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28
Feb

Safe haven……?

In early January, when bitcoin was rising strongly, the prevailing view was that bitcoin was acting as a risk off asset, much like gold. At the time I said I very much doubted that was the case. Simply, no sane person in a time of crisis looks to hide away in a volatile asset class.

January 17th
“In what may become an increasing trend, bitcoin appeared to respond positively to global political volatility, adding 22% during the height of the Iran conflagration.

I must say, I don’t personally subscribe to this point of view. Bitcoin is still hugely volatile, I can’t think that people are ready to charge into an asset that can lose 30% in a day at the first sign of global instability. A view backed up by the fact that we now have a China trade deal and a deescalation in Iran but the bitcoin price is even higher, at US$8,700. Quite possibly in time bitcoin will be seen as a safe haven but there are other factors that are far more influential on the bitcoin price than geopolitics at this stage.”

So it has proved to be, bitcoin having had a bad week is now only 20% up this year and we are back in the usual position of being well in front where most people believe bitcoin is down in 2020. That’s volatility for you.

As the penny drops globally about coronavirus and the markets start to panic, the world is surging into bonds. The problem is significant, particularly for those levered into equity, as it means margin calls in a falling market. These have be met by selling liquid assets which will include bitcoin and likely gold. Recall in 2008, gold had a very rough time in the early part of that crisis.

Where does that leave us? Fundamentally, it looks more and more like interest rates are going to fall again, 10 year US bonds are now at 1.5% continuing their 30 year decline, the Chinese government is injecting enormous cash into the market. All signs point to a Federal Reserve interest rate cut at their next meeting in March.

Cash printing without limit is our investment thesis and it continues to play out. The US bond chart tells the story about interest rates and about the action central banks will take to “correct” the market. Central banks are out of bullets and unknown territory beckons. Unknown territory is where bitcoin lives.

Price levels

When it comes to bitcoin price levels, I try not to say too much. Ultimately price is a function of so many other variables, not least in the wider economy and I don’t pretend to be able to predict short term price trends. My sense though is there are certain price levels which are important for bitcoin for different reasons. All figures are USD:
  • $10,000
Psychological only. It’s just a number but it is a heavily traded level. Bitcoin has now spent roughly a year bouncing around either side of this because it is an important level for day traders. New supply halves in May, and expect this level to be challenged before and after.
  • $15,000 – $17,000
You may recall that bitcoin’s all time high was $19,783 on December 17 2017, 4 days later it was $13,000. Hardly anyone bought in at that all time high price, it lasted a couple of hours and the average price for the week was $17,000. Many people scarred from the late 2017 experience who still hold their coins will likely look to exit in this range, many have held on expressly for that purpose, consequently there will be active selling in this range.
  • $20,000
Clear air. Beyond here anything can happen because nobody knows. I do not expect the time spent at $20k will be anything like as long as the time spent at $10k. Mostly because by the time bitcoin gets here, new supply will be a lot lower (half in fact), demand is growing all the time and there ought to be very few people at this level sat on losses they are seeking to recover.

I’ve also made the point before that we can spend a long time doing nothing and then get very strong price moves unlike those you see in other asset classes. The single biggest day gain for bitcoin has been around $3,000. I expect we will see a single day gain in excess of $10,000 in future.

As I have said before, we can also (and will) see $10,000 drops, this week we have seen a $1500 drop, it’s not unusual.

There is one other price level.

  • $0
The chance of complete failure recedes with time. 11 years of uninterrupted operation should give people confidence in the security and robust nature of the protocol. Even so, $0 is a possibility, just as it is with any equity you might buy. Portfolios should be allocated with that risk in mind.

Brainhard

Actually, it’s Lael Brainard, a Federal Reserve Governor. She repeated her calls (which we discussed some weeks ago) for a new strategy to achieve 2% inflation. Back in December she first discussed this and at the time I wrote the following when she first floated the idea:

“If there is a huge backlash then Lael will presumably be running the Bank of Greenland before the end of the year. So far there hasn’t been any backlash, so I expect Jerome Powell to be parroting the same tune some time next year.”

Well there hasn’t been a backlash and she isn’t in Greenland. Indeed, we are now seeing more colour on the idea. In a speech in New York on Friday she called for a “flexible inflation averaging approach”. Further, the Fed should “pre-commit to low interest rates prior to any recession and this forward guidance could be reinforced by interest rate caps on short term Treasury Securities of the same horizon”.

These are astonishing admissions, in the end the market sets the interest rate, how much is the market willing to pay for a bond? The Fed has been embarrassed by this before with the bond market demanding interest rates of 9% on overnight lending until the Fed intervened.

What are we being told?

  • We will print money to maintain a low interest rate, including to monetise our own debt and cap interest rates
  • We will print money to get inflation going because deflation will crush us under a debt mountain
I would say their policies are completely crazy but they are not. Simply, they have no other options. Full bloomberg article here.

Peter Thiel

Peter Thiel is most famous for being the founder of PayPal but probably his best investment to date was in Facebook where he was the first outside investor, he put $0.5m in for 10% of the company. He was introduced to Facebook by Reid Hoffman, who as CEO of LinkedIn at the time and didn’t make the investment himself because he believed it might be a conflict of interest. A costly one, as it turns out.

Why is this interesting? Well Reid Hoffman has been a big bitcoin investor for a long time and he is also a major shareholder in Blockstream, probably the biggest bitcoin development house. Now, Peter Theil’s bitcoin mining operation, Layer1.com, which was announced last year has gone live. They are based in Texas and are aiming to become the world’s first vertically integrated bitcoin miner, which means they are designing the equipment to mine the coins (the ASIC chips), the solar panels which will create the power and the coolant that will keep the operation running.

Ideally you mine bitcoin where it is cold, Texas is not. LayerOne are overcoming this by housing their mining equipment in liquid coolant, this insulates them from heat and significantly reduces the requirement for air conditioning.

The essence of their business model is that the most successful mining operation will be the most efficient one through the whole operating chain. Which means, most efficient processor, lowest cooling cost, lowest power consumption per unit of mining power. If you have this, you win. It’s a huge challenge to be all three, in particular the chips are really hard to design, especially while simultaneously trying to improve the efficiency of your solar panels.

I suppose their business model is correct. “If we are the most efficient we will win”. Correct. It will be hard to do though, as many bitcoin mining operations have effectively free power and are often operating in cold climates requiring no cooling (e.g. those that operate in Iceland receive free excess geothermal power and require no cooling due to the climate). That is a zero cost base and it’s hard to beat, even if you are Peter Thiel. One operator in particular Upstream Data has been installing mining equipment using vented methane for a number of years, those installations are effectively immune to changes in electricity prices and in most of their installations from the heat too. You can have the fastest chips in the world and still not beat them for efficiency.

Once fully online in a few weeks, LayerOne believe they will represent 2% of global hash power. From there, they believe they can get to 30% of global hash rate by 2021. I don’t want to bet against the PayPal Founder, but that isn’t going to happen. Even so, I’d rather have Peter Thiel and Reid Hoffman investing in the ecosystem than not and if I’m wrong about their ambitious goals, even better.

New website

Our new website went live this week. We are still tweaking bit’s and pieces on there but any feedback is welcome. In particular, you might like the Bitcoin Live link which visual representation of the bitcoin blockchain. As a brief guide, everything to the right of the dotted line are existing blocks, everything to the left is unprocessed transactions waiting to get in the blockchain.

In this snapshot we were up to block #61915. You can see average fees, size of blocks and number of transactions outstanding as each block passes through.

In addition the education section lays out how bitcoin works.