Anyone who tells you that money is the root of all evil has nothing. This line was brought down by Ben Affleck in his famous Boiler Room speech that exemplifies the alpha male drive for money that characterized investment banking environments at the time. Money may not buy happiness, but there is a connection between depression and poverty. There is also a relationship between work ethic and wealth. The harder you work, the luckier you get.
On the streets, you should always be afraid of a person who has nothing to lose, because his erratic behavior often defies common sense. That’s what you see in the investing world with Meme Stocks. Those with real money become less interested in making more of it, and more interested in keeping it. The desire to preserve wealth increases as you age because you will soon need your wealth to fuel retirement.
Cryptography as an alternative asset
The biggest tool investors have for preserving wealth is diversification across asset classes. Alternative assets such as art and wine have only recently been opened to investors and provide mechanisms for storing wealth that moves independently of the financial markets. More traditional high-quality assets like gold are now being challenged by the likes of cryptocurrencies like bitcoin. This is a good part of ARK Invest’s bullish bitcoin thesis on the largest cryptocurrency with a market capitalization of around $830 billion.
The amount of stupid money flowing through the cryptocurrency world has inflated prices, resulting in more stupid money experiencing the effect of home money. It’s hard to think of a riskier place to deposit your money at the moment, which is why only 1.3% of our assets under management can be found in bitcoin.
Our recent article on why a Bitcoin crash may be imminent highlights the systemic risks associated with Tether that threaten not only Bitcoin, but the entire US financial system (In Janet Yellen). In response, a subscriber suggested that we consider investing half of our bitcoins in the world’s second largest cryptocurrency, Ether. Sounds like a solid plan, so what’s the difference between Bitcoin and Ethereum?
Editor’s Note: Ether is a cryptocurrency used on the Ethereum platform. Yes, we know it is a mortal sin to use the two words interchangeably, but most of our readers don’t care about the distinction, so please just let us suffer the sin.
Bitcoin vs Ether
Bitcoin is a store of value that only works that way because people allow it. Bears point to a greater deception theory, while bulls suggest that the US dollar shares the same characteristics. Of course, the US dollar is widely accepted in almost every country by almost everyone, while Bitcoin ATMs struggle to conduct basic transactions using an infrastructure that was not built for transactions.
Bitcoin processes 7 transactions per second while Visa processes about 1,700 transactions per second on average. Enter the cryptographic trilogy which suggests that a decentralized network that sticks to the man can never be secure and scalable. Here are the options:
- Decentralized and scalable with poor security
- Decentralized and secure but not scalable
- Centralized, secure and scalable
The last point is the system that we have today that works really well. Whatever value society ascribes to Bitcoin, it is how useful it is.
Then there is the Ethereum network that can process 15 to 30 transactions per second, depending on who you talk to. Since there is such a large demand for this limited capacity, transaction fees (Also called gas fee) is ironic, and one that ConstitutionDAO members discovered the hard way when their average donation of $230 lost at least half its value when a $60 gas fee was charged both ways in the best-case scenario. Perhaps the most exciting thing about Ethereum is that it supports smart contracts, a use case where the blockchain may actually create a significant amount of value. The big unknown for Ethereum right now is Ethereum 2.0. It’s equal parts exciting and terrifying.
There is nothing in the world more impotent, irresponsible, and corrupt than a man in the depths of his etheric greed.
Credit: Hunter S. Thompson
In order to solve the transaction issue, an open source development effort is underway to change the way Ethereum works so that it can scale to 100,000 transactions per second or more. (The explanation for how to achieve this is equal parts technical and boring.) The second big change will be the move from Proof of Work to Proof of Stake. Instead of having very powerful computers that use electricity to mine ether by solving complex problems, people who own ether can simply generate more of it depending on how much they have.
The interpretation is not as important as the end result – faster transactions, lower fees and 99.95% lower electricity consumption. Ethereum 2.0 will be released in phases as big things happen this summer. If it’s like any other software project, expect the dates to be late and the functionality to be less than promised.
If you are someone who works in the field of enterprise software development, you will understand how incredibly hard Ethereum 2.0 works without a hitch. From an article by Fortune on the subject:
It’s the most important Ethereum update ever, but it’s not without critics. Moving to a point-of-sale model will reduce miner revenue by between 20% and 35%, according to some estimates. And there are concerns that changes to Ethereum’s incentive model could prompt disaffected miners to leave the network, attempt to sabotage it, or start a competing chain.
It is almost difficult to read with a straight face. Is the second largest cryptocurrency in the world unpredictable? All bitcoin mining bulls might want to think long and hard about your thesis if the community suddenly decides they don’t need your mining efforts anymore because they want to reduce electricity consumption by 99.95% to satisfy ESG types.
Think of what this looks like to someone whose sacred cow was built on the Ethereum platform. They are left wondering if the upcoming release will ruin the past several years he spent working 80 hour weeks trying to build a business. If Ether/Ethereum suddenly collapses, it could bring others down with it.
Before we talk about diversification, we need to talk about correlation – the extent to which Aslan behaves in a similar way. If you own two stocks that always move in unison, the only diversification effect you get by holding both is that the risk for the company is halved. If a company withdraws Enron, you still have half of your money, all things being equal.
So, how similar are the price movements of Bitcoin and Ether to each other? Eric Norland of CME Group spent several hours putting together an exceptional piece on the subject, so we’ll give him credit for that briefly and then further his hard work for our audience as you would any good MBA. Here is what it concluded:
- Bitcoin price tends to follow the cost per transaction and its trading volume
- Ethereum price is closely related to bitcoin, but has seen higher volatility
Of course, correlations change over time, so provide this helpful chart that shows just that.
For all the people out there you don’t sleep well at night because your paper money is evaporating before your eyes, fear not. It is just part of the normal cycle of volatility according to the chart below.
In conclusion, diversifying our investments in bitcoin is meaningless if the entire group of cryptocurrencies are highly interconnected. Even if cryptocurrencies are not correlated, it is still difficult to find an easy, low-risk, low-fee way to diversify.
If this is Microsoft’s next, all I need is a little. If not, I’m glad I only invested a little.
If Bitcoin Fanatics Like Michael Saylor Are Right And Bitcoin Jumps + 2500% Compared to today’s rate, this means that our meager 1.3% investment will swell to approximately 25% of our portfolio (We start trimming slowly at 10%). But if the most popular cryptocurrency proves to fail miserably for any number of reasons, it is likely that some other cryptocurrency will take its place.
There are a growing number of ways to diversify your exposure to cryptocurrencies such as funds like CRYPTO20 that charge a reasonable 50 basis points (0.50%) to be exposed to a basket of cryptocurrencies whose weights are adjusted based on movements of market capitalization. We have two problems with this approach, the first is to include some names.
We can’t care much about Dogecoin price movements as the monkeys are trading Robinhood FOMO YOLO without the slightest evidence that this $23 billion joke started as a joke. We have less desire to be exposed to the Shiba Inu coin which is an $18 billion joke. At least you have some criteria that filter out garbage. The second sticking point relates to the need to summon a third party to trade the thing. Either make it available as a token on Coinbase – a company we trust – or have it trade on common stock exchanges.
Self-made fortune teaches you the value of money. People who work hard for their money don’t want to waste it on volatile cryptocurrencies that have no intrinsic value. Any fear of getting lost we may have is easily overcome by our fear of investing in something so volatile that few people can adequately explain it.
When Ethereum 2.0 goes live, we’ll see if it delivers on its promises and consider diversifying our exposure to Bitcoin a bit by buying some Ether. We will also be looking at ways to get diversified exposure to cryptocurrencies that don’t use a sprinkle and pray method that includes some straightforward junk.
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