Looking back, Thinking Clear
As those who’ve read my missives in the past may know, I’ve keenly followed both the progress and regress of blockchain technology, specifically the explosion of Bitcoin onto the financial scene. Every so often, I like to revisit past thinking and re-address some fundamentals. Is blockchain still a relevant technology? Does it continue to hold the promise its proponents have been touting? And is Bitcoin still a viable investment?
First let's take a bite out of FAANG
FAANG" is the acronym that Jim Cramer famously coined for the collection of the five most powerful internet stocks. These stocks (Facebook, Amazon, Apple, Netflix, and Google) have been paramount to the returns realized in the S&P 500 over the last several years. The aforementioned internet titans have grown so large that they now make up a whopping 11% of the total index of S&P 500. In recent years, Facebook, Amazon, Netflix, and Alphabet stocks are up about 30%, 29%, 28%, and 21%, respectively, year to date *. This compares to the 7% return of the S&P 500's over the same period. Furthermore, these stocks' big gains in 2017 extend to an extraordinary track record for each. Facebook's, Amazon's, Netflix's, and Alphabet's (Google) stock prices are up about 150%, 220%, 220%, and 80%, respectively, compared to three years ago. During this same period, the S&P 500 increased just 27%, which is in line with historical returns, however heavily dependent on FAANG.
Tech is wobbly
It seems that these companies have had a seamless transition from disruptive technology to established brands which, intuitively might make one believe that these stocks have had consistent returns. Nothing could be farther from the truth as FAANG stock's return profile more resembles the old Wall St. adage of taking the stairs up and the elevator down, complete with volatility spikes and rapid downward pressure on prices.
These moves tend to be painful to the majority of investors as the market's dramatic fluctuations punish and test their conviction about these technologies and their respective company’s prospects. For instance, Apple's Initial Public Offering took place in 1980. Since then the stock has returned an amazing 25,217% return at an annualized rate of 17%. However, in 2000, the stock dropped -71%, in 2008 -57%, and in 1993 the drawdown was -50% against a positive S&P return.
This is not unique to Apple. Amazon, Google, Netflix, and even Microsoft have had periods of extreme drawdowns. For instance in 2007-2008, Google lost -65% of its value. Facebook, whose IPO price was $38, traded down almost -48% just 4 months later before rebounding. What compounds the pain is the math behind getting back to break even. For example, a -33% drawdown means a 50% return to break even, a -50% loss would need a 100% return and in Google's case, the -65% loss would need a return of 135% merely to break even.
Gartner Hype Cycle
Parabolic moves and the resulting drawdown in stock prices of disruptive technology can be viewed through the lenses of the Gartner Hype Cycle Methodology (GHCM). It explains the psychology of the investor or general public around emerging technologies as it goes through stages of innovation triggers, inflated expectations, disillusionment, enlightenment, and final productivity (see chart above). The parallels between FAANG stock prices and the price of Bitcoin can be drawn and provide insight into future price movements. The chart above signals blockchain in the cycle of disillusionment, which certainly can be argued is reflective of the Bitcoin price movement from over $19,000 down to @ $6500 per coin. If blockchain technology flows according to the GHCM, we are in the early days of what could be a seminal technology benefiting multiple industries on a global level.
So What about Bitcoin?
Blockchain technology and cryptography are the underpinnings that have enabled the birth of a digital currency, in turn bringing along the innovation of a new, uncorrelated asset class. What is vital to understand is that blockchain is a decentralized, transparent and immutable software product where the growth is driven by a digital asset or native token. Bitcoin is the engine that powers the move from double-entry bookkeeping of the 15th century to the software efficiencies of decentralized ledgers. Another way to look at this would be to compare a centralized model like Microsoft, whose product growth is driven by tens of thousands of sales professionals, to a decentralized community where the token or coin is a de facto sales force. If we believe the premise that blockchain technology will be a multi-decade growth engine and tokens become common as a utility function, Bitcoin will most likely continue to be the barometer for all things crypto. When we apply GHCM to the blockchain (BITCOIN), from an investment thesis we can conclude not having exposure to this asset class in a portfolio increases the probability of underperforming early adopters and missing a FAANG type of investment. As any venture capitalist model will show you, picking winners is generally a low probability bet with a select few winners driving the majority of positive returns. So how does one gain exposure to the asset class or gain beta exposure to blockchain technology with the highest probability of a positive result? in a word Bitcoin.
Gartner Hype Cycle, Tulips and the South Sea
Is Bitcoin a bubble? The price action certainly has shown a lot of similarities to a bubble at various stages over the last ten years. But not all bubbles are the same and not all bubbles go to zero. The lessons learned from the price action of the FAANG stocks have taught us that bubbles in disruptive technology are more clearly identified as opportunities for a second or third bite of the Apple (pun intended). History has shown us that large swaths of portfolio returns come from these companies whose technology changes our actions and daily habits. Using traditional equity valuation methods, whose value is predicated by cash flow, therefore, does not pertain to Bitcoin. The value of Bitcoin is derived from several different use cases, therefore, is not synonymous with equities, however, a striking analogy comes in the form of the comparison to disruptive technology and the ability to reach critical mass adoption. Blockchain is a good, even powerful technology that can wring out inefficiencies across industries through its decentralized and immutable properties. Blockchain, however, has a symbiotic relationship with Bitcoin and when combined creates a truly transformative application that spans the global economy.
Mark Twain is quoted saying " history doesn't repeat itself but it rhymes". Disruptive ideas tend to be generational and in the 21st century, technology is the catalyst of change. It might be said that the optimal portfolio over the next decade will have a digital wallet (or its replacement) aligned with traditional assets. Prudence and precedence would dictate that disruptive technology be included in that portfolio and if blockchain is the catalyst of change then Bitcoin will be its champion.
What has changed?
Since Covid hit the US in March of 2020, markets have been prone to a lot of volatility, meaning price movements are sharper and larger. BTC has always been a highly volatile asset but interestingly has become more correlated (trades in tandem) to tech and FAANG stocks. Non-Correlation to traditional assets along with being an inflation hedge were attributed to BTC, but last several years leave these attributes in question. This is most likely the result to a larger macro investing environment (big economics), higher volatility across all markets as well as more adoption of institutional trading for BTC and cryptocurrencies.
Where are we now?
BTC is currently around 22,000** and has recently shown signs of consolidation at these levels. This corresponds to roughly a 66pct correction and mirrors FAANG stock drawdowns. While this return is a painful point for long-term investors, this also corresponds to the thesis that blockchain and BTC are emerging technologies and trade like the FAANG cousins. What else has changed? If we refer back to Gartner Hype Cycle chart, we may have slide further down the "Trough of Disillusionment". While the crypto and equities markets fall into a bear (down) market, building and investing around blockchain technologies has boomed behind venture firms like Andreessen Horowitz, Google Ventures, Fidelity Investments, and Blackrock to name a few. The world has gone through upheaval over the last 4 years and while BTC hasn't lived up to all the hype, the secular trend for blockchain and Bitcoin seems to be on Terra Firma.
* 10/1/18
** 8/22/22
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