Welcome all new subscribers to Alpha Letter. Every week I write about interesting opportunities in the public market. I focus on stocks off the beaten path. Broken businesses. Assets trading under liquidation value. Macroeconomics and where the economy is heading. I don’t like investing in large, popular companies and find a fascination with assets no one else is looking at.
Today’s piece will on bitcoin and how the crypto crash was predictable.
But before we get in today’s piece, first a word from today’s sponsor…
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The Crypto Crash Was Predictable
Back when I was in college I was driving to my friends house listening to NPR radio. It was an autumn day. Leaves were blood orange. The wind was brisk. I donned a flannel jacket and work boots that were covered in meat and grime. There was a soothing voice on the radio of a English man talking about the dark web. A place where people could buy drugs, guns, hitmen and anything else your dark side desired. I was intrigued. A black market for anarchists. Right up my alley. Later that night I downloaded the TOR browser and surfed the dark web.
While searching online marketplaces for drugs, guns and god knows what, I stumbled upon the term bitcoin for the first time. Within these online marketplaces an interested buyer could pay for all of their dark desires using a currency unknown to the majority of individuals with bitcoin. Before my first pilgrimage to the dark web I had no idea what a bitcoin was. Shortly after my introduction to the dark web, bitcoin began to pick up mainstream interest. At the time I think bitcoin was trading under $100 USD.
I continued to hear more and more about bitcoin and cryptocurrencies as time passed. The words I heard were from my nerdy computer science friends. They talked in terms I still don’t understand to this day. They seemed excited about it. Some owned it. Others used bitcoin to make transactions on the dark web. These nerdy computer science friends were excited about what bitcoin meant. I was more excited about online black markets. I imagined how these online black markets would remove physical transactions of buying drugs. The eBay of drugs with potential to remove local street dealers. The Amazon of selling coke!
A week or so later the first, best and infamous black market, The Silk Road, was taken down by the Feds. New online black markets immediately emerged from the fallout and took market share. Some of these black markets were more shady than others. One black market built up their business and allowed people to hold their bitcoin within their internally built online infrastructure. When that black market had enough bitcoins deposited they shut the website down and stole all of the bitcoin. Probably one of the first rug pulls. Way before the term rug pull was even invented.
I ended up joining the buyside a few years after the Silk Road was taken down. The term bitcoin was started to become mainstream. Friends I knew from high school, with zero education in finance or investing, were posting about bitcoin on Facebook. I went to small-cap conferences and bitcoin hype was everywhere. The most promotional and dirty companies you can think of were transitioning to a crypto business model. During a fireside chat at the conference the main speakers all talked up crypto and gave their price targets. Bitcoin was hovering around $5,000 then. The biggest bull said it would go to $50,000 in twelve months. They all seemed stoned to me. Just another hype and fad that comes and goes in financial markets.
After the conference bitcoin ripped through a higher valuation and the cryptocurrency officially went mainstream. This was during Christmas of 2017. While at Christmas parties, family members pestered me about bitcoin and what I thought. Everyone wanted to know how to buy it. This was before Robinhood launched the ability to buy bitcoin on their app. Cryptos were easy to buy at this time if you knew the industry. But as a retail investor wanting to gamble, the process was more complicated, limiting many from making the plunge into crypto gambling land. I continued to think that bitcoin was just a hype and market for gamblers to speculate. My value investor mindset never swayed. A Ben Graham student, straight as an arrow.
I talked mad crap about bitcoin at $20,000. The hype around the currency was crazy. Everyone talked about bitcoin. People who were not in the crypto watched as others made incredible money. FOMO was setting in. Fuck, even I was upset because I knew about bitcoin at under $100. Why didn’t I just buy some back in 2013 when I was looking up how to buy drugs on the internet? Moronic. Then at the peak in 2018 bitcoin started to collapse. By 2019 it was under $4,000 again.
I don’t remember much from bitcoin in the 2018-2019 era. Small-cap conferences were raging about electric vehicles this time around and bitcoin was put to the side. Things like Crypto Kitties were long gone and Tesla was in the spotlight. The same dirty businesses that changed their business models to bitcoin were quickly shifting to electric vehicle business models. The next hype was here. Bitcoin was set aside.
Then 2020 came. The world shut down. Individuals with nothing to do downloaded Robinhood and were introduced to day trading. Bitcoin went ballistic along with thousands of other altcoins. The retail traders who wanted to buy bitcoin during the 2017 hype, but unable to figure out how, found it easy to trade with Robinhood. FOMO kicked in hard. Gurus and experts on crypto came from every shady corner of the world. If you had any negative thoughts on bitcoin the famous words from the cult like followers of “have fun staying poor” littered your inbox. We went full on bubble. Anyone who thought in terms of free cash flow could see through the rose colored glasses. Everyone else was drunk on quick money.
During the final hype of bitcoin I was building a small media business on Twitter. I watched first hand people who were not financially savvy become rich overnight. Cryptos that went public would make a few rich as they dumped them on their followers. NFT influencers created images in Microsoft Paint and flipped them for hundreds of thousands. A new market was created by a fake online currency and everyone wanted to get rich. Public companies began buying bitcoin and other cryptocurrencies. Michael Saylor told people to mortgage their house to buy bitcoin at $69,000.
We went full on cult mode. If you talked bad about bitcoin negative hate was spewed everywhere. FUD. Big named gurus became the cult leaders. There were conferences in the Bahamas where the sheep came to watch their cult leaders speak. Celebrities started to endorse bitcoin. Fans of crypto changed their twitter profile image to laser eyes. Even the Bachelor became a bitcoin fan.
At times I thought I was wrong about the entire industry. Maybe there was a real use for all of this. But I always went back to my roots and turned towards financial history. Everything that was going on in the industry screamed a massive financial bubble.
Today the crypto industry is in full collapse mode. Exchanges that once were the poster child for the industry have turned out to be complete Ponzi schemes. Bad actors are starting to get exposed. Celebrities that endorsed these exchanges have had civil lawsuits filed against them.
The price of bitcoin has collapsed from a high of $69,000 to $16,000 as of this writing. Altcoins that made few rich are priced at zero. NFTs have zero bids. Investors have lost billions. Retail gamblers were burned. Many who cannot even cash out as the exchanges they traded with stole everything.
There were many signs the crypto industry was a complete bubble from the start. Here were a few:
People who never invested a dime in their life were getting rich
Shady companies at conferences were quickly shifting to a crypto model to capitalize
Celebrities began to endorse cryptos
Cult leaders like Michael Saylor were formed
Projects with zero real world use were valued higher than actual companies generating cash flow
Investing legends like Warren Buffett and Charlie Munger gave multiple warnings
The biggest sign this was a financial bubble was the lack of free cash flow. At the end of the day an asset is valued off all future free cash flows it can generate. Cryptocurrencies never generated their holders any free cash flow. Smoke and mirrors with the only value the ability to sell it for a higher price sometime in the future.
That being said, I do think there is a terminal value for an online currency like bitcoin. The ability to purchase items on the black market that are untraceable will always have some value. The online black market will continue to grow as well, leading to a higher terminal value for any online currency that can make the transactions work.
I think bitcoin continues to collapse here as more investors fly out the door. At some point it will make sense to nibble on bitcoin when maximum negativity fills the air. I don’t think we are there yet. But I do think we are close. At the end of the day, there will always be a need to launder money, buy drugs online, purchase guns and move money across international borders without the Fed knowing. Bitcoin accomplishes this.