I recently had a discussion with Taotao He (Director of Alternative Assets) and Jorge Go (Advisor) at Marto Capital, about the recent volatility and future impact of the crypto market. Despite this year’s bloodbath in the crypto-asset space, the industry will likely still generate considerable investor surplus in the long-run. In fact, an investment in a basket of the top crypto-assets (largely Bitcoin) has the best chance to deliver the most attractive risk-adjusted returns over the next 10-years, compared to less controversial favorites such as Amazon stock, 10-year U.S. Treasuries, an apartment in Manhattan, or other “consensus longs”. While the bull thesis for crypto-assets is far more nuanced than can be covered in a short article, in our discussion, we outlined four of the most salient themes below.
Bitcoin as a Macroeconomic Hedge and “Holy Grail” Portfolio Asset
Bitcoin is a rare, unlevered asset in a levered world. Global debt has reached $250 trillion ($70 trillion higher than in 2008); the U.S. runs a trillion-dollar deficit, pension funds are underfunded amidst retiring populations, and student debt has snowballed to $1.5+ trillion in the U.S. (with 9/10 borrowers struggling to make payments). All of this puts pressure on central banks to print excessively into the foreseeable future, diluting the value of fiat currency. Smart money (and increasingly, just more money), will flock to unlevered assets that have limited supply – gold, bitcoin, or other alternative assets that aren’t part of the mainstream investment world. Traditional assets such as equities, government / corporate bonds and real estate are all highly levered.
Further, from a portfolio theory perspective, bitcoin is an asset that is non-correlated (volatile yes, but volatility that is unrelated to fiat investments) and therefore a true method of diversification that boosts the overall portfolio’s risk-reward (e.g. Sharpe, Sortino), and with plenty of upside that is premised on secular and defensible trends.
Blockchain is Built on the Premise of Social Scalability
The story of humans is a story of networks - where throughout thousands of years of history, we’ve organized ourselves into networks which we use to get things done. Cooperation across boundaries has produced nations, businesses and other crucial institutions. But cooperation requires a protocol that sets the rules of cooperation, and that traditionally requires some gatekeeping entity to be in charge - because someone always cheats. That entity historically would be a king, an elite, a corporation, or a crowd. The problem is, if you put a king in charge, you pave the way for a tyrant; if you put an elite in charge, you create an unfair aristocracy; and if you put a corporation in charge, you get a rent-seeking monopoly. If you put a central bank in charge, it will manage money supply to optimize the health of its own currency and balance sheet, not to the benefit of the individual saver or investor. A misaligned central bank may be incentivized to protect itself by devaluing your savings.
At the same time, we have open protocols in which participants of a network can inter-operate permissionlessly without a gatekeeper. The English language is an open protocol because it’s not owned by anybody (e.g. we don't need the government's approval to converse in English, or add a new word to the language). Parts of today’s internet are open protocols as well. Blockchains will allow open protocols in almost everything, where anyone can participate in all sorts of networks where no single entity is in charge. But unlike a pure democracy, these networks are not entirely flat - they are meritocracies. In the Bitcoin network, the more security you provide, the more bitcoin you’re paid, and the more say you have in the network's governance. In the Ethereum network, you get paid in ether to verify computations. Blockchain-enabled systems are merit-based, peer-to-peer marketplaces that allow humans to continue to form valuable, efficient networks without relying on legacy gatekeepers.
Blockchain Technology Enables Financial Inclusion without Rent-Seeking Intermediaries
As a corollary to the last point, the technology now exists to have a financial network separate from the control of kings and central banks. Beyond this, crypto-assets also democratizes access to capital for financially neglected pockets of the world outside the Wall Street elite.
Without going into the technicals, blockchain technology combines software engineering, economics, behavioral psychology, and other fields to create an open, permisionless and distributed ledger that anyone in the world can access and audit from anywhere. The four main benefits of blockchain include i) judgment/censorship resistance, ii) decentralization/broad points of failure, ii) immutability, and iv) perhaps most important, trustlessness. The most game-changing aspect of crypto-assets is that it allows for the automated programming of incentives; and if you can program incentives, you can start programming human behavior — and ultimately remove the need for a trusted third party (“TTP”).
Take Bitcoin for instance. It is faster / cheaper to send, inherently deflationary, easier to store / divide and is a true non-correlated hedge. Unlike gold or the US dollar, it works on weekends, 24/7/365. It is judgment and censorship resistant — subject to no capital controls, bank restrictions, or asset freezes. It is trustless in that a TTP is not necessary to handle your assets, and in the sense that you do not have to trust a government to preserve value on your behalf (e.g. The Fed pumping trillions of dollars in the last recession to devalue the dollar, India decommissioning certain bills arbitrarily wiping out value, Venezuela’s hyperinflation).
Crypto-assets’ Large Addressable Market Results In an Investment with Asymmetric Upside
Blockchain’s total addressable market (TAM) includes all the disruptable markets dominated by TTPs, from insurance to gambling / prediction markets, to virtual real estate. We think that could be at least a third of global GDP ($80 trillion), plus a non-trivial amount of Global Wealth ($300 trillion).
If you buy the premise that BTC is better than gold (based on this article and related links above), perhaps the TAM in an ultimate bull case is global wealth, or around $400 trillion in 10 years. Imprecisely, if BTC takes just 2% of this TAM, it would have an $8 trillion cap, vs. the ~$150 billion it is now. If you have something that can potentially 50x, you must have 98% conviction that it’s not going to happen for you to not put money in.
Oftentimes, people look at investing in crypto-assets as this binary concept — do I invest given the asymmetric upside, or do I not invest because it’s vaporware that could go to zero? This is a false dilemma. The reconciler is simply a matter of sizing. One must ask themselves, is it worth putting a dollar into the space? The answer is undoubtedly “yes.” How about two dollars, three, four — and you go from there. We believe every well-balanced portfolio includes a crypto-asset allocation — and the only question is one of sizing.
