One Professional Investor's Take On Bitcoin

Authored by Kevin Muir via The Macro Tourist blog,

We all know Dirty Harry’s viewpoint about opinions, but I wonder what Detective Callahan would think about today’s bitcoin mania. It seems like every Tom, Dick and Harry feels obliged to weigh in about the manic action of the their favourite virtual currency, yet I am curious how many of these crack pundits have ever even transacted in bitcoin.

I am by no means an expert, but have at least owned bitcoins, mined them, and even arb’ed them across various exchanges. I use the word “I”, but in reality, it was with the help of my co-worker, the millennial computer engineer whiz kid that sits beside me. This is the story of my great bitcoin bungle, a tale painful to repeat, but should really be put to paper, so I can forever remember, what a knob I am…

But first, a trading yarn as old as the hills.

It comes from a story about a man who joined a friend down at the docks. They were working in a fish market. Their job was to “trade” fish.


All day long the price would change dramatically, the action was fast and furious. Buying and selling, selling, buying, etc. Making and losing large sums of money.


There was a great speculation, and the price of fish rose to levels that did not justify fundamentals. Eventually, the market collapsed, and our new trader found himself long way too many cans of sardines. The man was hungry so he opened one of the fish containers he had been trading and took a bite. “Hey”, he exclaimed, “these fish are rotten!”.


“Those aren’t eating sardines”, his friend explained, “they are TRADING sardines”.

Back to my bitcoin story. I can’t remember the exact date. I think it was early 2012, but that’s not the point. What is important, is that it was well before most anyone on Wall Street had ever heard of bitcoin. My millennial co-worker, who I refer to affectionately as the “kid”, had just discovered an exciting new technology, and was keen to share it with me.

“I was reading this subreddit programmer thread, and there is a new virtual currency called bitcoin that many computer guys are getting real excited about. It’s basically a decentralized currency unit. Transactions occur peer-to-peer, with no bank or government getting in the middle” he told me.


“But who controls it?” I asked.


“That’s the beauty of the technology, no one” the kid responded.


“If no one controls it, how do you know when a transaction occurs? How do you stop from being ripped off?”


“Well, there are a network of computers that are building a distributed transaction ledger, using a system based on cryptography to ensure a consensus is reached,” he explained.


“I don’t get it. So you basically have a ledger in the sky, that is controlled by no one. Yet we are going to use this as currency?” I asked incredulously.


“Yeah,” the kid responded with a big grin on his face, “it’s beautiful. No one controls it, so no one can screw with it. It’s like a libertarian’s wet dream. We should really buy some.”


“What? Are you f’ng kidding me?” I barked back.


“Yeah, maybe just take $10,000 on a punt. Who knows, it probably won’t work, but the technology is incredible. It has the power to change the world…”

At this point, I shook my head in disbelief.

“You want us to take $10,000 and buy… bits in the sky?”


“It’s really ground breaking stuff. It might not work, but if it does…”


“That is the dumbest idea I have heard in ages,” I said as I ended the conversation.

That day the price of bitcoin was around $4. In my opinion, about 390 cents too high. Over the years I have gotten a lot of things wrong in my life, but my bitcoin call takes the cake.

And it’s not like the Market Gods didn’t give me another chance.

A year later, the kid brought it up again.

“Remember that crypto currency I mentioned last year? Well, it’s moved up. Actually, it’s moved up a lot. It’s now at $30 and it’s getting some real buzz. I really think this technology is catching on. We should have a look at it.”

To which I replied, like an idiot, “that’s just a short term bubble. People will wise up and realize they are buying nothing but bits in the cloud, and that fad will be over before you know it.”

Well, I couldn’t have been more wrong…

In the next few months, the price of bitcoin started to accelerate. Before I knew it, it was $80 and no longer just some theoretical nerd experiment, but a currency people were using to transact. Granted, much of it was for clandestine illegal goods or services, but hey, the great alcoholic beverage conglomerates of today started out as bootleggers.

To my credit, at this point, I realized if it was $80, it could be $200, or $2,000. I had seen enough bubbles in my day to know that fundamental value means jackshit.

So I asked the kid to teach me all about bitcoins. I created a wallet. I bought some bitcoins. We transferred them between ourselves. I learned what it was like to actually use this technology.

And I hated it. The transactions took forever to commit to the blockchain. The process was confusing. You needed a computer science degree to actually use bitcoins. It did little to convince me that this was anything more than a fad.

But money is all the same colour, so we pressed on.

We started with some simple mining using an extra computer we had laying around the office. The kid quickly became somewhat of a bitcoin expert, and convinced us to buy these specialized computers from butterfly labs that were much more efficient at mining bitcoins. We spent a bit of bread, ordered a couple of these computers, and plugged them in. I couldn’t bring myself to outright buy bitcoins, but if we could mine a bunch, then I was happy to ride a long position after taking out our cost.

In the meantime, the price of bitcoin was exploding higher. Next thing we knew, the value of our mining was rising so quickly, the computers were paying themselves off in a matter of a couple of weeks. So we ordered more computers, each time worried the price of bitcoin would collapse and make our mining payback period unreasonably long, but the decline didn’t come.

$100, $110, $120, $140, $160, $200… the price of bitcoin kept rising.

Then bitcoin became a little more mainstream. I was introduced to RealVision TV’s Raoul Pal in November of 2013 when I came across a piece written about bitcoin - Valuing BTC Using a Macro Framework. Suddenly, the Wall Street guys were coming for it, and the price started gapping higher.

No longer was it rising by $10 a night, but bitcoin went parabolic and starting skidding 50 or a 100 handles higher in a blink of an eye.

What had started out as a bit of a joke had suddenly turned into a real business. I was scared to death the price wouldn’t hold, but gosh darn it, it was beginning to make us some real money.

And here is where the story gets more interesting. Not content to simply mine bitcoins, we started trading them.

You can mine all the bitcoins you want, but eventually, to lock in your profit, you need to sell them. For people in the financial industry, we take it for granted that when you execute a transaction, you will get your money. Send in the stock certificate to your broker, execute the sale on the exchange, collect your money. Easy peasy.

But government regulation makes sure that process flows smoothly. Brokers are regulated. There are safeguards.

Back then, bitcoin exchanges were like the wild west. It was like depositing money in a freshly opened Montana bank in the early 19th century. Yeah, it might be perfectly legit, but the recourse if one of these banks might fail was limited.

We had noticed that amongst all the exchanges, there were a couple of persistent arbitrage opportunities. Mt. Gox, a Japanese exchange, in particular seemed to consistently bid bitcoins at prices that were above the offers at other exchanges (eventually Mt.Gox would go bankrupt and bitcoin traders would lose almost everything).

In terms of my collaboration with the kid, I didn’t bring much, but this is where my extra years on this earth shone through. Realizing that these exchanges were nothing more than shoe string technology companies in some guy’s parents’ basement, I insisted we tread carefully.

Mt. Gox was obviously out of the question, something was wrong there, it didn’t take a genius to see that. But how would we know which exchanges were legit?

So we went about testing them. We transferred small bitcoin positions, made a trade, then requested the money. We timed how long it took to get our cheque or wire. The longer the delay, the less likely we were to trade with that exchange.

Once we had figured out which exchanges were (somewhat) trustworthy, we went about creating automated programs to arbitrage between the two exchanges. Don’t forget, on stock exchanges, brokers are not allowed to lock the market (offer at the price another exchange is bidding). In bitcoin, there are no rules, so there were not only locked markets, but often straight arbs (where you could buy on one exchange and immediately sell it on another exchange, locking in a profit).

For a few wild months, we mined, arb’d, and speculated on bitcoins. During that period, the price of bitcoin soared from $150 to almost $1,200. We had bought so many computers that office became so hot, we were forced to move them to an cold, Canadian un-heated garage.

When the price spiked, and then sold off, I figured the mania was over. It was like gold at $800 in the late 1970’s. Not only that, but the media attraction to bitcoin had made mining and arbitrage much more difficult. We sold the last of our XBT, and retired our mining computers.

Again, my prediction of the demise of bitcoin was completely off base.

Sure, bitcoin got quiet and drifted lower. Two years later it was $250 again. Yet, then Xi into power with anti-corruption regulatory drive. The Chinese government clamped down on capital flows, and gave bitcoin a second life I never expected.

Since the end of 2015, the price of bitcoin has gone parabolic. Not only has it surpassed the 2013 high, it has exploded to almost $3,000.

A lot has changed since our early days of bitcoin mining and trading. It has become much more professional. It is no longer simply a currency to buy illegal goods on Silk Road, but a real alternative to fiat government currencies.

Yet I feel my experience gives me a better filter in which to judge the recent bitcoin mania. I am not some bitter old man yelling at the kids to get off my lawn. When it comes to bitcoin, I can objectively say I have used it, and understand the pluses and minuses of the new technology.

But make no mistake, I have not changed my view. I am still a big bitcoin bear. And let me walk you through my reasoning.

Let me start with my main complaint.

Although I understand the supply of bitcoins is finite, the supply of virtual currencies is infinite. There is nothing stopping another virtual currency from coming along and supplanting bitcoin as the main currency. In fact, in case you didn’t think I was enough of a mope, the kid actually told me about Ethereum way ahead of the recent price rise. He highlighted the fact that Ethereum could be a better system, and might eclipse bitcoin.

Today it is Ethereum, tomorrow it could be another new virtual currency. The supply of bits in the sky is infinite. I understand the network affect, but do you really want to own something that is reliant on it maintaining popularity?

Even if you are the biggest virtual currency bull in the world, you might get the macro picture correct, but miss the micro decision by picking the incorrect eventual winner. How many technologies have seen the original incumbent eventually go bankrupt, while another company ends up dominating the industry? Is anyone using their Rio MP3 player anymore? Yet they were way ahead of Apple.

And let’s face it, bitcoin’s network is far from robust. As it is currently implemented, it can handle a theoretical maximum of about 7 transactions per second. Seriously? That’s laughably low.

The energy required for these transactions is also staggeringly high. It has been estimated that a single bitcoin transaction takes at least a thousand times more energy than a VISA transaction.

Yeah, I know… VISA is part of the banking system, and bitcoin’s genius is that it lies outside the financial system. Efficiency is not driving bitcoin’s popularity - anonymity and decentralization is.

I understand bitcoin’s attraction. But many of these individuals using bitcoin are doing so through exchanges. These transactions are by no means anonymous. To think governments are not going to get involved in regulating these exchanges is naive.

And I don’t buy the argument that the network makes bitcoin immune to government regulation. At the end of the day, the internet is run by corporations that answer to governments. Sure, bitcoin’s decentralized technology makes it much more difficult. But what if governments outlaw bitcoin exchanges? Or at least heavily regulate them?

Virtual currencies could prove a legitimate threat to government fiat currencies. No doubt about it. Everyone assumes that the virtual currency technology that exists up in the internet cloud makes bitcoin, and their ilk, free from government tinkering. Desperate governments, do desperate things. I would be scared to have any real worth tied in a currency that is such a threat to governments. Especially when that currency is based in a computer internet network that the government ultimately regulates.

Which brings me to gold. Isn’t gold an equal threat to governments? Yes, any alternative currency that might replace government fiat is a threat. But gold hasn’t seemed to capture the public’s imagination. It is difficult to store and transact in. The exact opposite of bitcoin, which has zero storage cost and is easily transferable (at least when compared to gold).

So yes, I understand why bitcoin is exploding higher versus gold. And this next tweet made me laugh because it hit so close to home.

Can’t say that I don’t feel a little tinge of a bitter sting. I have long attempted to find an asset that is impervious to Central Bank bat-shit crazy balance sheet expansion. I was handed the answer with bitcoin, well before most others, and completely whiffed. Not only that, but I have been early with my gold purchases, so I suffer from the double insult of being offside with my gold investment. I might as well get a face tattoo with the word MOPE on my forehead.

But I can’t bring myself to give up on my barbaric yellow rock. Nothing sums up my attitude about the differences between bitcoin’s ledger entry store of value versus gold’s physical presence better than this picture from Roman times:

Not sure, but I think that today even the most ardent virtual currency supporter would take the gold coin over the ledger entry debt.

Over the long run, owning a physical asset that is dependent on no one, is gold’s greatest strength. It has been a store of value for thousands of years, and I don’t think bitcoin or any other virtual currency will replace it.

During the past few years, it has become fashionable to proclaim many different asset classes bubbles. Probably no asset more so than equities.

I have seen bubbles, and they have never been low volatility grinds higher. Nope, they have been exponentially rising, high volatility affairs, filled with emotion and talk of new paradigms. Do stocks or bitcoin fill that bill better?

One of my favourite twitter traders shared this insight the other day.

And lest you think this sort of rise is sustainable, look at these anecdotes.

This is the stuff of bubbles. No doubt about it.

So far, I have been lucky enough to take some money out of bitcoin, but my forecasts have all been completely wrong. I understand if you want to ignore my warnings.

Yet I worry the public is climbing aboard a technology many don’t fully understand, with little regulation and way too much hype. In the coming months, we will hear stories of people being ripped off. I suspect when it is all done, we will look back on this period and shake our heads.

But what do I know? I am the idiot who left over $5.5MM on the table from a simple $10k investment. The only solace I take is that at least I am not the guy who paid for 10,000 bitcoins for two pizzas in 2010. That’s some expensive pizzas…