Why hedge funds think Bitcoin will save them from inflation
We're about to see one grand monetary experiment collide with another.
There's been a lot of discussion around money printing in recent years, much of it around the question of whether we can or can't solve all the world's problems just by printing money.
Then along came COVID-19 and suddenly the discussion ended. Almost overnight, and without as many safety goggles or lab coats as you'd expect, the world decided to collectively embark on an unprecedented experiment in modern economics.
Welcome to the Great Monetary Inflation, as macro investor Paul Tudor Jones called it in a recent market outlook report.
"It has happened globally with such speed that even a market veteran like myself was left speechless," he said. "Just since February, a global total of $3.9 trillion (6.6% of global GDP) has been magically created through quantitative easing. We are witnessing the Great Monetary Inflation (GMI) – an unprecedented expansion of every form of money unlike anything the developed world has ever seen."
Bitcoin is increasingly looking like a good investment right now, he said, so much so that the Tudor BVI Fund is now composed of a "low single-digit percentage" of Bitcoin.
Something appears wrong here and my guess is it is the price of Bitcoin."
The idea of a large hedge fund allocating even that much to Bitcoin would have been unthinkable a few years ago, and now Tudor Capital is among the first to do so.
It arrived at this decision, in part, through a horse race.
"At the end of the day, the best profit-maximising strategy is to own the fastest horse," Jones said. "Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be Bitcoin."
Horses in a row
The idea behind the race is basically that there's going to be a lot of money flying around in coming years, and all that money will need to find a home.
The assumption is that money is most likely to land in the best store of value, whether that means it's being loaned out, used to buy stocks, parked in gold or even just left as cash in a shoebox.
To try to get a glimpse of the future, the report went back to basics and considered how different assets functioned as stores of value in their most basic form.
The four horses in the race were:
- Bitcoin. The digital stallion. A crowd-pleaser despite its history of doping allegations.
- Financial Assets. A diverse group of assets encompassing stocks and bonds. The biggest horse in the race, by market cap, by a very large margin.
- Gold. The shiny metal. Although occasionally derided as a mere show pony, it boasts a solid track record spanning several millennia.
- Fiat currency. Physical cash and its equivalents. It likes apples.
These horses were then assessed across four criteria, for a general overview of how useful they are as stores of value, come what may:
- Purchasing Power. How does this asset retain its purchasing power over time? Can it beat inflation?
- Trustworthiness. How is it perceived through time and universally as a store of value?
- Liquidity. How quickly can the asset be monetised into a transactional currency?
- Portability. Can you geographically move this asset if you had to for an unforeseen reason?
Some assets were disqualified from the race, because they'd break a leg if they tried some of these races. Real estate, for example, would instantly fail on the liquidity and portability front even as the utility it provides isn't factored into any of the criteria.
Each of the four horses were subjectively assessed across each of these criteria by a "team of informed persons".
Spoiler: Bitcoin lost the race, but went on to win the cup.
The panel liked financial assets here, mostly because of their yields. Jones was less convinced though.
Many of the panelists weren't around for the double digit inflation of the 70s, he pointed out.
"Financial assets were particularly popular with the thirty-something crowd who gave financial assets the highest score across the board. I reminded them that in the 1970s, inflation was near double-digits at times... virtually all financial assets were shunned because the yield could not keep up with inflation."
On the other end of the spectrum, fiat currency scored very poorly on purchasing power, simply because through inflation alone, it doesn't make much sense to hold money.
That left gold and Bitcoin in the middle, touting similar scarcity-based value propositions. While gold is technically more scarce than Bitcoin by some measurements, that will change over subsequent Bitcoin halvings.
Purchasing power and liquidity are an extension of how trustworthy an asset class is, making it an important if somewhat subjective criteria. The results here were largely a reflection of how long the asset has served as a store of value.
Gold won with its 2,500-year history and Bitcoin lost with its 11-year history.
While fiat currency as a we know it today really only came into existence in 1971, that was more than long enough to cement it as more trustworthy than Bitcoin... so far.
Cash naturally scored the highest here, while everything else was a bit jumbled up depending on the circumstance, such as what kind of financial asset it is, whether it's a gold ETF or a gold bar and how much Bitcoin you're trying to sell.
"Liquidity is one of those things that never matters until it does (every 10 years it seems)," Jones said.
"But as we have all probably experienced in the last two months, liquidity is hugely important when things go pear shaped. It is reasonable to assume, given the number of bankruptcies we are about to witness and the number of people who will be jobless and near poverty, that both companies and individuals will have a much higher preference for liquidity in coming years."
Bitcoin may have the most room for improvement on this front. It's already the only horse that trades 24/7 and many of its liquidity woes can be solved simply by having more money in the market.
As a purely digital asset, Bitcoin smashed this category.
"Like liquidity, it is not an issue until it is. Imagine a geographic upheaval whether it be caused by war, an epidemic, or change in government that becomes hostile to holders of wealth," Jones said.
"A great store of value can be seamlessly moved from one jurisdiction to another with little or no transaction costs. Cash is obviously good for that; gold is ok but clunky; but, of course, nothing beats Bitcoin, which can be stored on a smartphone among other options."
Lost the race, won the cup
Bitcoin came in last, but it was still a tour de force performance from an underdog (underhorse?) that highlighted how capable Bitcoin already is.
"What was surprising to me was not that Bitcoin came in last, but that it scored as high as it did. Bitcoin had an overall score nearly 60% of that of financial assets but has a market cap that is 1/1200th of that. It scores 66% of gold as a store of value, but has a market cap that is 1/60th of gold’s outstanding value."
"Something appears wrong here," he said, "and my guess is it is the price of Bitcoin... Owning Bitcoin is a great way to defend oneself against the GMI, given the current fact set."
Of course, the Bitcoin network's functional performance presents some uncertainty. While Bitcoin mostly has only room to improve across each of the four areas, some of its old bugbears could still bring its score down in the future.
Scaling issues stand to hit its liquidity and portability, private key management could affect trustworthiness and so on.
Between Bitcoin and the GMI, we're watching one monetary experiment collide with another. Make sure to wear your safety goggles.
Disclosure: The author holds BNB, BTC at the time of writing.