor’s Friend - CHAINLETTER 45
Price volatility has always been a stick with which to beat bitcoin. But is it a useful tool for understanding either its risk or its value? We argue that for those who take the time to understand bitcoin, volatility is simply the cost of compounding.
Owing to the rapid growth of the crypto space and the burgeoning opportunity set, we will be launching DIGITALVISION as a sister publication to CHAINLETTER later this week. While CHAINLETTER will continue to concentrate on bitcoin, DIGITALVISION will cover everything else. And we’ve started a DIGITALVISION portfolio, which contains our best ideas outside bitcoin. DIGITALVISION will give subscribers visibility into our portfolio construction, research process, asset selection, performance and trades. Look out for the first edition on Substack later this week!
Technical
However, bullish we might be about the long term, there’s no denying that the BTC price is overbought. The spot price has diverged enormously from the moving averages, to an extent not seen since the 2021 bull run.
It makes sense that potential new buyers are reticent to commit at these levels. By the same token it also makes sense for existing holders to lock in some profits. Putting these together, a period of consolidation would be of little surprise.
Could that turn into a meaningful slump? We don’t think so, because, as argued in the last edition, the demand and supply dynamics are so favourable. But there are a couple of things to be aware of.
First, at times like this, a lot of leverage starts entering the picture. I am indebted to a reader for forwarding me this article from the Wall Street Journal which highlights some dysfunction in geared MicroStrategy ETFs in the US.
Given that MicroStrategy (MSTR) is itself a geared play on the price of bitcoin, a sharp fall might break things, and induce forced selling.
That said, there is no sign of breakage yet. The MSTR price is adjusting down to a more sensible level and the premium to NAV is pulling back commensurately.
We also know that a lot of good news is “in the price”.
Trump is in, Gensler is out, MicroStrategy have bought another pile, Senator Lummis has put forward her bill for a US strategic bitcoin reserve, and something similar is happening in Brazil (and elsewhere if this article is to be believed). It’s hard to know what we could hear that would make us any more bullish.
That’s always a bit unnerving. It suggests that the price is now “bad-news-sensitive”. Hopefully there won’t be any bad news, but we will look at some of the Macro tensions later in the letter, and see if there are any obvious headwinds.
On-Chain
While the price of BTC has risen, activity on-chain has barely registered an increase in pulse.
The value transacted over the network – as measured in US$ - has increased, a consequence of the higher price rather than heightened activity. Indeed the shorter term “spend” metric has now dropped below the 30-day moving average.
The amount of BTC transferred onchain has pulled back after the initial spike (blue line, below). Similar to the big move in March this year, what we have seen is an initial spike in activity, followed by a return to normal as the price consolidates.
Our in-house valuation – now at US$81,000 - is rapidly catching up with the price. This year at least, those moments when the premium to fair value has reduced to zero (ie when the green line hits the red line, below) have represented a decent entry point.
Somewhat surprisingly the number of transactions has tailed off after heightened summer activity. There’s little to read into this, save to acknowledge the lack of correlation between the number of transactions and the value transacted – and the price for that matter.
What we might infer – confirming what we already suspect – is that bitcoin is being priced as a store of value asset rather than as a payments network at this stage of its evolution.
This lack of activity means that fees remain very low. For transactions done at scale, it is a remarkably cheap payment network.
Continued Dispersion
Longer term holders naturally tend to sell into waves of euphoria. We discuss why later on.
Once again, as we enter a leg higher, we see selling from wallets that were previously unmoved for over a year.
Good. Dispersion means more holders. More holders means a growing network effect.
Altcoins Join The Party
The jump in the BTC price has seen follow-through from the rest of the crypto world, accompanied by some stunning moves. This has reduced BTC’s overall market share of crypto (its “dominance”) back to the 55-56% level.
It seems like a large correction, but it only takes it back to where we were in July, and back to the long term (365-day) moving average.
Having previously made the case that bitcoin dominance could rise to 70%, that’s clearly unexpected in these quarters, but we won’t write off the view quite yet. The macro might present a challenge for altcoins, which in our view have a completely different risk profile to bitcoin.
Macro
I sense I’m not alone in struggling to make all the pieces in the puzzle fit together. Some of the mental models we have been accustomed to haven’t been very helpful.
The most obvious is the strong dollar, which is typically regarded as unhelpful for risky assets. As you can see below, however, BTC has flown higher as the dollar has strengthened.
What do we make of that? The obvious comeback is that the behaviour of BTC has very little to do with the dollar, which would doubtless upset a few asset allocators. But it’s true, ultimately.
In the recent episode, bitcoin has reacted to the promise of greater regulatory accommodation and the expectation of broader acceptance as a financial asset. The dollar is an irrelevance in this context.
The second comeback is that the market no longer sees BTC as such a high risk asset. Allied to point one, this makes sense. Institutions are coming, volatility is dropping, liquidity is increasing, and the technology is improving. Each one of these points to a lower medium and long term risk profile.
All that said, this latest move in the price is really the consequence of one thing: the result of the election.
That is now priced in. Will the macro now take over?
Liquidity
As long as the planet is awash with enough liquidity to prevent a crisis, bitcoin can continue on its merry way. I take the simple view that central bankers will do whatever it takes to keep the show on the road because the alternative is unpalatable.
“Whatever it takes” is likely to have either currency debasement or inflationary consequences, which plays into bitcoin’s hands.
For the time being at least, all seems benign. The post-election surge of the dollar has stalled, bond market volatility has fallen and Central Bank liquidity (according to CrossBorder Capital) has been improving.
No need to fret.
Turkish inflation
Good news from Turkey, where the inflation rate keeps falling.
It fell to 47.09% in November.
That is a troubled history. No wonder we saw so many bitcoin shops and advertisements while on holiday there last weekend, augmenting the many gold stores.
Ethos
Risk Perception
I often get asked “Why is bitcoin so volatile?”. While the second order reason is that it attracts leverage and liquidation cycles, the underlying cause is the wide difference in perception and understanding of what bitcoin is.
To the majority of observers, bitcoin is the poster child of crypto, the riskiest asset class in existence. It is something to maybe have a punt on. To most professional investors, it is simply a tool of speculation. Charts, narratives and X posts are their feedstock. Its volatility is what got them here in the first place. Everything is about price, volatility, and the opportunities thrown up by system inefficiencies.
At completely the other end of the spectrum are those who believe bitcoin is the least risky asset in existence. They have no argument with those who think “crypto” is the most risky asset class, but make a whole-hearted distinction between bitcoin and everything else in the crypto space.
In our view this is the correct stance.
Why is this the case? Here we have to distinguish between the price of an asset and the asset itself.
Let’s look at gold. When you hold a lump of gold in your hand, you are holding something that was created at the dawn of time. It has survived everything, unsullied and unchanged. The price of that lump may fluctuate, but the asset itself is riskless. It is no-one else’s liability. It is just a rare rock.
No other asset comes close to that. Let’s take sovereign bonds, or cash in the bank? A government might default on its debt, while we know that commonly used currencies have continually debased through history. You really don’t want to think too hard about fiat currencies, which are wholly reliant on a shared presumption of value for them to prevail. Your money in the bank, meanwhile, is only as sound as the bank itself, and the computer programme in which it exists.
What about blue-chip equities? Well, while their prices may be less volatile, the underlying asset is clearly more volatile. Even in their (relatively) short lifetime, the composition of equity indices has changed out of all recognition. What were once blue chips no longer exist. Competition, bad judgement, fraud, regulation, fashion – all these can destroy a company in a matter of a few years. Equities as an asset class might be low risk, but individually they are high risk.
This is why bitcoin is so important and why it won’t go away.
It has risk properties that place it much nearer to gold than any other asset class. Regulators will tell you that it’s risky, but that’s because they look at the price. The underlying asset is supremely secure.
Let’s break that down:
Let’s return to the question of risk.
For those who understand the underlying risk properties of bitcoin, it is an absolute no-brainer to steadily accumulate, and to be particularly aggressive when the price crashes. That is because these “sound money” attributes pretty much guarantee that it will recover relative to traditional fiat.
Of course, those who understand bitcoin’s properties have a unique insight into the misinformation surrounding it.
It’s a classic informational arbitrage. Anyone who has spent a lot of time familiarising themselves with something will recognise the behaviour of the amateur fool. Yet just about everyone has an opinion on bitcoin, almost exclusively gleaned from ignorant sources.
This is important because it drags people in for the wrong reasons.
They are coming into it not because it is a remarkable asset with the potential to be a widely adopted global monetary network. Rather, they are buying it because they think it might go up in the near term. And we know that if it doesn’t go up, they will panic and sell because they don’t know what they’ve bought.
Hence the volatility. At the margin there is a natural cycle of transfer between owners and speculators.
Yet price volatility is widely thought of as the way to measure the risk of an asset. While that is understandable on a short term basis, it is damagingly insufficient for the long term. In the case of BTC, this conflation of volatility and risk has deterred a generation of investors from bothering to figure it out.
This is why we urge investors to make an effort to learn about blockchain technology and bitcoin.
The flipside of risk is opportunity. In the case of bitcoin, volatility should be seen as the cost of compounding. Strong hands will lighten up in market frenzies, and add back on weakness.
This is because they know that this is an asset which will endure.
Education
We hosted our latest Crypto Bootcamp last week
“The Bootcamp was one of the best training workshops I have ever been on for a number of reasons. Perfect blend of practical and theory, colourful stories to bring the subject to life and a good interplay between yourself and Will. The group size was ideal too, enough so we can get to know each other to a degree.”
I’ve scheduled the next one for the 21st January 2025 and then the following week on Tuesday 28th. The price is ￡250, which in addition to the course includes lunch and a drink at the end.
Please could you let me know interest as soon as possible by emailing me at [email protected]