When’s the last time you thought about Esperanto? Not being an “esperantist” myself, it had been a while. Yet I was searching for some kind of metaphor for bitcoin: a fictional and entirely artificial currency without state backing and having a value tied strictly to facilitating global peer-to-peer transactions when I remembered the fictional and entirely artificial language without state backing and having a value tied strictly to facilitating global peer to peer conversations. Esperanto still exists, but today it is more known by teenage boys everywhere as a fictional car similar to a mid-70s Cadillac El Dorado in the video game Grand Theft Auto (or so Google tells me – this author loves cars but is no gamer).
Esperanto was developed in the late 19th century to be a universal second language. The idea was simple and appealing: everyone would maintain their native language and learn Esperanto, such that wherever one traveled he or she could converse with the locals. There would be no need to learn the local language of where you were traveling, and an esperantist could, theoretically, travel anywhere and converse with anybody. Esperanto was based on an amalgamation of several romance languages with a rigid set of phonetic and grammatical rules that would be easy to learn. Esperanto’s algo, as they say, was robust. It sort of caught on, but mostly as a niche skillset. Today, Esperanto is spoken by between two million and ten million people worldwide – approximately the same number of people who have accounts holding cryptocurrency.
We’ve put off writing about bitcoin in this blog, partly because we really don’t understand it, few of our clients invest in it, bitcoin’s performance has little to do with whether the RIA industry performs well or poorly, and we desperately wanted to avoid making allusions to tulips. The attention that cryptocurrencies received in late 2017 got our attention, though, as a barometer for trends that will buffet the investment management industry in 2018. Our cursory understanding of bitcoin suggests:
1. This Market Craves Volatility
The financial market experience of 2017 felt like standing in the Whitney Museum watching all eight hours of Andy Warhol’s film, “Empire.” We kept expecting something – anything – to happen, but it never did. Despite a raucous political landscape, global instability popping up everywhere, and pinched cultural nerves at home, the financial markets in the U.S. were very nearly sleepy. With little of interest going on, the market needed a narrative that only a fictive asset with an uncertain purpose could supply. We have, it seems, made it full circle from the credit crisis, when the only asset class in vogue was cash, to a market in which the only asset in vogue is fake cash.
2. Traders Want Their Revenue Share Back
It’s difficult to overstate the degree to which trading revenues have been decimated by technology. I’m old enough to remember the “5% rule” being a topic on the Series 7 exam. The thought, today, that prime brokers could ethically charge commissions as high as 5% on each side of a trade is beyond laughable. Suffice it to say, though, that trading used to command a much higher share of investment management revenues. Trading was a valued skill. Technology has destroyed that, as have placid markets and pricing transparency. Bitcoin is a mysterious asset with an unproven market and substantial bid-ask spreads; traders can exploit it so they love it. Look for new products that have pricing inefficiency and arbitrage opportunities that can generate trading revenue.
3. The Lines Between Asset Classes Are Blurring
We haven’t fully left the 60/40 world where asset allocation meant choosing capitalization brackets in domestic and foreign equities, mixing fixed income investments across different maturities and different ratings, and throwing in some cash for a rainy day. However, portfolio construction isn’t as simple as it once was, and it probably won’t be again anytime soon. Bitcoin wasn’t the first shot fired at this way of thinking about diversification, but over time the investment community has become littered with categories of investments and some blurring of lines (i.e. large cap domestic companies tend to generate material amounts of profit overseas – so are they “domestic” or “global”?). What bitcoin suggests is that investors have come a long way from having to be talked into investing in something other than treasuries and the S&P 500. “Buying what you know” seems to have lost favor in a world where speculative upside has, at least for some, become more sought after than returns which are measurable and knowable.
4. Investors Are Becoming Complacent
An old and true Wall Street maxim is “every bull market climbs a wall of worry.” Does it feel like we’ve run out of worry? From a practical perspective, it appears that the “wall of worry” is lower than normal. Short interest is in retreat, reserve cash is being depleted, the yield curve is flattening, and nobody cares. Bitcoin is interesting as a gauge of the market’s appetite for speculation. A short nine years ago we were in the throes of the credit crisis, interest rates were going negative throughout the world, investors were shunning equities, and my favorite metaphor for the chaos was uttered (I just don’t remember by whom): “We’ve lost the buoys that mark the deep channel.” Now we’ve swung to the other extreme. I haven’t wandered down to the office library to blow the dust off our copy of “Dow 36,000”, but I’m getting close.
5. Finance Evolves Slowly, But It Also Evolves Constantly
Cryptocurrencies are less than a decade old, but the concept has gained ground rapidly. Yet the big banks have largely stayed out of the fray, with Jamie Dimon being openly dismissive of bitcoin in October, and Goldman Sachs only recently announcing that it would open a desk to trade cryptocurrencies; even that won’t be operable until the summer of 2018 (!). So if you feel like you’re being left out of the party, you have good company. What this all demonstrates is that the financial services community changes slowly, which explains the pushback against the fiduciary standard and the mixed response to large broker dealers leaving the protocol. Markets move more rapidly than the people and the firms that serve the markets.
Final Thoughts on Bitcoin
Are cryptocurrencies an asset class? Is bitcoin speculation or a hedge? Will bitcoin have a permanent place in finance or will the magic fade? Is it going to $100,000 or zero? We have no idea.
The idea of a universal second language should have worked. Esperanto still exists, but possibly because it doesn’t reflect the life and culture of any particular subset of humanity, it’s really just an effect for the erudite. This makes us wonder about the future of bitcoin. Because it is not state sponsored, it also does not reflect any particular segment of the global economy (except perhaps for that part of the economy that lurks in the shadows).
125 years or so after the development of Esperanto, the universal second language is English. Eight years after the development of bitcoin, the universal reserve currency is the dollar.
We don’t expect a revolution from cryptocurrencies in 2018, but the follow-through on the 2017 hype should make for a good show.
As always, feel free to reach out to us if you’d like to talk further.
