A Safe Bitcoin Trade?

Note, that question mark is at the end for a reason. Is there really such a thing as a safe way to own bitcoin? There just may be!

First, as always when I broach these topics, I am not giving investment advice. I am not suggesting you put this trade on. This is really more of a paper portfolio idea that might be a prompt for someone to do additional research on their own.

OK, with that out of the way, if you’re expecting me to tell you this is a great time to buy or sell bitcoin, well, you’re in the wrong place. The most I’ll say about that is a) I think bitcoin has some non-zero value as an inflation hedge but b) not as a currency, because currencies aren’t inherently volatile. I think the investment case is more equivalent to a precious gem (as it has scarcity value and some people find it fashionable).

What I can tell you is there may be a way to own bitcoin that limits your risk if it goes down 50% or more. If you’re sensing a hedge, you’re on the right track. So how do we hedge bitcoin to limit downside?

Gold? Nope, it doesn’t correlate well. The dollar? Obviously not. Microstrategy stock? Maybe, but that’s more a theoretical hedge. I’m not sure if it works in practice or not.

Doge

No, the obvious hedge to bitcoin is something that’s just as volatile, trades with the same sentiment, but is less likely to have long term value. May I introduce you to Dogecoin!

For those that don’t know, Doge is the ultimate symbol of insanity. It was created as a joke and wasn’t meant to have any value. Yet, it’s value, in aggregate, peaked at over $50B last week. Rather than be scarce like Bitcoin, Doge supply is unlimited. There is no logical reason it should have any value.

When the investment world decides to be safe again – and someday it will – there is a good chance Dogecoin goes to 0. So am I really just making a call to short Doge? If so, why not just do that without a hedge? Or go long something safe against it?

You certainly could, but if you are trying to minimize volatility, a naked short in Doge is dangerous. It seemed like an easy call 500% ago. Who knows how extreme things get before the top?

However, if you have the capacity to stick out a trade, the risk/reward of long Bitcoin, short Dogecoin seems very compelling. Let’s do some scenario analysis.

Crypto Becomes Mainstream

For our first scenario, let’s assume crypto becomes widely accepted. Not ubiquitous as the mega bulls might anticipate, but that it becomes something like gold where it can be used as a medium of exchange and nobody looks at you funny for trying to buy a car with Bitcoin.

What would that mean for our respective positions? Well, it is debatable what the value of Bitcoin would be. It may be that expectation is already discounted in today’s price, so it would settle lower, but still at a substantial level, or perhaps it would continue to go higher.

The good news is we don’t need to think that hard to figure that out. If “fair value” is 100% higher from here or 50% lower, it will still likely do better than Doge. Why? Because it is hard to imagine you’re ever going to be able to buy anything with Dogecoin. It is highly likely to go down substantially over time, so our trade works.

Crypto Goes Away

Now, let’s take the other extreme. The bears are right and crypto is a fad. Whether it be due to environmental concerns or a realization that crypto is a technology not a currency, the bubble bursts and Bitcoin goes down 90+%.

While this obviously would be painful as a holder, the good news is we have our Dogecoin short. What will happen to it in a world where crypto loses interest? I think we can say Doge would be down 99%, maybe even 100%.

So it is a small benefit to be long Bitcoin. Obviously, it would be better to be naked short Doge, but remember, this is in the long term and, if it triples first, you might get forced out of the trade while you wait.

Certainly, if you feel strongly crypto won’t retain value, it is probably best to short Doge outright as long as you know you have adequate margin available to handle any near term volatility. If you are uncertain though, then the hedge still has merit.

Bitcoin Goes Mainstream While Dogecoin Disappears

This is really a variation of the first scenario. Bitcoin again is widely accepted, but in this case Dogecoin doesn’t even maintain any novelty value. People sober up and realize it was never a serious effort and it goes to 0. This is another win for our hedge.

Dogecoin Goes Mainstream While Bitcoin Disappears

I don’t think there is a way to produce this scenario, though I’m open to suggestions, so let’s cross this one off the list.

Muddle Along

There is one other outcome we should consider. No clear resolution. We continue to debate the role of crypto and have wide swings in market value as sentiment flips back and forth. In this scenario, Bitcoin and Dogecoin likely trade fairly similarly. The hedge might produce small gains or losses, but will, for the most part, generate little value.

Expected Value

Now, of course, it’s hard to put exact percentages on the probability of each scenario, but I’m not sure that matters too much. In muddle along and crypto goes away, you end up essentially breaking even. In bitcoin goes mainstream, you win. The only way you loses is somehow Doge wins while Bitcoin loses. I think we can call that a <1% likelihood.

So does this qualify as a safe trade? Mostly! If you have limited chance of losing and a decent probability of a substantial win, that’s a pretty good risk profile.

Warnings

However, the above assumes you put this trade on in a safe way, meaning in small amounts relative to your overall portfolio. Why? Because this trade assumes you are have a decent time horizon and that means you can’t have any outside influences that could alter that holding horizon.

Like what? Leverage. If you lever up the trade, it might go against you in the short term and your equity could get wiped out before the final outcome. Similarly, don’t use margin. Margin obviously can also force you out of a trade due to short term fluctuations.

Finally, be aware of the tax implications. Crypto trading is not tax friendly! If you are truly holding these positions, you shouldn’t have any surprises, but don’t take my word for that.

There is also the practical reality that it is unclear what market maker will let you short Doge. It may have an obscenely high cost of borrow which will sidetrack the trade.

But if you can find borrow capacity cheaply and have the time horizon to see the trade through, it certainly seems like a pretty high probability of at least breaking even.

NFL Draft Predictions

OK, this will be a fun one. I’ll predict the top 10 picks for Thursday’s draft (as if no trades happen) and then I’ll try to come up with possible trades that might muck it up. But first, I’ll give some quick thoughts on the quarterback class. The obvious analogue year here to me is 1999.

That was also a 5 QBs in the 1st round year with the top 3 picks all QBs. You had a clear cut #1 in Lawrence and Couch (just cause Couch didn’t work out doesn’t mean he wasn’t consider a near can’t miss at the time), the one year wonder from out West (Akili Smith and Zach Wilson), the small school star with amazing physical tools (Culpepper and Lance), the big name popular player with questions about reading defenses (McNabb and Fields) and the less exciting player from a big name school (McNown and Mac Jones).

I think, similar to 99, Fields ends up having the best career and, sorry Jets fans, but Wilson won’t work out. Also, if the Niners pass on Jones, he’s falling to the 20s.

On to the mock, I think there will be fewer trades than expected. I don’t think the Broncos or Patriots are coming up (Patriots likely trade for Garoppolo if Niners takes Jones) which means you’re looking further down to someone like the Raiders or Bears or Washington but that’s a pretty far move back for a top 10 team.

Team	Pick (No Trades)
Jaguars	QBLawrence
Jets	QB Wilson
Niners	QB Jones
Falcons	TE Pitts
Bengals	WR Chase
Dolphins	WR Waddle
Lions	OT Sewell
Panthers	OT Slater
Broncos	LB Parsons
Cowboys	CB Surtain

So, if there are no trades, we have two QBs free falling. We know the Falcons, Lions, and Panthers are looking to move back if someone wants a QB, but I’m not sure there are buyers. If you’re one of those teams like Chicago or Washington, why pay a ransom to move up to 4 or 7 if you think you might be able to wait and move up to say 12 or 14 for a lot less and still get your guy?

It’s a fascinating game theory exercise because you have this big void after #4 where teams can convince themselves they don’t need a QB, similar to what happened in the Aaron Rodgers draft.

If you want a surprise team in the top 10 that takes a QB, look at the Lions. They have everyone convinced they’re trading down, but if they don’t get the right offer might they decide to change course and groom a QB behind Goff? And if it’s a surprise trade up, I’ll go with the Raiders. Gruden falls in love with QBs and if he wants Lance or Fields, he will be aggressive.

Postscript

Remember when I said GameStop should raise money to take advantage of it’s elevated valuation? Well, they just closed on $500M! Good for them. They are truly proving a Hare! Still doesn’t mean they have a real business, but they have taken the $0 risk off the table by fixing the balance sheet.