Carlos Velásquez · Medium · 9 min read · Source: unsplash.com Bruce Mars
Suppose that on September 1, 2011, a friend emailed you a White Paper titled Bitcoin: A Peer-to-Peer Electronic Cash System.
In her email, she recommended that you “…Transfer $200 to Magic: The Gathering Online eXchange and buy 24 bitcoins…Also consider downloading the open-source software and begin mining bitcoins; they could be worth a lot someday.”
Would you have followed your friend’s advice? Would the techies among you have trusted the open-source software and dedicated resources to mine $8.21 bitcoins?
Most people would have bought or mined a lot more bitcoins had they been quicker to grasp Bitcoin’s use case.
Or so they would say.
Skepticism: A Real-Life Simulation
A friend sends you the following messages:
“Mine digital currencies on your phone by downloading the following four apps:
– Pi Network
– Bee Network
– GeoCash
– TimeStope
Use the invitation codes below.”
Does your self-talk sound something like this?:
“…Silly waste of time. They will probably steal my personal data. How can these digital currencies ever be worth anything?”
The self-talk you would have experienced upon reading your friend’s email could have been similar. Relatively few people understood cryptography in 2011. Chances are you were not among those who understood it.
Instead, you would have probably been too skeptical to send money to “Magic: The Gathering Online eXchange” (Mt. Gox) or to download the open-source software. You may have even been skeptical of your friend’s intentions — especially since Mt. Gox had been hacked early that year.
To many, Bitcoin was a “…Silly waste of time.”
To some, it still is.
Combating Skepticism: In Search Of Returns
Peter Diamandis, coauthor of The Future is Faster Than You Think; Cathie Wood, CEO of ARK Investment Management; and Robert Friedland, billionaire financier, believe emerging technological changes will revolutionize entire industries in the coming decade. Asymmetric risk-reward investment opportunities will exist not only for VC firms, but also for retail investors with exposure to publicly-listed stocks, SPACs, and digital assets.
A few companies will end up capturing a large market share of these transformative industries, perhaps even combining elements of some to form new ones (think DeFi). In other cases, the winners will expand the Total Addressable Market of industries (think Uber in the Taxi industry) or be situated to capitalize on Black Swan events (think small-cap biotech winners vis-a-vis COVID-19).
Not unlike Bitcoin, many of these investment opportunities will initially appear speculative. Skepticism will cause some investors to dismiss them the way Bitcoin and Uber were dismissed (Uber was initially viewed as an expensive Taxi service with a limited TAM to some VCs).
Investors will need to combat this skepticism in order to capitalize on these asymmetric risk-reward opportunities.
They can do so by adopting the mental framework of an early Bitcoin investor.
Mental Framework Of Early Bitcoin Investor
* Having zero exposure is risker than having some exposure to speculative bets.
Investors that did not buy bitcoins at price levels below $1k have missed out on 50x-6000x, or greater, returns. Those that did not buy bitcoins in the $1k-$10k range have missed out on 5x–50x returns. The consequences of these missed opportunities apply to even modest would-be investments. Below are $200 bitcoin investment scenarios, at various prices, and their results to date.
The risk-reward of having zero exposure to bitcoin:
- risk (net gains forgone to date) = $800 to $1.2 million
- reward (the amount not risked) = $200
The risk-reward of having some exposure ($200) to bitcoin:
- risk (the cost of the initial investment) = $200
- reward (net gains to date) = $800 to $1.2 million
Mental framework: Skepticism has its benefits. But in the realm of investing (particularly when considering the pros v. cons of a small speculative bet), even correctly placed skepticism has a limited benefit. Worse still, incorrectly placed skepticism eliminates exposure to “positive” Black Swan events — i.e. Bitcoin.
Eliminating all exposure to speculative bets, as such, can be more detrimental than beneficial to an investor’s lifetime returns. Making many small speculative bets simultaneously caps the maximum loss of any single position while exposing the portfolio to a multitude of positions with asymmetric risk-reward potential, which in the aggregate can amount to a sizeable allocation to convex return exposure.
* All aspects of a small bet do not need to be understood.
A company’s success is the byproduct of thousands of endogenous and exogenous variables and their associated feedback loops, many of which are a happenstance of timing and luck. Investors face an uphill battle incorporating these variables into their investment theses, especially when Black Swan events can blindside even the best-prepared investor.
“…those who clamor for ‘conscious direction’ — and who cannot believe that anything which has evolved without design (and even without our understanding it) should solve problems which we should not be able to solve consciously — should remember this: The problem is precisely how to extend the span of our utilization of resources beyond the span of the control of anyone mind; and therefore, how to dispense with the need of conscious control…” ~ Friedrich Hayek, The Use of Knowledge in Society. From Knowledge Management.
Mental framework: While basic investment narratives should be established (i.e. holding bitcoins is an inflation hedge) all aspects of an investment need not be understood. Hayek’s quote is useful when considering how a rules-based investment process that systematically incorporates many small speculative bets enables investors to “dispense with the need of conscious control”. Instead of formulating concentrated portfolios prone to blow-ups, investors can utilize simplified investment narratives to create *diversified portfolios that cap downside risk via small position sizing while simultaneously benefiting from the asymmetric risk-reward profile of many speculative bets.
(*The diversified nature of this portfolio construct also captures sector, industry, company size, country, asset-class, and temporal diversity that is not easily replicable via concentrated portfolios, ETFs, or mutual funds. No transaction fee brokerage services now make small equity investments feasible.)
* Think in probabilities, not binary outcomes.
Stating “I believe there is a 95% chance bitcoin will fall in value” is more prudent than dismissing it outright. The corollary is that there is a 5% chance it will not fall in value, prompting an investor who reasons in probabilities to act according to said prediction. Conversely, binary thinking invites lazy thinking. It has allowed Bitcoin detractors to throw it into the “speculative bubble” category without further exploring the benefits of cryptography, the Antifragility of the Bitcoin blockchain network, or imagining the circumstances in which the Bitcoin narrative could evolve and result in wider adoption.
Mental framework: thinking in probabilities enables investors to devise a strategy that facilitates placing small bets despite having little conviction on many of them. Such a strategy is a hedge for that which we lack the bandwidth or expertise to understand — which is the case for many investment opportunities. Fewer investors would have been caught flat-footed regarding Bitcoin, or the stock market in late March-April 2020, had they thought in probabilities instead of binary outcomes.
* Small bets afford the patience that allows positions to appreciate.
Investors that construct concentrated portfolios (10-20 positions) often decrease a position when it exceeds 25% of the portfolio’s value. When these investors establish an equity position in assets like Bitcoin, or in companies like Netflix, they miss a lot of the upside due to their risk control management strategy. A 5% bitcoin position established at $1k/bitcoin would have been trimmed starting at $5k/bitcoin. Similar position trimming would have occurred with NFLX, which traded under $10 in the early 2000s and is now valued at over $500/share. Even a much looser 50% position size threshold would have left a lot of the bitcoin and Netflix gains on the table under this type of risk control management strategy.
Mental framework: An investor that constructs a portfolio to include many small bets can more easily allow any single position to appreciate beyond 25% of the overall portfolio. Early Bitcoin investors, for instance, established their positions when bitcoin was in the $10 to $1k price range. If they still believe in Bitcoin’s long-term narrative (and most do), they are unlikely to exit their positions.
Reasoning From First Principles
Applying the mental framework of an early bitcoin investor results in neither an active investment approach (in the traditional stock-picking sense) nor a passive investment approach. It falls in the middle, fitting particularly well within a Barbell Portfolio strategy. Reasoning from First Principles can help clarify why this in-between strategy works:
- What are investors in search of? Asymmetric returns.
- What are the challenges of realizing asymmetric returns? Investments that result in asymmetric returns are difficult to identify in advance.
- What is a solution to better identifying asymmetric returns in advance? Adopt a framework that systematically exposes one’s portfolio only to bets with asymmetric risk-reward potential.
Asymmetric v. Conventional Returns
Let us consider a $1,400 investment that was equally weighted among the seven digital currencies lineated below. Creating such a basket of digital assets during the 3/9/20 through 12/16/20 timeframe would have been worth $4,050 to $25,088 on February 18, 2021; and at least 10x returns would have been earned had it been fully vested by mid-April. Convex returns like these were also reaped by investors who bought small-cap stocks, deemed speculative by some, in Q2 of 2020.
Let us now consider a more standard return profile associated with a conventional portfolio: initial investment of $100k; an assumed 10% annualized compound ROR over 15 years; a $1,000 monthly contribution. Graphs like the one below that depict this portfolio construct are often used to drum up business by investment firms and their advisors. But they omit the impacts of investors’ behavioral errors/biases, investors’ inability to continue making monthly contributions due to job loss, or March 2020 type drawdowns.
Market Surprises
I recommend that you listen to episodes of your favorite financial podcast that were recorded in the 2016-2020 timeframe. You will be surprised at how inconsequential the issues raised by the financial experts ended up being (and how inaccurate their predictions were, especially post-March 2020).
Markets surprise even the experts.
They will surprise you.
Luckily, positive surprises are the reason speculative bets work.
Keep this in mind, and think like an early Bitcoin investor, when betting on the technological revolution of the upcoming decade.
(Click on these links and use the codes to try the apps mentioned above: Phi Networkhttps://minepi.com/Antifragilista, use code: Antifragilista; Bee Networkhttps://bee.games/download.html, use code: antifragilista; GeoCash downloads.geodb.com, use code: 01262021_FLIHKT; TimeStopehttps://www.timestope.com/antifragile)
Author also wrote: N. Taleb’s Minority Rule | Your Inner Voice | Bitcoin’s Volatility | Blockchain Stocks | 50 Investment Lessons | Flywheel Effect | Crypto Moonshots | 4 Crypto Stocks | Bitcoin: Insurance | Brief History: Money | Spontaneous Order | Ackman’s $2.6B Moonshot | Fragility Inducing Events | Antifragile: Definition | 1% Bitcoin: 99% Cash | COVID-19: Market
twitter.com/C1_Velasquez | carlosvelasquez-5316.medium.com/
Disclaimer: Topics covered herein are for informational purposes. Before acting on investment information consult with a financial professional. This article is intended for people who understand the pro/con impacts of tail risk, convexity, and asymmetric risk-reward in the context of an investment portfolio. The price of cryptocurrencies will likely remain volatile. I have no financial interest in the four apps mentioned in this article.
