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Circle of Competence Issue #29

Quote of the week: "I can calculate the motion of heavenly bodies, but not the madness of people." Sir Isaac Newton, after losing a fortune in the South Sea Bubble of the 1700's


Last week I read an excellent investor letter written by Mark Yusko of Chapel Hill NC firm Morgan Creek Capital on how the current cryptocurrency investment opportunity could be likened to the gold rush of 1849 in California. Today, I wanted to explore some of my own thoughts around Cryptos.

To start, let's get some facts out in the open. Satoshi Nakamoto released his Bitcoin paper in 2008, and since the creation of Bitcoin in 2009, it has increased in price from $.10 to a current price (as of 9/15/18) per BTC of $6,523.99. This represents a remarkable ~240% annualized return over the past 9 years. This includes, by the way, a 60+% decline from the 2017 high of ~$19,000. It was originally intended to be a peer to peer medium of exchange whereby people could send payments to one another without a financial intermediary (an ideal not lost on those who witnessed how much havoc could be wreaked by overleveraged financial institutions during the great recession).

So what's the best long term use case of cryptocurrencies? From what I have read and listened to over the last year, it seems that the best case for cryptos is as a permanent store of value that allows 'the people' to control their own currency via a truly open and free market pricing mechanism. In contrast to fiat currencies which are backed by nothing more than the full faith and credit of whichever government issues them, cryptocurrencies are driven by underlying demand for ownership and transaction. Cryptos simply shift the value of currency to a demand dynamic rather than simply supply driven (fiat currencies are controlled by each respective central bank by increasing or decreasing money supply and base discount rates in an economy). Ultimately, cryptos are about giving the power of exchanging value and valuing that medium of exchange (currency) back to the people.

Crypto enthusiasts make the case that since they have a limited supply written directly into their code, they are more of a permanent store of value versus fiat currencies (essentially rehashing the traditional gold standard currency argument). They argue further that since fiat currencies tend to depreciate over time as governments print more fiat money over time (either slowly or very quickly depending on the government policies used), that cryptos would allow the people to control their own supply of currency rather than letting a centralized (dictatorship?) government control the value of their currency. Some even think central banks could use cryptos as a reserve in addition to traditional fiat currencies to blend their currency risk between fiat currency and digital cryptoreserves.

Now for the other side. To begin, cryptos are not productive assets like real estate, farmland, or businesses that produce goods and services. So, to 'invest' in these is more like 'to speculate' because if you are buying in hoping to sell them at a higher price, you may just be playing the greater fool's game (listen to Buffett's interview for a simple explanation). Though traditional fiat currencies are not productive assets eit