Fortuna, Contrarians, and Crypto
By Parker on The Capital
In Machiavelli’s famous work, The Prince, the Italian philosopher asserted, “I hold it true that Fortune is the arbiter of half our actions, but that she still leaves us to direct the other half, or perhaps a little less.” One of Machiavelli’s greatest critics, Fredrick The Great, who wrote a chapter-by-chapter rebuttal of The Prince agreed with Machiavelli on this point saying, “the older one gets the more convinced one is that his Majesty, King Chance, does three-quarters of the business of this miserable universe.” When framed in this way, the prospect of investing sounds rather futile. In another sense, it emphasizes the importance of that part of life within our control. It implores us to be hyperfocused on preparing for opportunity — those few times when Fortuna goes our way. Machiavelli relates fortune to a raging river carving through the land and that we must prepare for it as follows:
it does not follow that men, when the weather becomes fair, shall not make provision, both with defenses and barriers, in such a manner that, rising again, the waters may pass away by canal and their force be neither so unrestrained nor so dangerous. So it happens with fortune, who shows her power where valor is not prepared to resist her, and thither she turns her forces where she knows that barriers and defenses have not been raised to constrain her. (The Prince, XXV)
Machiavelli wrote The Prince for literal princes, but we are all princes of our own assets and financial principalities. For princes, part of preparing for opportunity is a life-long dedication to the art of war. To Machiavelli, there are effectively two options: take calculated risks or settle for mediocrity. Machiavelli portrays this reality through Francesco Sforza, who, “through being martial, from a private person became Duke of Milan; and the sons, through avoiding the hardships and troubles of arms from dukes became private persons.” Of course, in modern times, unless you are China or Bashar al-Assad, martial power as a means to grow one’s estate is generally out of the question. However, Clauswitz famously characterized war as “the continuation of politics by other means,” thus the principles of war and winning are not so far removed from the political actions between principalities, businesses, or persons.
Therefore, if we accept Sun Tzu’s notion that, “all warfare is based on deception” and we accept the Clausewitzian view that, “war is the continuation of politics by other means,” through the transitive property, all politics is based on deception. As defined by Wikipedia, politics is “the set of activities that are associated with making decisions in groups or other forms of power relations between individuals.” This is also the nature of capitalism itself, which is perhaps at its purest form in global relations, where countries tend to operate in their own interests and mostly uninhibited by morals or a higher governing body. Part of coming to the negotiation table is understanding the interests and objectives of everyone involved. In investment terms, this is known as understanding the consensus view — or as Sun Tzu stated, “if you know the enemy and know yourself, you need not fear the result of a hundred battles.” By understanding the consensus, the assumptions and perceptions of reality held by an opponent, one may attempt to deceive and achieve exceptional outcomes.
That is not to say that there are no benefits operating within consensus, but that such deals will always be, by default, average. To truly find asymmetry in the potential of a deal, an investment, or trade, someone has to be deceived. Otherwise, the outcome is “priced-in,” so to speak. It’s not necessarily out of malice; sometimes people deceive themselves with false premises, assumptions, and information. Therefore it is necessary to always consider what others are missing so that they can be exploited and so that one can be, as the concept is known in the trading world, contrarian.
The debt investor, Howard Marks, describes the process of identifying potential investments using the model below. Of the four possible outcomes, only being right and having a non-consensus view leads to above-average gains. Note that one can still be right and follow the consensus and be profitable, but by following the consensus view it is impossible to beat the S&P 500’s average 9.8% average return over the past 90 years.
Billionaire Michael Steinhardt required of his interns the following framework for pitching an idea:
He should be able to tell me, in two minutes, four things: (1) the idea; (2) the consensus view; (3) his variant perception; and (4) a trigger event.
Which brings me to crypto — 1) Long Ether (ETH); 2) Bitcoin will always dominate the crypto market, Ethereum has too much inflation, EOS has better scaling, and Ethereum is only used for silly cat games; 3) Ethereum is widely underestimated and the future impact of proof of stake, Dapps, and DeFi, is neither realized nor understood by the market; 4) PoS and Sharding deployment later this year that will allow Ethereum to scale decentralized applications for millions of users.
Speaking of being nonconsensus and right, Mike Novogratz and Dan Morehead, former Goldman traders turned crypto hedge fund managers, appeared on a virtual conference called the “AIM Summit.” They present the best case for Bitcoin I’ve ever seen. In one slide (below), describing the recent impact of COVID-19 on the market, Bitcoin is clearly the winner above Gold and equities. Morehead mentions in his commentary that ETH is up 85% on the year, but notice that ETH is not even on the slide.
To be equitable to Morehead and Novogratz, it’s likely the institutional investors and family offices they are pitching to are already taking a leap investing in Bitcoin, let alone a lesser-known cryptocurrency. Morehead even goes on to say that he is speaking about Bitcoin as one would speak of Kleenex, as the largest brand in the space and as a generalization of the entire asset class. The question still remains: why is ETH still downplayed and viewed as a “venture bet” rather than an asset like Bitcoin?
I’m not claiming Morehead and Novogratz are being purposely deceptive, but they know the numbers better than anyone. It is true that Ethereum is a riskier play in many respects, but if it is truly asymmetric bets they are after, they are looking at ETH hard. Eth 2.0 Proof-of-Stake economics are too good to be ignored, and while neither manager will admit it publically, they know there is no competition. Just as the Winklevoss twins recently disclosed their recent acquisition of a “material amount” of ETH, clearly Morehead, Novogratz, and their respective funds are heavily invested in Ether as well. In the period between 2016 and 2018, Bitcoin rose by 5000%. Meanwhile, ETH grew by 8500% before both currencies dropped 80% over the course of the following year. Still, no one big is talking about ETH just yet.
BTC is still a contrarian investment due to the fact that institutions and retail investors are still skeptical and generally lack understanding of the currency. ETH is even less understood due to the underlying complexity and constant development. There is a significant amount of misinformation surrounding ETH propagated by maximalist and competitors which ironically just makes ETH a better buying opportunity. Vitalik Buterin recently tweeted the following about ETH’s inflation:
If this all pans out as planned, the disruption of Bitcoin as the de facto “digital gold” could be a formidable threat. Historically, Bitcoin has a huge bullish effect when it decreases its inflation by half. Imagine a coin that is actually deflationary and the subsequent effect on the price after a long period of inflation — which would be the aggregate effect of multiple mechanisms in ETH 2.0. On top of that, imagine lower fees, faster transaction times, more use cases, and continual development. All this to say, BTC could go 10x this time around, but ETH is likely to match that or do better over the next few years.
BTC is the safer play, but ETH is more asymmetric. Both are extremely contrarian and therefore provide the most attractive opportunities available in any asset class. To use Machiavelli’s example, it is important to prepare for the raging river of fortune, floods and droughts alike, and crypto seems a good defense against the newest path carved by that river: quantitative easing by central banks. The new environment this river has entered looks more and more like one without physical money in our pockets, but digital currencies instead.
Steinhardt and Marks quotes from the book “The Aquirer’s Multiple”
*This is not investment advice, only the author’s opinions.