Dear readers,

I don’t know whether it’s because few of you hold crypto investments or if it’s because you’re now embarrassed to admit it — I hope it's the former — but for whatever reason, I haven’t gotten a lot of mail objecting to my series of newsletters hating on cryptocurrency and cheering the fall in crypto asset prices.

One brave reader has written in to say that I’m wrong — at least as regards Bitcoin. I appreciate him speaking up, even though he’s wrong, because his argument for Bitcoin only goes to demonstrate what’s wrong with Bitcoin as an investment.

He writes:

I'm a millennial. I graduated from undergrad in 2009, and I remember the 2008 financial crisis unfolding right as I was attempting to find a job my senior year. It was impossible, so I went on to law school. When I graduated, I had law school debt that seemed entirely disconnected to reality of the job market we faced. My wife and I inherited a small sum of money and fortunately were able to buy a small house with the down payment. By 2020, I saw my younger brother unable to afford his own house and get further and further behind as assets and real estate grew more and more expensive for our generation.
I believe a lot of the economic inequality since 2008 was driven by poor Federal Reserve policy that inflated real estate, stocks, and indirectly things like student loans. But during that time, from 2013 until now, the best asset I had was Bitcoin (I bought my first in 2013, when I graduated law school). I feel my generation has been disempowered and fallen further and further behind our parents’ generation. Bitcoin was and is our equalizer…
So when you attack crypto, calling it “magic beans,” you're attacking a political position, an ideology, and a statement against the broken system. Consider Bitcoin a modern Occupy Wall Street. I ask that you study monetary history a bit more and perhaps Fed policy since 2008. People like me will buy Bitcoin even if it did go to zero (which I don’t believe it will).

This reader has some complaints about the economy that are valid (universities have sold a lot of law degrees to people at prices that don’t make sense) and some that aren’t (if the Fed hadn’t eased so much, interest rates and unemployment would have been higher and inflation and real GDP growth would have been lower; therefore, his debts would have become more burdensome, not less) but you’ll notice what’s not in here anywhere: a theory of why Bitcoin should have any particular price. Instead, our correspondent makes an emotional appeal — a red flag in investment analysis if I’ve ever seen one.

He says Bitcoin is “a modern Occupy Wall Street,” but Occupy Wall Street is not an asset and does not have a price. There are no returns on investment to model. Desire to “stick it to the man” will be with us forever, but it could be more or less intense next year than this year; it could take on new outlets and new fashions, and indeed it has done so (see the ludicrous message-board claims about the GameStop and AMC bubbles as revolts against Wall Street). Maybe people will go back to venting their rage by camping out in Zuccotti Park, beating drums and shouting slogans. Absolutely none of this creates a reason to expect the price of Bitcoin to go up and up and up.

Instead, there are economic pressures that have arisen over the last year that cryptocurrency assets are especially poorly positioned to withstand.

Our correspondent is right that loose monetary policy tends to push asset prices up. Importantly, this applies even to cryptocurrency assets. Why did crypto prices soar during the long period of zero interest rates and crash when the Fed suddenly started hiking? It’s because retail investors poured into crypto as part of the “search for yield” when low rates were holding down the yields on stocks and bonds; then, this year, rates went up a lot, and that reversed the direction of the pressure on prices.

You see the particular problem this poses for crypto, right? When a company’s stock price falls due to rising interest rates, investors can look to financial statements or projections and see that the company’s expected future profits have become more attractive relative to the price. With bonds, they can look to the promised coupon payments, which look increasingly large relative to the purchase price. With crypto, there are no profits to distribute, and all that investors have to look to is an expectation of future price increases; indeed, those price increases must be exponential in order to produce a consistent yield. But this year, all the market can produce is price declines. That means rising rates are a double whammy: They push prices down, and they sow doubt about whether investors should really expect prices to keep going “to the moon.”1 This is why crypto enthusiasts are so fixated on drivers of “fear, uncertainty and doubt” — hype is literally the only thing that holds prices up, and there are no fundamentals to fall back on if market participants stop buying the hype.

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Don’t invest angry

It’s fine to have ideological views, but if you let them drive your investing, you just make yourself into a mark for scammers — the sort of person whose rage about big government leads you to respond to those gold ads on cable news by actually buying physical gold at an egregious markup. You’re better off assuming that market participants are aware of the same public policy deficiencies you’re upset about — if those concerns don’t appear to be capitalizing into prices, the market probably understands the issue better than you do.

Importantly, this applies whether or not your grievance is valid, and whether or not your public policy preferences are just. The markets do not care about those things, and if you invest based on them, you invest wrong.

I’m not sure how many of you actually need these messages. I’m not under the impression that a lot of cryptocurrency enthusiasts are subscribers to this newsletter. Even though I have only written about it intermittently before this month, I definitely don’t have the “vibe” the crypto crowd is looking for. I have boring, stick-in-the-mud views about investing and financial markets; I believe the semi-strong form of the efficient markets hypothesis is, to a first approximation, true; therefore, I am skeptical when professional investment managers claim they can produce alpha, and I’m downright derisive when retail investors say they can do so.

A view like mine is what makes it easy to reject out-of-hand an offer of a financial product that purports to generate a low- or no-risk return of 8%. Because I believe financial markets are basically efficient, I believe that risk and expected rate of return rise in tandem — while alpha is virtually impossible to find, any idiot can goose average returns by loading up on beta, and so when I see promises of high return, I know there’s risk — beta — lurking under the hood.

And even if you already know this, you might do your friends a favor by telling them.

Best,

Josh

1

Of course, the repeated implosion of crypto-related companies, turning people who thought they were holders of Bitcoin and Etherium into unsecured creditors, can’t have been helpful for confidence either.

Very Serious

Investments Are Not Ideological Statements