Sound Money

Bitcoin’s detractors often refer to it as a speculative asset. This is partially true - an investment in bitcoin involves a speculation on an inherently uncertain future. But the connotation implied by ‘speculation’ is often unhelpful because it associates bitcoin with fly-by-nights who are merely trying to make a quick buck. In this article I re-frame speculation because it serves a purpose, all investors are speculators and central banks are forcing us to speculate on an increasingly uncertain future. We must obviously push back against the nonsense that bitcoin is a money-making scam, but we need to embrace speculation into bitcoin’s incredibly positive potential.

Speculation could mean different things to different people, but the definition tends to involve investments with higher risk, more volatility, shorter-term horizon and, at the extreme, an incomplete investment thesis. A technical analysis trader who is merely making bets based on charts on a screen with very short time horizons is probably the typical example of a speculator.

5 reasons to embrace speculation:

1) Speculators serve a purpose

Speculators provide liquidity, which improves efficiency and enhances price discovery. Without speculators, price changes could be very sharp and sudden. Real money participants could also struggle to execute their trade/investment/position timeously without speculators who are usually willing to provide a market price. Even if you don’t want to be a technical trader yourself, I don’t think you need to undermine the service these actors provide.

One could make a similar moralistic argument against bar tenders, for example. Should we dislike them because they’re aiding and abetting alcoholics to get their daily antidepressant? I didn’t think so.

2) We’re all speculators

Any human action involves a speculation on an uncertain future so there’s a speculative element to every day we’re on this earth. Investments are particularly uncertain and they all incorporate a speculative element. Certain types of investing, like value investing, try to mitigate speculation by buying cheap assets with elevated yields but even value investors must make some degree of speculation on an uncertain future. For example, value investors still need to determine if a cheap company will remain in business over the next 5 years.

To diminish one persons speculation without recognising the speculative element in our life is hypocritical and a poor excuse to dismiss bitcoin.

3) Unsound Money Forces Speculation

The financial market conditions created by central banks and fiscal authorities encourage more speculation than otherwise. Low interest rates and large amounts of debt make traditional investments overvalued, which reduces the role of the value style in investments. This is clearly visible in the underperformance between value and growth in the last 10/20 years. Investors have not been rewarded for reducing speculation and purchasing cheaper assets; they’ve been rewarded for increasing speculation and purchasing expensive assets in the hope that they might become more expensive in the future.

Look at the market capitalisation of Tesla vs. the rest of the vehicle market - it’s completely disproportionate. Tesla investors are speculating based on the future potential of electric cars and Tesla’s technology. So far their speculation has been correct because the share price continues to go higher. But this degree of speculation wouldn’t be possible if monetary policy were normalised.

I’m not critiquing Tesla here. I’m using Tesla as an example of the speculative world that we find ourselves. This doesn’t imply that we need to all speculate on the most expensive technology stocks. This thinking provides a lens to contextualize the bizarre conditions and the mindset required to navigate it. Everything you do is somewhat of a speculation and you’re being forced to speculate more by authorities, so where are you placing your bets? Hiding out and waiting for the uncertainty to clear is not going to cut it.

4) Systemic risks are difficult to hedge

Unsound monetary and fiscal policies are so extreme that they’ve had a pernicious impact on economic growth, inequality, trust, social stability and corruption (I write about these challenges in my monthly newsletter, here’s the latest edition). These challenges are systemic and difficult to hedge against.

In the past you could mitigate against socioeconomic challenges in one country by investing in less challenged countries. Or, you could mitigate against overvaluation in one asset class by investing in a cheaper asset class. The global nature of our unsound monetary and fiscal policies implies that it’s much more difficult find a suitable hedge. Most countries and asset classes are facing similar challenges.

Governments have caused the problems through overuse of their policies, so they aren’t going to solve them. The ‘government solution’ is to double-down on unsound monetary and fiscal policies, not repeal them. Hence, the systemic risks mount. Systemic unsoundness elevates the risk of socioeconomic regime change in the next 10 to 20 years because eventually some people might say “this system isn’t working for me!” I’m not an anarchist, I’m just stating the facts. Look around – more and more people are frustrated in 2020.

Talking about regime change is inherently uncertain, unquantifiable and speculative but ignorance thereof could be catastrophic. Bitcoin functions as an alternative form of money and it could have a role to play in future monetary regimes, so it serves as a rare hedge against our current monetary system. Uncertain yes, but enormous potential, and a hedge worth speculating on.

5) Speculation vs. high-probability outcome

One doesn’t need to believe in an economic/political regime change to see value in bitcoin. Bitcoin is a functioning digital, decentralised store of value. It has stored wealth for users under the current regime. 3-year rolling returns are almost always positive so anyone who has held for longer than 3 years has stored value in US dollars.

From this perspective, one could argue that bitcoin isn’t very speculative at all.

In section (4) I was just articulating the speculative mindset required to think through the future. And if one expects economic policy to continue along its current trajectory and bitcoin functions in the way that it has for the past 11 years, this speculation on the future may turn into a high-probability outcome. 

Those who focus on bitcoin as a mere speculation, don’t understand the value proposition and are scared of the volatility. Obviously, we need to educate on these topics, but I also think it’s important to embrace speculation. Speculation serves a purpose and all human actions are inherently a speculation on an uncertain future. Most of us would like to reduce the speculative uncertainty from our lives. But unsound monetary policies exacerbate this challenge by removing the pricing mechanism and inflating asset valuations across the globe, which creates systemic uncertainty. Bitcoin is rare opportunity to invest in an anti-fragile technology which specifically responds to unsound monetary policies. In that sense it’s a high probability bet within a speculative world.