September 2018 Commentary

April 20, 2020

Let us start with some of the major developments in the crypto-currency ecosystem that came out in the past month.

  • Fidelity investments is a fourth largest asset manager with $7.2 trillion in assets under administration as of October 2018. Fidelity has announced on October 15th that they are forming a subsidiary called Fidelity Digital Asset Services. This subsidiary will provide crypto related services to institutional investors. They intend to provide a trading execution platform, enterprise-grade custody solutions and institutional advising solution. Since the cryptocurrency markets never close, this division operates 24 hours a day and 365 days a year. Financial institutions tend to act like a herd. This is a clear sign that wall street herd is coming into the crypto world. Fidelity currently has 80 million retail customers. If each of them wants to buy just 1 bitcoin, we know it is impossible.
  • This announcement makes TD Ameritrade’s investment in ErisX earlier this month look like a small ball. TD is about a third of the size of Fidelity with 11 million brokerage customers and roughly $28 billion market cap.
  • Nasdaq was earlier planning to launch some crypto-centric analytic products before the end of the year. Nasdaq is also planning on launching its own crypto exchange and was reported on CNBC.
  • Goldman Sachs has entered invested into digital currencies custody market by investing $15 million into BitGo Holdings. BitGo is trying to launch institutional level custody solution.
  • It was reported that a user transferred 29,999 BTC (equivalent of $194 million) was sent with a $0.10 fee. Imagine trying to perform the same wire transfer via banks. Many have calculated that at a minimum it would cost around $10000 today to perform the same transfer with TransferWise.

Ikkurty Capital fund was started on October 1st of 2017. We are pleased to announce to the partners that we have a 1-year return for the fund. In a severe bear market that we are currently experiencing in digital currencies, our 1-year return is 61.78%. I like to bring the patient, long-term oriented investing style of Warren Buffett to the Blockchain assets. I view this as a marathon, not a sprint. It is like we have covered the first mile in the marathon, and we still have another 25 miles to go, or 25 years if you extend the analogy.

Compounding is a powerful force in investing. If we continue to provide the same annual returns (i.e. 61.78%) to the investors, $100,000 will grow to $1.1 million in 5 years, $12.28 million in 10 years and $136.1 million in 15 years ( See calculations).As you can see from the bar chart above that S&P has returned 15.67% in the last year. The same $100,000 invested for 15 years in S&P 500 will grow to be $880,000 (see calculations). Despite this big difference in the outcomes of these two calculations, I view S&P 500 as highly overvalued. As the size of the fund becomes bigger it becomes harder to grow the fund at the same rate. Since we have started small, I feel we have a long runway to achieve growth as digital currency market evolves.

In this letter, I like to answer some of the frequent questions that were asked by my friends about crypto-currencies. One question, I received is this: If you think bitcoin is such a great improvement over fiat currencies, why don’t I see bitcoin being used by any of the merchants around me? Where is the empirical evidence of its usage in the real world?

It is true that today bitcoin is not even used by 0.1% of the merchants in the world. It is a valid statement, empirically speaking. To understand why, we need to look at the monetary history of the world and see how a single monetary good emerged as money when various monetary goods compete in a free market to become money. Throughout human history, Bronze, sea shells, glass beads, copper, silver, carved stones and gold tried to be used as money. This list is only a small subset of all of the choices humans have experimented with and eventually gold has emerged as the victor amongst all of them. We can think of money as a small condensed packet, which holds the value of the goods or services that we provide today, in order for it to be readily available to us at a point in future. In order for this commodity to carry this value as a packet, this commodity should be durable in time and in space. In other words, it has to be saleable in future to convert it back to goods and services.

If this monetary good loses its form and deteriorates in quantity or qualitatively, it seizes to be money.  For example, iron is metal that is available in huge quantities on the earth’s crust, but it rapidly rusts and changes form due to natural chemical reactions. This rule out iron, as a form of money. In order for any form of money to gain acceptance, it goes through 4 stages, as observed in the monetary history.

  1. Collectible
  2. Store of value
  3. Medium of exchange
  4. Unit of account

In its first stages, usually a monetary good will emerge as a collectible by a small group of people in the society. It could even be beads, or rare kind of sea-shells or ornaments, which possess certain qualities that make it scarce and desirable. If it is not scarce it will never become a collectible. If it is one of kind item, like a Mona Lisa painting it can never be used as a monetary good. In order to become a collectible, multiple similar items of that monetary goodhave to exist in the society. This will prove its value to a small group of individuals who value possessing them.

Once this stage continues, for a few years this monetary good proves its usefulness to a small section of the society. As long as it remains scarce, it becomes a store of value. Money has to prove itself to be a store of value for number of years, before it will become a medium of exchange. In order for any monetary good to be a medium of exchange, it has to be held widely by the populace. If only say, 1% of a society holds these monetary units (beads or sea-shells), they cannot be freely exchanged with others. The person who is receiving them also need to be convinced that this monetary good is valued by others.  It needs to be saleable to a wide population. What if I receive 10 glass beads as payment for my labor, but I am unable to sell it to anyone when I need to purchase some food to exchange these beads? A person is only willing to accept these beads as money, provided there is large portion of the population values them. The larger the market is for his beads, the more inclined the individual is to accept this monetary good as payment. 

Can a monetary good become a medium of exchange if it is not proven as a store of value? Short answer is No. The answer was proven in the monetary history numerous times. If a monetary good is not widely held as a store of value, it is not available as a medium of exchange simply because nobody holds it. The free market will determine something as a store of value, only when it is scarce. Scarcity is fundamental to the store of the value. This should be obvious, even without getting into economics. In the middle of a desert, I will be willing to pay 10 times more for the same bottled water, than in a big city where bottled-water is plentiful. In order for any monetarygood to be a good store of value, it has to be scarce and useful. In order to be scarce for any object it should be very difficult to produce it. All humans desire money. The forces of free markets will ensure that people will compete to produce more and more of this scarce commodity. Since bringing new gold into the market is very hard relative to the other commodities, it secured its place in the history as a store of value.

As a good becomes more widely recognized as a suitable store of value, its purchasing power will rise as more people demand it for this purpose. The purchasing power of a store of value will eventually plateau when it is widely held and the influx of new people desiring it as a store of value dwindles.  The following image from twitter user, Willem Van den Bergh represents this path very clearly.

Once the purchasing power of the monetary good is stabilized, the opportunity cost of using money to complete trades will diminish to a level where it is suitable for use as a medium of exchange.  In the earliest days of bitcoin, many people did not appreciate the huge opportunity cost of using bitcoins as a medium of exchange, rather than an incipient store of value. The famous story of a man trading 10,000 bitcoins ( worth approximately $65 million at the time of this article writing) for two pizzas illustrates this confusion.

Unit of Account is final stage of a sound money. I define ‘sound money’ as the one money good that emerges as the winner, chosen by the market participants in a free market, amongst various competing monetary goods. When money is widely used a medium of exchange all consumable goods and serviceswill be priced in terms of the monetary good. In other words, the exchange ration against money will be available for most goods. Currently US Dollar plays this role world-wide, owing to its military strength United States dictated oil-producing nations to price oil contracts in terms of US Dollars. This created an enormous demand for US Dollar and established it as a reserve currency for the rest of the world. Every country in the world requires oil and hence need to hold huge amount of US Dollars to pay for their oil imports. In America, the dollar seamlessly serves the three functions of money: providing a medium of exchange, a unit for measuring the cost of goods and an asset where value can be stored. In Argentina, on the other hand, while the peso was used as a medium of exchange- for daily purchases- no one used it as a store of value. Keeping savings in the peso was equivalent to throwing away money. So people exchanged any pesos they wanted to save for dollars, which kept their value better than the peso.

Bitcoin is currently transitioning from the first stage of monetization to the second stage of unit of exchange. It will likely be several years before bitcoin transitions from being an incipient store of value to being a true medium of exchange, and the path it takes to get there is still fraught with risk and uncertainty. The same transition took centuries for gold. Every government in the world is going to create obstacles to this path of store of value for bitcoin, as it will threaten the central banks’ monopoly on money printing. Bitcoin only faces headwinds from governments, and receives no tailwind from any government pushing bitcoin over their sovereign currencies. Despite all of the obstacles created by governments around the world, bitcoin managed to organically grow from fraction of pennies to $6500 as the free markets are slowly recognizing it as a store of value. Bitcoin will continue to be in this store of value phase till its market value reaches close to $8 – $10 trillion dollars in value from its current market value of $100 billion dollars.

The ability to easily transmit bitcoins across borders and absence of a need for a banking system make bitcoin an ideal monetary good in many developing nations afflicted by high inflation. In the coming years, as fiat monies continue to follow their historical trend toward eventual worthlessness, bitcoin will become an increasingly popular choice for global savings to flee to. This will slowly usher in the phase when bitcoin becomes a medium of exchange on a large scale.

Managing Partner