Housekeeping
Like always, it goes without saying that what I write in these posts is not financial advice. Also the opinions here are solely my own and they don’t represent the views of any company I might be affiliated with at the time of writing.
Value
In my last post, I described George Soros’ view that prices in the market are driven by reflexivity and tend to end up in booms and busts.
I disagree with Soros in that he doesn’t consider an asset’s intrinsic value as important. I do believe that one of the surest ways to succeed in the market is to buy assets that are trading at prices lower than their intrinsic values. Notice I didn’t say anything about P/E or EV/EBITDA ratios. At least for the long-term investor, and it seems to me that being in the market for anything other than the long-term is folly, the short-term price of an asset is only important in relation to its intrinsic value.
Soros is right that markets tend to swing from one extreme of the pendulum to the other, spending little time in the happy average (it’s evident when looking at reality). It’s no secret that price drives sentiment in the stock market. When prices are up most investors are exuberant and can see no wrong, precisely at the time when they should be careful. And when prices drop sharply investors flee through the door, at the exact moment when they should be greedy and put cash to work. These swings are one of the main reasons why the market sometimes offers incredible opportunities for buying great assets at wonderful prices for those investors sharp enough to focus on value and composed enough to control their emotions.
But what is value? Most investors would tell you:
“The value of an asset is the present value of its future cash flows.”
They’re right. It’s absolutely true that if you’re valuing a company/bond/property then the cash flows that you’re entitled to as the owner/lender will be key determinants in the value of the asset alongside other factors such as returns on capital and growth.
But the answer above is definitely incomplete. There are many assets that have intrinsic value that do not pay cash. Some people say these assets don’t have intrinsic values, just prices. I digress. Maybe it’s extremely hard (or even impossible) to estimate their value, but that does not mean that they are value-less.
Let’s look at Bitcoin🤔
Bitcoin
Another disclaimer here. This is not a valuation of Bitcoin. There are some important aspects of Bitcoin that influence its utility that I don’t touch upon. I’m assuming that the technology is sound and that the network will continue functioning as intended, which is of course a big assumption. In my opinion, debates on the value of Bitcoin should be centered on the limitations around blockchain technology and the mechanisms around mining incentives, which is where I can see some good arguments against it.
This is also me arguing for the value of an asset like Bitcoin, not Bitcoin specifically. The specifics of which asset ends up filling this need that I see will depend not only on perception from the public, but mainly on the soundness and scalability of the technology. I don’t mention other crypto projects here because very few try to tackle the problems Bitcoin attempts to solve. I feel like I do have to say that there are some projects I believe also have value (and possibly tons of value), but for different reasons. The vast majority of what you find in crypto tends to be garbage. I therefore find it essential to make distinctions.
“If you… owned all of the bitcoin in the world and you offered it to me for $25, I wouldn’t take it. Because what would I do with it? I’ll have to sell it back to you one way or another. It isn’t going to do anything.” - Warren Buffett
I usually find myself agreeing with what Warren Buffett says. But it’s refreshing to disagree from time to time. Reminds me that I should never blindly follow anyone, no matter how smart and successful they may be. I constantly remind myself of the importance of being my own person, something many so-called value investors (read: Buffett/Munger cultists) seem to have forgotten.
Anyway, there are 3 main traits that I think give an asset like Bitcoin at least some value:
Bitcoin is self-custodial. When you deposit your money in a bank, you’re buying a product from the bank. You do not really have full control of your money. It becomes the bank’s liability, i.e., it owes the money back to you, and in the meanwhile they use it to make loans and other risky activities. There’s a fantastic primer on deposits and how they work by Patrick McKenzie here.
You’re money is at risk of disappearing if the bank goes under. You’re money is at risk if the bank gets hacked. You’re money is at risk if the bank gets sanctioned as a result of 3rd party actions and loses its license to operate in your country (more on this below).
Heck, even if you’re a sovereign nation, the definition of what constitutes your money is not clear anymore. Case in point: Russia’s FX reserves in the US, EU and Japan were completely gone overnight as a result of sanctions. They were these countries’ liabilities as much as they were Russian assets. I can’t stress the value of self-custody enough.
By the way, this is an advantage of Bitcoin you forego when you hold your coins with exchanges or companies like Celsius, BlockFi, Voyager, etc., which have been proven to be nothing more than banks taking undue risk with customers’ funds:
Bitcoin is decentralized. No single entity controls the Bitcoin protocol. No entity controls its inflation rate, its issuance mechanism, its rewards, or its record of transactions. No centralized party can make decisions that harm users of the network or change transactions to steal user funds. The incentives of the network are structured in such a way that security is maintained and transactions recorded in a clear and transparent manner.
In other words, no one can screw you by abusing their position. There is no central authority that will confiscate your funds or arbitrarily devalue your purchasing power.
Bitcoin is digital. Transferring it and transacting in it is frictionless. Stashing cash under your mattress is possible, but inconvenient, especially if you need to move all of it during an emergency, such as a war.
Don’t even get me started on gold. Try carrying gold bars across a border and let me know how it goes. Also, the only reason gold has value is because we as a society agree, for whatever reason, that it’s worth something. Curious, isn’t it?
Those who refuse to learn from history… yadda, yadda, yadda
Many events in history illustrate how an asset with the 3 traits above can be valuable, at least for some people. It’s not any of these traits individually that are valuable, but rather the combination.
Many of Bitcoin’s harshest critics come from developed regions, such as UCAN, Australia, and Europe, who of course live on a different realm than the majority of the global population.
The very “Western” point of view that Bitcoin offers minimal improvement on the existing banking system and fiat currency system tends to focus on the speed and costs of transactions. But this ignores the fact that Bitcoin has never prioritized these variables. Especially not so when weighed against self-custody, decentralization and transparency.
Why would this be necessary? After all, governments would never abuse their power and act in detriment of their own citizens, right? Right? Well…
Don’t cry for me Argentina🇦🇷
During the 2001 economic crisis (at this point the Argentinian peso was pegged 1-to-1 with the US dollar):
“As more people began worrying about the sustainability of the peso, they put more of their wealth into dollar accounts at banks. After all, if the government ripped up the law and devalued the peso, they would be safe with dollar accounts right? They were right to be worried about the peso. But they were too optimistic about their dollars.
On December 1, 2001, the government froze all bank accounts, initially for ninety days. Only a small amount of cash was allowed for withdrawal on a weekly basis. First it was 250 pesos, still worth $250, then 300 pesos. But this was allowed to be withdrawn only from peso accounts. Nobody was allowed to withdraw money from their dollar accounts, unless they agreed to convert the dollars into pesos. Nobody wanted to do so. In January, the devaluation was finally enacted, and instead of there being one peso for one dollar, there were soon four pesos for one dollar. This should have been a vindication of those who thought that they should put their savings in dollars. But it wasn’t, because the government then forcibly converted all the dollar bank accounts into pesos, but at the old one-for-one exchange rate. Someone who had $1,000 saved suddenly found himself with only $250. The government had expropriated three quarters of people’s savings.”
- Robinson & Acemoglu, Why Nations Fail (emphasis mine).
If you think this type of events have been exclusive to Argentina, I have some emerging market bonds to sell you.
“Oh, but this only happens in emerging markets.” Well…
Sberbank🏦
Sberbank is Russia’s largest bank by assets👆🏼
They also had operations in 9 European countries under their Sberbank Europe Group AG subsidiary. That is until Russia’s invasion of Ukraine, after which thousands of customers began withdrawing their funds, endangering the company’s financial position. Authorities ordered the closure of the subsidiary, based in Austria, and in the end, due to sanctions, Sberbank ended up losing its licenses to operate in Czech Republic.
The Czech company, wholly-owned by the Austrian subsidiary, is currently undergoing insolvency procedures. Hopefully, the liquidation of the assets allows for repayment to all depositors, but it remains to be seen whether it will be possible.
Bank deposits in the Czech Republic are insured, up to 100,000 euros (200,000 in some cases). You had more than that? Tough luck buddy. Maybe the liquidation can make depositors whole, but if you had your life savings there, how do you go about your day-to-day until that moment comes?
The worst part? Sberbank had a good financial position, and was generally responsible in managing its operations. This was an external event outside of their control.
“Oh, but this could never happen in the US.” Well…
Executive Order 6102💸 (no, not the Star Wars one)
The executive order, signed on April 5, 1933, by US President Franklin D. Roosevelt forbid the “hoarding of gold coin, gold bullion, and gold certificates within the continental United States.”
Citizens of the US that held physical gold were forced to deliver their gold to the Federal Reserve in exchange for $20.67 per troy ounce. They were allowed to keep/hold up to $100 worth of gold. Violating the order was punishable by a fine of $10,000, up to 10 years in prison, or both. Yes, seriously.
The US government decided overnight that their citizens property was no longer theirs. The rationale was to allow the Federal Reserve to control the monetary supply in order to be able to stimulate the economy since at that time the US dollar was still on the gold standard (i.e., redeemable for a certain quantity of gold).
Now, I know what you’re thinking.
“They had a good reason”.
“It was for the greater good of the economy.”
“People still received dollars for their gold.”
Etcetera, etcetera, etcetera.
This doesn’t change the fundamental fact that the government decided overnight that their citizens’ property was no longer theirs to keep. Mind you, gold is often touted as an asset that people can use to escape monetary devaluations and as insurance against catastrophes.
Similar laws were issued at various points in time in Poland, Australia, and the UK, to name a few examples. These laws have been repealed, but do you really think the probability of similar laws in the future is 0%? Perhaps I’m too paranoid, but we did just live through two years during which governments forcibly locked down their populations.
I’d like to point out that events like the above have occurred on numerous occasions, during this century and previous ones, in developed markets and emerging markets, and for a myriad of reasons. The fact that issues such as the above can occur does not mean that Bitcoin is the solution. Maybe Bitcoin does not solve this. But given its traits, I’d be inclined to consider it useful during such events. In that case, it would be hard to argue that it has no value.
Thanks for reading! See you next time.