My thoughts on Crypto

Cryptocurrencies have been going crazy this week, particularly the altcoins lead by quick triples in DOGE and XRP. I do wish I held onto the bit that I sold off a week and a half ago as they all jumped, some by 50%. Of course if I did hold I’d just be selling them now. I realize that this is the manic phase where Bitcoin is supposed to jump past $100k in a month or two while the altcoins gain multiples, but I just don’t feel comfortable with them.

Turkey became the next country to restrict Crypto – banning purchases in it but not ownership of it. I don’t see this as a surprise because all countries have traditionally required use of their own currencies in transactions, the exception being those with high numbers of foreign tourists who encourage them to spend by accepting dollars and/or euros. In the US this has been the case the whole time, as any payments in Crypto are considered taxable events recorded as selling crypto for dollars when the payment is made.

A few things still puzzle me about Crypto in general.

  1. What is the use case going to be? Speculation doesn’t count here, as that can apply to anything. Here are my thoughts…
    1. Money transfers. Banks may charge you significant fees to transfer money outside the country, and will take days to process any transactions at all. Transfers from a Crypto wallet are very quick with low fees. Question: How will banks react? Will they ultimately offer solutions that lower their fees and increase their processing speeds? When they do, why would they use cryptocurrencies at all rather than an internal electronic system in their own currencies?
    2. Currency hedging / store of value for emerging markets. People living in countries which periodically face significant currency devaluations – Argentina, India, Turkey and many others – have traditionally held more gold and silver to help shield their savings. Cryptocurrencies are much quicker and easier to use for this purpose and have lower transaction fees. Will more countries ban their use because of this? India has periodically banned gold imports as a way to stop flight from their currency, so banning the use of any and all crypto products shouldn’t be a surprise.
    3. Smart contracts for insurance products. As an example, instead of paying premiums for hurricane insurance followed by a huge process involving insurance adjustors you pay premiums to a crypto-based insurance product which essentially says you get a payout (5-10x your money back?) if there is a hurricane of pre-defined category strength that hits landfall within a pre-defined distance from your house within a 1 year period. There is an array of products that are under development and getting licensed (many based on Etherium), but we haven’t quite seen them advertising yet. How big can this get? How will our insurance companies react? How will the government react to their powerful lobbying efforts? Will this take off in emerging markets first, where they don’t have these entrenched interests?
    4. Smart contracts for financial products. An array of things have been discussed, from young athletes selling portions of future potential major league sports contracts, to small businesses selling a percentage of revenues over a fixed period, to college students selling a percentage of future paychecks over a fixed period. Mostly the idea is competing with traditional products like credit cards or lines of credit by creating an equity-like structure where a failure or setback doesn’t result in bankruptcy but the payback would be significant if it all works out. I think this idea is in its infancy, but with the prior advent of “crowdfunding” sites I could see it getting somewhere.
  2. Can Bitcoin really keep going up forever?
    1. Bitcoin is a deflationary asset – both because the total supply is fixed as new users are added, and because keys can be lost over time which locks up those coins forever.
    2. Large central banks will never own Bitcoin for two reasons – one is that it is subject to strategic attacks from the basic banning of transactions in it to a coordinated hash attack on the “proof-of-work” system. Two is that large countries have much more to gain from keeping their own currencies dominant.
    3. Small central banks and/or large hedge funds have significant reasons to get into bitcoin. They are big enough to move the price significantly, so they can easily do an accumulate-then-peg campaign where they try to build up bitcoin from a rise of say $50k to $200k and then let it float but purchase whenever it drops below their $200k peg. These entities gain much more from the borrowing capacity they get by holding an asset with high value than they get from selling it to realize the gains.
      1. How would this affect transaction volume? If strong entities like this take up most of the bitcoin, will you get to a point where most of the transaction volume simply dies off? If that happens, couldn’t bitcoin be displaced altogether by a cryptocurrency with a more vibrant transaction base like Etherium, Polkadot, Cardano, Binance, etc?
      2. Another way of looking at this – if bitcoin became too concentrated, would people lose faith in it as a store of value? If all retail holders were reduced to tiny fractions of bitcoin, wouldn’t the risk/reward seem to fall apart or move in favor of other assets?
  3. Why do smart contracts need to push up the value of crypto coins at all?
    1. The simple answer is that they don’t. You can already hedge emerging market currency with “stablecoins” that track dollars or euros, and any transactions for insurance and/or lending products would ultimately be settled in the local currency as nothing else would make sense.
    2. It follows that the main point of fluctuating cryptocurrencies is to attract interest through speculation. However, if this speculation is not tied to any direct use (like oil futures) or value (like company earnings), then it can potentially fizzle out just like any former collectables craze.

I’m not sure what else to say about Crypto except that I have always struggled to believe in it, warily eyeing the huge price increases that could easily reverse sometime. This seems funny on the surface because I am still a big believer in gold and silver. The reasons there are partly history – these metals have been the common currencies of the advanced world for millenia, they initially provided the backing for the modern fiat currency regimes, and they are still valued as central bank reserves assets (though gold much more than silver). The world is dividing and any country wanting to or needing to de-dollarize has been primarily turning to gold as the alternative reserve asset. If Russia is worried about their assets in US dollars, they won’t feel more comfortable relying on Euros, Pounds, and Yen instead. I don’t think we will go back to a gold-based system, but I do think that countries will look to diversify their holdings and to de-dollarize more of their international trade.

Here’s where my holdings ended up:

  • DOWNSIDE BETS (38.9%)
    • 31.4% TLT Calls
    • 4.6% IWM Puts
    • 1.9% EEM Puts
    • 1.0% Short dated puts
  • GOLD (22.8%)
    • 6.9% FNV, WPM, GOLD & NEM Calls (Large gold miners)
    • 8.4% EQX (Small gold miner)
    • 7.6% SAND Calls (Small gold streamer)
  • SILVER (19.9%)
    • 10.7% AG (Small silver miner)
    • 0.8% AG Calls
    • 5.3% SILV (Small silver miner/explorer)
    • 1.2% MTA (Small silver miner/explorer)
    • 0.8% RSNVF (Really small silver miner/explorer)
    • 1.1% SILVRF (Really small silver miner/explorer)
  • COMMODITIES (14.5%)
    • 9.5% CCJ shares
    • 2.0% ALB (Lithium)
    • 1.5% NMGRF (Graphite)
    • 1.5% NOVRF (Nickel/Copper)
  • CANNIBUS (5.7%)
    • 5.7% split between CRLBF, GTBIF & TSSRF (companies with significant US footprints)
  • CASH (-1.8%)

I picked up some short-dated puts in SPY and calls in SQQQ, thinking that the market may have reached a short-term top. One of the chartists I follow is calling for an end-of-month pullback that will likely turn to new highs in May and then a much more substantial drop to follow. Short dated well-timed puts along technical points on the charts seems like relatively good downside protection as long as I keep the bets small. My long dated puts have been bleeding quite a bit of value over time, as have my long dated TLT calls.

I really think my precious metals holdings are ready to break out. Sentiment had bottomed in the space, and gold is hitting 1770 resistance with the stochastic still low and rising – a ways to go before it is overbought. Long consolidations are like coiled springs building for a big move. I currently don’t have covered calls sold on anything – my last batch of CCJ covered calls expired worthless on Friday – so I am poised for a big up move in those assets.

The main danger of course is still the potential liquidity squeeze as margins are reduced, margin calls are triggered, forced selling hits reducing values, more margin calls and stop losses are triggered, and even more forced selling occurs. In a case like this, forced sellers tend to sell whatever has held its value best which would hammer gold and silver but create great buying opportunities. This will happen at some point – parabolic debt-driven asset price increases tend to end that way. Some prefer to hold more cash ready, but I have opted to try different “downside bets” for this instead.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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