Investing Logic & Crypto Currency
I’ve never invested in Bitcoin or any other crypto-currency. However, our office spends a lot of time thinking about it. We allocate tremendous time analyzing all sorts of assets, most of which we will never invest in. A key to successful investing is knowing what you will do and why, as well as what you won’t do and the logic supporting this. If not, you are apt to chase every story thrown your way.
Aaron is a friend of mine who loves to chase all sorts of investments and gambles. Lately, his focus has been on Bitcoin.
In talking with him, I attempt to frame the conversation from multiple perspectives. For instance, if you bought Bitcoin last October, you’ve had an enormous return and you are an obvious rock star. However, if you chased the “hot thing” and bought the crypto-coin between February and May of this year, you have posted a significant loss. How do you feel now that you are underwater?
Such wide variability in outcomes is enough to make someone neurotic.
For this, or any other asset, we attempt to run through a check list to focus our attention. The goal is to assess an asset or investment as logically as possible.
I asked Aaron why he is attracted to this asset. Does he genuinely think it has solid investment merit? Or, is it simply a case of jealousy, watching others seemingly make money out of thin air. Jealousy will make you do lots of undisciplined and foolish things.
Often, we lie and deceive ourselves or use revisionist history. The similarities between great fishing stories and investing home-runs are so similar they are comical.
If Aaron genuinely thinks Bitcoin is a solid investment, he needs to write out his investment thesis.
Whether discussing Bitcoin, or any other asset, begin by asking these questions:
What gives this asset value?
What provides a sustained competitive advantage over any other asset?
What is your valuation process for this asset? If Aaron can’t do this, then he has no idea if he is getting a good deal or not.
Furthermore, rarely does a day go by without some politician discussing what should happen with crypto-currencies. As such, I asked Aaron, “What will the government do and how will regulation impact his investment?” He acknowledged he didn’t know.
Earlier in the week, Poly Network announced their system for transferring crypto-currencies had been hacked. Thieves stole $611 million in crypto-assets. Although this is the largest theft of crypto assets, it is not the only incident. Given this, I asked Aaron where he would keep his crypto-currency and what gave him assurances his cyber asset would be safe? With any asset, ask yourself how you will be protected from fraud.
Although Aaron heard about the theft, he wasn’t sure if he would be protected.
After offering these foundational questions, I asked Aaron, “Given everything you know about investing and Bitcoin, what will happen next?”
As I asked this, I added that you can’t just answer, “It will go up.” Write out your thesis supported by math and logic as to the expected rate of return and the time frame for this assumption. Assigning a time frame forces you to distill your instinct and logic and be more rational with your investment process.
Writing your thesis also allows you to determine if you were smart or just lucky. This process should allow you to determine if you will be able to duplicate your success.
If you can’t logically and consistently determine, within a reasonable range, what happens next, you are just gambling. One of the many negative impacts of the pandemic is that many people have turned to the financial markets to get their gambling fix.
I told Aaron I was okay with gambling as long as he was honest with himself, and it was something he could control. Investing and gambling are two completely different disciplines and unfortunately many gamblers are not honest about their odds or outcomes.
Regardless of the asset, all investors benefit from having a well-defined process of logic, discipline and documentation. Lastly, don’t be afraid to pass on an investment if you don’t understand it. There will always be another opportunity waiting around the corner. However, be patient as you wait for the right one.