When Bitcoin Crashes, It Doesn’t Get Cheap (BTC-USD)
Cryptocurrency such as Bitcoin (BTC-USD) is such an unusual asset class that it is particularly bad when its price drops. As a value investor, I like investments that have fallen and are now cheap. Crypto has crashed, but it still isn’t cheap.
In fact, there is no price at which it becomes cheap. It is one of the few assets that does not become a better value when the price drops.
- When the S&P drops like the ~20% it has dropped this year, it becomes a higher yielding investment going forward.
- When the Dow Jones or NASDAQ declines, its constituents on average become higher yielding investments in the future.
- Even binary speculative stocks get a better reward/risk ratio as they get cheaper.
The mechanism of each of them is similar in that they offer profits or, in the case of speculative stocks, the potential for profits. When the price drops, his investment buys more income, making them better buys as the market price drops.
Why Earnings Matter
I understand that the scholarship is like a popularity contest. Stocks go up and down based on preference and whim, but if we step back and really learn the underlying mechanics of valuation, it is inevitable that market prices will move towards fundamental earnings potential.
In the long term, it is a mathematical certainty that income will matter.
It all boils down to what present value really is – all future payments to shareholders discounted up to the present.
Every dollar earned ends up being paid out to shareholders.
The most direct route is through dividends paid out of current earnings.
The indirect route is that the retained earnings are reinvested in the business and in turn generate more profits. The extra income will eventually facilitate higher dividends.
Even in the extreme case of a company that never intends to pay a dividend, increased profits still benefit shareholders by increasing the value at which the company is ultimately bought out. You see, future buyers of the business will receive the revenue stream as compensation for the buyout, so the higher the revenue, the higher the price.
So earnings matter for all stocks, even growing companies that don’t pay dividends. Earnings growth always leads to an acceleration in value that is ultimately paid out to shareholders in one way or another.
Why Crypto is Different
Earnings yield is inversely proportional to price and when the denominator of earnings yield (earnings/price) decreases, earnings yield increases.
Crypto is unique. His earnings are $0, so he has a numerator of 0.
When crypto was on top of the world with an overall market capitalization of trillions of dollars, its performance was $0 in a few billions. As the crypto crashes, it becomes $0 divided by a much smaller number.
Zero is a mathematically interesting number when it comes to ratios. When it’s the numerator, it doesn’t matter what the denominator is, the result will always be zero. 0/X = 0.
This means that crypto as an asset class is uniquely positioned to fall excessively and potentially permanently. It’s not cheap. It does not become attractive because the price becomes low. It always has and always will have zero payoffs.
Now, when I say crypto has no income, I’m often met with a slew of dissenting opinions, so let me address some of those ideas here.
False notion of earnings #1: Blockchain is a valuable technology that will produce tons of revenue
I agree that blockchain is a valuable technology and I believe it will be used for some important applications and thus will generate significant revenue. The problem here is that owning a cryptocurrency does not convey ownership of any kind. By owning the Bitcoin cryptocurrency, one is not entitled to any kind of fee or royalty when the blockchain is used, even if it is the Bitcoin blockchain that is used.
There is no mechanism by which the owner of Bitcoin crypto actually gets paid, no matter how phenomenal the blockchain turns out to be. I have written more extensively here about how owning crypto does not convey ownership of the blockchain.
Earnings Misconception #2: Crypto Staking Generates Dividend-Like Earnings
Staking is essentially a form of financial engineering in which the number of shares is increased in proportion to the amount awarded. This is akin to a stock split in which everyone who owns McDonald’s stock now receives 2 shares for every stock they previously owned. When this happens, the value of each share halves.
So investors now have two $50 bills instead of a single $100 bill. No values were created, just a few numbers moved.
It’s like when companies pay dividends in stocks rather than cash. A stock dividend is meaningless because the dilution in per-share value offsets the increase in the number of shares.
False notion of earnings #3: Legit Companies Are Getting Involved In Crypto And Making Money Doing It
Yes, there are countless respectable companies that are profitably involved in crypto. Their involvement is often seen as a sort of endorsement of crypto and is used to promote the legitimacy of crypto.
I don’t see it like that at all.
I see it as opportunistic companies coming to take advantage of the latest market craze. In fact, the income they generate is functionally negative income for crypto investors. Allow me to elaborate.
Interactive Brokers (IBKR), Coinbase (COIN), Robinhood (HOOD) and many others collect fees and commissions in exchange for facilitating transactions. They earn legitimate income doing this, but where does that income come from?
Commissions and fees come out of the pockets of those who invest in cryptocurrency. Therefore, it is functionally negative income for Bitcoin and other crypto investors.
Not too late to get out
I sincerely hope that crypto investors don’t see this article as a personal attack. Please consider this as a warning and an opportunity to recover the remaining value of your investment.
Although I strongly believe the crypto will go to $0, there is still time to get out. The hype machine is still going strong, with crypto providers continuing to pump billions into advertising. As such, it is always possible to find someone willing to relieve you of your position.
I’ll end with a final thought: when an asset is truly valuable, it doesn’t need billions of marketing dollars to convince others of its value.