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Hackernoon logoWhy You Should Start With A Small Allocation into Bitcoin in 2021 by@davidlovato

Why You Should Start With A Small Allocation into Bitcoin in 2021

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@davidlovatoDavid Lovato

Software Engineer at Google. San Francisco, CA

I first heard about Bitcoin in December 2017, at the peak of the bubble. My college roommates and I were drawing J curves on a whiteboard, predicting $100k Bitcoin and feeling FOMO for not getting in earlier.

Thankfully I had no money at the time, and by the end of 2018, Bitcoin had bottomed out at around $3,000, a loss of ~80%. Following the crash I wrote off Bitcoin and never thought about investing in it again.

Then the pandemic hit. 

The world was facing another economic downturn due to a global epidemic that was ravaging the world. One of the first acts that Congress passed was the CARES Act worth $2.2 trillion, with stimulus packages in Europe and Asia following suit. Governments around the world printed so much money so fast that it triggered a new meme:

Now, printing money isn’t always a bad thing nor necessarily results in inflation. Inflation is a factor of supply and demand. So while there’s been an unprecedented increase in the money supply, it might not result in inflation — at least not in the short term.

Demand will lag far behind its pre-pandemic levels as the economy slowly recovers, leading prices of consumer goods and services to stay neutral or marginally inflate.

Furthermore, the Fed has pointed out that inflation has barely been above 2% the last 10 years despite multiple rounds of Quantitative Easing following the Great Recession. Here’s a chart of the consumer price index (CPI) from 2010–2018:

Inflation according to CPI topped out at around 3% in 2012 and then has barely reached the Fed’s target of 2% in recent years. Many have pointed to this chart as evidence that the Fed and Congress pumping trillions of dollars into the economy will not result in inflation this cycle.

I disagree with this view.

I would argue that inflation has largely shown up in assets, e.g. stocks, real estate, and other investments, and not consumer-bought goods. Here is a chart of price increases in assets versus consumer goods the last ten years:

The story in 2020 isn’t any prettier. Real estate prices rose 3% in Q3 alone and stock indices such as the Dow and S&P are hitting all time highs, while the underlying economic data has been lackluster.

Debt is the new money on Wall St. and the Fed has shown that they’ll step in to provide liquidity (which makes it easier to buy and sell) to help prop up asset markets, like real estate and stock markets.

Despite the massive valuations and indicators that stocks are in a “bubble,” I actually don’t see the returns from stocks declining in the short term. The reason is that interest rates will continue to be near-zero for at least a year, and Fed members “expect rates to remain near zero for at least the next three years through the end of 2023.” [1]

Keeping interest rates near-zero for years will have a profound effect on asset markets and purchasing power for Gen-Z and Millennials. One of the effects of near zero interest rates is that treasury bills tend to have lower yields as well, which corporations and other entities with large balance sheets use to generate a fixed return.

Right now, the 10 year treasury bill yield is 0.95% and likely to stay low without an increase in interest rates. This will push corporations and endowment funds to invest in other assets to generate returns that at least keep up with inflation (CPI inflation). I would take this a step further and hypothesize that they’re going to want to keep up with stock market returns, since equities have been returning 6–7% every year.

Other assets such as real estate will also continue to appreciate, as record low mortgage rates and high stock returns allow consumers to take on more debt and buy a more expensive house. 

So what should Millennial and Gen Z investors do in order to retain purchasing power? At a minimum, portfolios need to match the returns of the overall stock market.

One way to do this is to move from passive investing into active investing and hope to pick the right stocks, like Tesla, Zoom, and other tech stocks that have boomed this year. Personally, I don’t trust myself to beat the market by picking the right stocks, which led me to look elsewhere.

Seeking Refuge from Asset Market Inflation

Now that the stage has been set, the question facing every investor is “What asset will be the winner in ten years’ time?” When I looked at the best performing assets of the 2010s and 2020, there was one clear winner: Bitcoin. [2]

Like many investors, I was initially skeptical of Bitcoin’s rise, but seeing it rally from the 2017 bubble was the market telling me that there’s real money behind this, so I dug into what the market was saying.

Understanding Bitcoin’s Rise in 2020

One of the biggest factors that made Bitcoin’s 2020 rally different from 2017 was the sheer amount of money being invested and the length of the bull run. Bitcoin’s market cap in 2017 was around $250–300 billion when it briefly jumped to $19k.

In 2020, Bitcoin’s market cap initially was $130 billion at a price of $7k and has since climbed to $440 billion at a price of $24k, where it’s been stabilizing.

While it’s an impressive one year gain, relative to stocks like Tesla this is a pretty tame jump, which gained 600% and $500 billion in market cap. That said, who was investing in Bitcoin this year? What was driving the price jump?

For most of its lifetime, Bitcoin has largely been a retail trade, meaning individuals were buying it. People like the Winklevoss twins or Silicon Valley engineers invested large amounts early on but there were no Fortune 500 companies or institutional investors.

That changed this year when companies like MicroStrategy and Square decided to invest part of their cash reserves into Bitcoin. In MicroStrategy’s case, they invested their entire reserves of $550 million, while Square invested 1% of its reserves, totaling $50 million.

Additionally, hedge funds and institutional investors decided to join the mix. Paul Tudor Jones wrote to investors in May stating that Bitcoin could serve as an inflation hedge and took a position.

Other hedge funds like One River Digital Asset Management stated that they had invested $1 billion into Bitcoin this year. Even institutional investors like MassMutual stated that they had invested $100 million into Bitcoin this year, although this represented a tiny fraction of its assets under management.

Lastly, part of the rally is still retail-driven, with PayPal and Square announcing this year that they would allow users to buy, store, and sell cryptocurrencies on their platforms. Overall, if 2017 put Bitcoin on the map, 2020 put Bitcoin into a different territory as an inflation hedge and investment.

Corporate Adoption of Bitcoin

In order for Bitcoin to rise in price even more going forward, large sums of money will need to be invested, on a much larger scale than your average everyday investor. If 2020 is any indicator, I believe it is likely that other institutional investors, hedge funds, and corporations will divest some cash from low yield treasury bills into riskier assets like Bitcoin, seeking higher returns and as an inflation hedge.

One of the barriers to more institutional money investing in Bitcoin is that it’s hard for a company to buy and manage it themselves. It’s not regulated by the SEC nor is there a Bitcoin ETF they can invest in, so they have to buy Bitcoin from the exchanges and manage custody themselves, which is a tricky proposition.

If you’re not familiar with how Bitcoin works, I suggest doing some research but essentially there’s public and private keys associated with each wallet, and anyone who knows the private key has access to your wallet.

If you’re a company and you buy $500 million worth of Bitcoin, you now have to figure out how to store it safely without losing or having the private keys stolen.

The other alternative is keeping Bitcoin on an exchange such as Coinbase, but then you’re trusting Coinbase to hold your keys, or paying high premiums to invest in trusts like Grayscale, which isn’t taking new investors at the moment.

In these scenarios, I believe that there will be a barrier to institutional adoption until a Bitcoin ETF gets approved, which so far hasn’t happened and might take a few years.

That being said, it seems that more than a few of these institutional investors and corporations with deep pockets have figured this out. In the case of high adoption among institutional investors, it would not be crazy to think that Bitcoin could repeat 2020’s performance in the next 5 years.

Another optimistic way to view Bitcoin is to compare it to gold, whose value is largely as an investment hedge. If gold is seen as the traditional inflation hedge and Bitcoin is seen as a “digital gold”, then it is possible for Bitcoin to command a larger fraction of gold’s current $10 trillion market cap.

Right now, Bitcoin’s market cap is about 5% of gold’s, so it has a lot of room to run as an inflation hedge if institutional investors and corporations allocate small amounts of cash reserves into Bitcoin en masse.

International Developments within Bitcoin

So far I have only covered what happened with Bitcoin in the United States, mostly because companies have lots of money and would be a big driver of price increases.

However, I am also bullish on Bitcoin because of what I’m seeing outside the United States, namely Iran, Nigeria, Venezuela, and a few other countries.

For many citizens across the world Bitcoin is being used to protect against asset seizures and hyperinflation. This is precisely what happened in Venezuela and Nigeria this year.

In Nigeria, officials froze bank accounts of SARS protest organizers, so people turned to Bitcoin in order to keep raising money and organize the movement. In Venezuela, expats have been using Bitcoin to send money back home to family members, and citizens have been using it for any savings to avoid having their savings inflated away.

There is a similar story in Iran where citizens experienced a very high inflation rate in 2020, and a small but growing number adopted Bitcoin as a store of value and means of exchange with merchants.

Unlike other countries, Iran’s government actually adopted Bitcoin as well, viewing it as a way to pay for imports and skirt international sanctions. While Bitcoin’s current market cap is too small for a country to adopt it as part of its currency reserves, I believe that countries like Iran and North Korea will adopt Bitcoin as a way to skirt around international sanctions.

Conclusion

Make no doubt about it, Bitcoin is a high risk, high reward investment. There has been massive volatility in the past, and its pricing isn’t easily modeled like stocks, bonds, and real estate, nor are there market closures or circuit breakers that prevent crashes.

In my opinion, the threat of Bitcoin succeeding could have far greater consequences than it dying, as it will threaten the central banks monopoly on money.

In this year’s G7 meeting, the German Minister of Finance made this clear, stating “We must do everything possible to make sure the currency monopoly remains in the hands of states.” Bitcoin’s volatility has let it hide in plain sight, but as it continues to rise and stabilize, governments may try to kill it before it gets too big.

Thankfully, enough Americans hold Bitcoin that Congress should be incentivized not to ban it. It’s also promising that a Senator-elect from Wyoming who believes in Bitcoin was elected this year and I expect this trend to continue.

As purchasing power continues to erode due to Federal fiscal and monetary policy, Bitcoin, much like gold, presents citizens with an opportunity to preserve their hard-earned savings and protect their assets from government seizure or mismanagement, as the people of Cyprus experienced in the 2010s.

However, I believe Bitcoin is much easier to own, transact, and move than gold, but both assets have their places in a portfolio.

Owning Bitcoin is a rare opportunity to participate in an asymmetric bet because of the ability to front-run institutional adoption. Bitcoin reminds many investors of how internet stocks were traded in the late 90s.

While many internet stocks ended up dying in the dot-com bubble, the internet itself never went away and companies like Google and Facebook continue to grow tremendously in value. I believe that cryptocurrency similarly is here to stay, and Bitcoin is far and away the best, with many trying to imitate it.

Appendix.

[1] https://money.usnews.com/investing/stock-market-news/articles/are-stocks-real-estate-in-asset-bubbles

[2] https://cointelegraph.com/news/bitcoin-is-outperforming-every-mainstream-asset-class-in-2020

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