Hey there!
I hope everyone had a great month of May and was able to enjoy the Memorial Day weekend! The past month has been pretty wild in the equity and crypto markets. After a monstrous run up in cryptocurrency plays, we experienced a steep sell off around the second week of the month. Leading up to the sell off, retail investors began piling into speculative cryptocurrency names like Dogecoin and thousands of other under-regulated projects in a FOMO-like state, placing big bets on tokens named after animals and food, often with no real use case or legitimacy. The gains in some of the “projects” were massive no doubt, but during a peak euphoria Elon Musk filled Saturday Night Live appearance, these gains began to unwind and come crashing dramatically back down to Earth. Many retail and traders new to the cryptocurrency space have been left burned and shocked. This newsletter will put some of that chaos into perspective and offer some insights as to what you can do to build strong positions capable of returning long term gains.
First though, these newsletters are meant to be informational and educational only. They are not financial advice, and I am not a financial advisor. Always do your own research before investing any of your hard-earned money into something!
Monthly Highlights
· Bitcoin Crashes Amid Various Narratives & Concerns
· Building Strong Positions for Maximum Returns
Index Year to Date Gains Through End of May
· S&P 500 +11.95%
· Nasdaq +6.5%
· Dow Jones +12.7%
· Russel 2000 +14.85%
· Bitcoin +26.25%
· Ethereum +237%
Bitcoin Crashes Amid Various Narratives & Concerns
If you want to hold the best performing asset over the past decade, you need to be able to handle to volatility. And if you want to trade or own various other cryptocurrencies, you need to pay attention to what Bitcoin is doing. Bitcoin is synonymous with volatility and has experienced it massively in the 13 years it has existed. However, not everyone has been involved in Bitcoin since its inception and most people have just begun to invest in the digital asset within the past couple of years or even months, and that’s OK. It’s still early! However, as an investor you should understand the volatility involved and the risks which surround Bitcoin. As a new asset, many narratives, criticisms, and risks will arise in which volatility will increase.
With a focus on the long-term and macroeconomic fundamentals for Bitcoin, investors must filter out the noise and FUD (fear, uncertainty & disinformation) and remain laser focused on the big picture. Let me fill you in on some of the top news stories this month and provide some clarity on the FUD and why we have sold off dramatically.
Concern #1 China Will Ban Bitcoin
This is not a new narrative. China has taken several steps to limit cryptocurrency trading in the country over the years. For instance, they banned ICO’s (initial coin offerings) in 2017, which prompted most exchanges to shut down in the country. There have also been restrictions placed on payment channels, making it more difficult for citizens to exchange crypto for the native yuan.
More recently, Inner Mongolia, a northern region of China, indicated it intends to ban cryptocurrency mining. Forward thinking would lead you to believe other regions in the country will follow suit. This has scared some investors because China is the undisputed world leader in Bitcoin mining. Chinese mining pools control more than 60% of the Bitcoin network’s collective hash rate over their five autonomous regions, due to the countries cheap electricity.
Not only that, but China manufactures most of the world’s mining equipment.
The perceived fear is that a large portion of the network will go offline in a short span of time, lowering the network’s security. This is FUD.
In reality, China was once responsible for over 73% of all Bitcoin mining. Now it struggles to reach 65%. The obvious reduction in mining centralization seems unlikely to stop any time soon, and that’s not a bad thing.
The way bitcoin mining actually works is that the network adjusts the difficulty of hash complexity for block creation to accommodate for overall network hashing power and maintain a new block creation roughly every ten minutes. The difficulty adjustments occur roughly once every two weeks.
If a large portion of the network were to go offline, the network would adjust itself downward accordingly to maintain the pace of ten-minute block creation. A downward adjustment actually makes it easier for miners to obtain bitcoin.
The bitcoin network is the strongest computing network in the world. Even with a large portion of the network offline, the ability to hack or compromise the network is essentially non-existent. In fact, just last month a large percentage of the network (roughly 30%) went offline briefly in China due to power outages. Even with a 30% drop-in network hash rate, which has since recovered by the way but has come back down some, the network was still more secure than it was just a year ago.
A periodic downward adjustment is a non-issue. Long term the network computing power continues to grow as more and more miners world-wide come online. With that, difficulty adjustments will continue to adjust upward over time making it increasingly harder to mine bitcoin and further securing the network. Don’t forget there is also a block reward halving every four years, essentially making it twice as difficult to obtain the same amount without difficulty adjustments even considered.
With such a large percentage of the networks processing power coming out of one country, China banning bitcoin mining actually helps the global network decentralization effort. Given the profitability of mining, it is no surprise that miners from China have already begun to shift their business to places outside the country, including Kazakhstan, Canada, and the US, where electricity is also cheap and the policies towards crypto are more friendly. Growth is also supported with data showing the hash rate recovering quickly from last month’s 30% outage. Bitcoin is a global network and the more spread out the computer processing power becomes, the more unstoppable the network becomes.
Further motivation for Beijing to curb crypto comes from its need to reduce emissions. Coal remains at the heart of China’s economy and almost 60% of the country’s total energy consumption comes from coal which helps explain why China accounts for 28% of all global CO2 emissions. Additionally, China continues to build coal-fired power plants at a rate that outpaces the rest of the world combined.
Even with a large percentage of hashing power located in China, the energy consumption in comparison to the rest of China’s overall consumption is miniscule. This is further supported with data supporting roughly 65% of Chinese hashing power coming from hydroelectric sources in the regions.
Reducing energy consumption from coal is a good thing for the environment and if cracking down on bitcoin mining in coal rich regions of China is to happen, it only helps to promote a greener bitcoin production and further decentralization.
Bitcoin Cannot Be Banned.
Regardless of what China does or implements, the bitcoin network is not a light switch you can turn on and off. It is impossible to actually ban Bitcoin on a full scale. Countries world-wide, notably communist, and authoritarian regimes have already implemented so-called bans without success. Data supports that the usage and premiums paid for BTC in these nations only went up after the outlaw.
Enforcing any bans will prove to be extremely difficult. Unless the governments can exert strict control over the internet, individuals could download the Bitcoin wallet software, run a node, and complete transactions freely and globally.
There is also a reason that BTC trades at a high premium in countries that have already proposed restrictions such as ~50% in Nigeria and ~200% in Iran. People will continue to pay up for the ability to trade and acquire sound money free from government intervention or devaluation. However further regulations and taxes by governments are never off the table. This is a catch-22 in my opinion because the more regulated and taxed BTC becomes, the more accepted and intertwined it becomes in society.
Concern #2 Bitcoin is Bad for the Environment
So, this narrative really came to light when Elon Musk and Tesla revealed they would no longer be accepting Bitcoin as payment until mining became more environmentally friendly. These comments really spurred market activity and debate. The reason that bitcoin mining has been discussed so much in research and the media is because its energy consumption is significant.
In 2020, electricity consumption of bitcoin mining was estimated between 0.1% and 0.3% of the global electricity use. With updated numbers it could be closer to 0.69% or roughly equivalent to the annual energy draw of small countries like Malaysia or Sweden. This certainly sounds like a lot of energy. But how much energy should a monetary system consume?
If you believe that Bitcoin offers no utility or is simply a device for money laundering, then it would only be logical to conclude that consuming any amount of energy is wasteful. This is a closed-minded and uneducated viewpoint.
A more informed viewpoint suggests that Bitcoin is offering tens of millions of users worldwide an escape from monetary and government repression, inflation, capital controls and short-term political agendas. Whether you feel Bitcoin has a valid claim on society’s resources really boils down to how much value you think Bitcoin creates for society.
However, there’s an important distinction between how much energy a system consumes and how much carbon it emits. While determining energy consumption is relatively straightforward, you cannot extrapolate the associated carbon emissions without knowing the precise energy mix (the makeup of different energy sources used). For example, one unit of hydro energy will have much less environmental impact than the same unit of coal-powered energy.
Given the intensive energy requirements, miners are incentivized to deploy the cheapest electricity sources to power their farms. The cheaper the electricity, the more profitable the business will be.
The cheapest electricity is known to come from renewable resources like hydro and solar power. Another promising avenue for carbon neutral mining is flared natural gas. The legacy process of extracting oil from the ground currently releases significant amounts of natural gas as a byproduct. This is energy that pollutes the environment without ever making it to the grid. Since it’s constrained to the location of remote oil mines, most traditional applications have historically been unable to effectively capture and leverage that energy. However, Bitcoin miners from North Dakota to Siberia have seized the opportunity to monetize this otherwise-wasted resource through the deployment of mining farms in oil and gas fields. Not only does this reduce waste gas emissions to the environment, but it instantly makes each oil/gas producer much more profitable as are able to convert free/wasted energy into mined bitcoin.
Based on the latest research, it is estimated nearly 40% of all global bitcoin mining is powered using renewable resources. That’s almost twice as much as the U.S. grid is utilizing, suggesting that looking at energy consumption alone is hardly a reliable method for determining Bitcoin’s carbon emissions.
The legacy banking system alone is more energy intensive than bitcoin if you add up the energy cost of banking branches, vaults, New York City skyscrapers, security trucks, etc. Furthermore, gold mining uses a similar amount of electricity but creates far more waste than bitcoin. Similar can also be said of lithium mining which is a critical ingredient in electric vehicle batteries. Wait I thought EV’s were green? Not so fast…
Again, it ties back to the value society is placing on the energy that is being consumed. The fact that Christmas lights in America are consuming a similar amount of energy yet are not frowned upon is telling enough.
Concern #3 Government Digital Currencies Will Replace Bitcoin
There is no doubt that government digital currencies are coming. The People’s Bank of China has been developing the digital yuan, a so-called central bank digital currency that aims to replace some of the cash in circulation. In fact, China has already started real world trials of the currency in numerous cities. We have also heard the US Federal Reserve speak on their version of these several times more recently, although the US is progressing with a much slower roll out and is in no rush.
The world is already a pretty cashless place. The issuance of these digital currencies will help speed up that process efficiently. These will most likely be issued on a blockchain based platform in my opinion, however it is not known for sure exactly how they would be issued at a nation-wide scale. Regardless of blockchain technology issuance or some other format, these digital currencies do not instantly become a Bitcoin replacement.
The value of the Bitcoin network is its strength and security through its decentralized processing power along with its fixed supply. That means that it is not controlled by any central bank or country, unlike the issuance of the digital government currencies. The value proposition for Bitcoin as a gold-like store of wealth and hedge against inflation, government manipulation, etc. remains intact despite digital dollars.
In reality the issuance of these digital dollars will allow the government to closely monitor every and all transaction you participate in.
So, with all of these recent narratives debunked, why is Bitcoin still down so much?
Well for starters, there is still a lot of uncertainty in the market and the price will take some time to stabilize. After running up from $20k at the end of 2020 to nearly $65k in four months many are fearing the bull market run is over. I personally do not believe so.
The seemingly coordinated FUD narratives coming across the news wire throughout the month snowballed an already speculative market environment into capitulation selling just to save some skin. We are currently sitting below some key technical resistance price levels, most notably at $40k and the 200-day simple moving average. Until we can get over those, price is action is not extremely positive. However, we have stabilized to some extent for now, putting in some higher lows after bottoming at $30k earlier this month.
For now, I believe we will be in an accumulation phase, staying range bound for a short period of time before looking to move higher later this year. Until definite price action pushes us out of this range, traders will be hesitant to take a directional position.
The on-chain analysis data of this month’s selling is showing there has been a clear rotation of supply from short term holders who recently purchased (1-3 mo. and 3-6 mo.) into long term holder’s hands who have been steadily accumulating.
Throughout Bitcoin’s price history, we have experienced several other massive draw downs as shown below. These were all met with extreme upside price action.
I remain neutral on the shorter timeframe technical. We are in a mid-bull market cycle sell off from a technical standpoint. Regardless of immediate price action, the Bitcoin fundamental use case could not be stronger.
Building Strong Positions for Maximum Returns
Part of the reason we witnessed such a slew of selling last month was the speculative nature of the newer traders. In order to build strong a position in an asset, one must do two things.
First is to have conviction in what they are purchasing. For instance, when you look to purchase a home, you do ample research on the price, home values in the surrounding area, niceties, etc. Not only because you’ll be living there, but because you will also be dropping a large down payment on the purchase and you don’t want to lose your money.
What were to happen if you purchased a home sight unseen for a large percentage of your net worth only to discover some major issue or flaw? Well, you would probably look to sell or get out of the deal. Had you have done a little more research on the property maybe this issue could have been avoided or deemed a necessary evil.
The same thing goes with building a large conviction position in an asset such as Bitcoin or any other for that matter. You need to understand the ins and outs, risks, positives, and inner workings in order to remain committed to an investment or make one of larger magnitude.
If you do not understand what you are investing in, the chances are you will be more likely to sell over bad news or FUD at a loss or missed opportunity or place a large bet on a loser.
We are witnessing the lack of understanding of some assets with many retail investors rushing into various speculative crypto names like Dogecoin or Shiba Innu Coin, with no utility or regulation, with most people not knowing or caring a thing about them!
The more you can understand an asset, the more you can recognize when good opportunities arise to buy more or even take a little profit so be it.
The second thing is a commitment to “build” the position. You don’t need to start with a large sum of money to get started investing. You do have to start though. That means consistently adding funds to the cause through a DCA (dollar cost averaging) program over a long period of time.
Individuals should pre-determine what works for them, but the DCA could be set up as a monthly/weekly purchase of $100 or whatever you deem. Regardless of price action, your position will consistently grow over time and will allow you to average into a long term play rather than risking a large sum of money in one sweep purchase upfront.
When you average into a position through dollar cost averaging, the fear and noise is less impactful to your decision making. This makes you less likely to panic sell in a downturn but rather add or simply sit tight and wait.
To further support your DCA plan, you should look for assets that are growing and can generate compounding yield/interest. This can be through dividends or interest accrual. Generating yield on an asset really kickstarts the snowball effect of building wealth. Coupled with your DCA, yield generated on an asset can be reinvested, further building out the position. With these two pieces in place, returns become exponential over time.
A plan like this can not only be implanted on an asset like Bitcoin or stock in a company but is actually similar to what is implemented on an auto-deposit 401k account or IRA. Although those funds are often extremely diversified, providing exposure to a broad range of market conditions at a lower risk/return rate. Risk/return rate should be crucial in your understanding of an asset.
Regardless of what you ultimately choose to invest in, provide yourself conviction in your decision making through ample research, perspective, and dedicated cash injections.
Consistency can allow you to build a strong position that can return ample gains over an extended period of time.
We live in an age where education and information on anything we want to know is accessible at our fingertips through the internet. You owe it to your future-self to become educated in money management.
By signing up for this newsletter you have already taken steps to accomplish that. Stay consistent on your journey and don’t stop learning.
Thank you for spending the time to read this month’s newsletter!
I look forward to sharing additional thoughts and perspective on economic and market outlooks along with money management tips and tricks to aide in your individual journeys.
P.S. if you like what you read here, please share with your friends and family!
Bryan Craig
Lefty Group Capital Chief Investment Officer