E3: Decrypting Digital Assets: Financial Game Changer?

Join us as we discuss how cryptocurrency and other digital assets have changed the financial landscape. Is it a viable asset in an allocation, what value does cryptocurrency have? Discover Basepoint's view on crypto and how it relates to our core principles and investment philosophies.

We kick things off with our segment, "What's the Most Important Thing" where we offer our insights and perspective on a relevant and timely topic on our minds. This episode, it's the Magnificent Seven. Be sure to subscribe to be notified of upcoming episodes. 
 

We hope you’ve gained some valuable insights or maybe even a fresh perspective on our topic today. We would love to hear from you with your questions or specific topics you would like us to cover. Simply email us your questions or suggestions to info@basepointwealth.com and who knows, your topic might be featured next.

Be sure to subscribe to be notified of upcoming episodes. Visit www.basepointwealth.com for more information and important disclosures.

Transcript

The Point Podcast, Episode 3: Decrypting Digital Assets: Financial Game Changer?

00:04

Welcome to the Point Podcast. We have informed intelligent conversations about today's financial topics submitted by viewers like you. Let's go ahead and get started. Here are your hosts, Landis Wiley and Alan Wallace.

00:24

Welcome to The Point, sponsored by Basepoint Wealth. I'm Landis Wiley, your host. I'm sitting here as always with Alan Wallace, Chief Investment Officer. Alan, thanks for joining me again. And thank you for joining in on today's podcast. If this is your first time tuning in.

00:39

What we do is we just like to talk about financial stuff. We do it oftentimes just sitting around in the office, and we thought it'd be kind of cool to invite you in and let you hear the conversation. So the way that this works, we have no idea what we're going to talk about today, no kidding. There are topics in a hat over here hidden behind the coffee mug, and in a few minutes, we'll reach in, pull it out, and see what we get to talk about. So, topics are submitted by you, the viewers, as well as those folks here at Basepoint, and so hopefully you'll 

01:09

find it insightful. Before we get to that we like to kick off each episode of The Point with a 60 second segment called The Most Important Thing. And just as the title suggests, The Most Important Thing is something really critical that's influencing the world of finance and by extension may be impacting you and your pocketbook day in and day out. So without further ado, let's look at The Most Important Thing. The Most Important Thing is the Magnificent Seven.

01:35

This is a congratulatory moniker given to seven mega cap stocks that are dominating the S&P 500. The club includes Microsoft, Amazon, Meta, Apple, Alphabet, Nvidia, and Tesla. These stocks are trading at more than 50 times earnings and make up over 27% of the S&P 500's total allocation. That means that $1 million in an S&P 500 index fund contains over $270,000 in just these seven stocks.

02:01

For 2023, these stocks were up 71% while the entire index showed a 19% gain. This means that the other 493 stocks in the index only increased by 6% for the year. This type of concentration and divergence is common at market tops, and with such a large allocation of the index comprised by such a small number of stocks, it necessarily indicates the volatility will be magnified. Keep in mind that volatility applies equally to advances and declines. The last time the market was this concentrated was in late 1929.

02:29

This situation is amplified by the large amount of assets being passively invested in index funds. Recent data indicates that almost 57% of all retirement assets are currently being passively invested. While there is no way for us to predict what will happen, or when, we can clearly see that this type of market situation has historically ended in pain for investors. Keep a close eye on these seven stocks. All right, well thanks for that segment, Allen. And so now we'll get right into the meat and potatoes of the point. As I shared earlier...

02:59

All we're trying to do here is have a conversation about finance. So we appreciate those of you who tune in and who send in topics that you'd like to hear us talk about. And so I'm going to reach over here. We'll grab this hat, Allen, and let's see what we get to converse about. All right. What do we got here? Here we go. How has cryptocurrency and other digital assets changed the financial landscape?

03:25

Is it a viable asset in an allocation? And what value is there in cryptocurrency? So cryptocurrency, you know, I think maybe there's a couple things involved in that question and maybe we need to cover the landscape in case folks out there are unfamiliar with it. So cryptocurrency, I think most people may be familiar with Bitcoin or Ethereum or Dogecoin, Elon Musk's favorite. You know, that's maybe the most common thing that you see on the headline.

03:55

news. Underneath that, you know, you have the underlying technology, which is blockchain, right? And so, you know, both from an investment perspective, as well as just maybe a utilitarian perspective, you know, it might be important just to kick us off, maybe just talk a little bit about the difference between blockchain and cryptocurrency. So yeah, I think that's a good place to start. So block blockchain is a distributed ledger technology. And so what that means is that

04:22

tens of thousands of computers have the same copy, and then you have to solve an equation in order to update that ledger. So in the case of a cryptocurrency, that means that transactions are going to process when that new algorithm is solved.

04:37

Blocking technology can be used for a lot of different things. One of the most useful purposes of blockchain and finance is they're trying to update the way that bonds trade, right? So instead of going through a custody agent or a clearing agent in order to transfer bonds, they update the ledger and distribute the changes in bond ownership that way. And I think that there are some really viable uses for blockchain technology over time because it's secure,

05:07

it's backed up because it's on multiple different computers. They all have to sort of agree with each other in order for the transaction or whatever it is that's being posted to be updated. It's difficult for a government to control that type of technology. So the blockchain technology itself, I think is probably viable over a longer period of time. Like anything else, we have to figure out what the uses for it are. I think that when the internet was first invented, we didn't think that our toasters and refrigerators were going to have internet, but they do now. So I think that the similar thing can be said for

05:37

blockchain, but there's a lot of money going into blockchain from the big banks. JP Morgan is one of those. Cryptocurrency is something that runs on blockchain, but it's a separate thing. So in the case of let's use Bitcoin, just because that's the one that most people are familiar with. You have you own a Bitcoin, you want to have a transaction with someone so you

06:03

you transfer some of your Bitcoin over to this other person and then when the ledger is updated, that transaction is processed and then you've had an exchange of value, right? On its own, that seems relatively simple and useful. The problem is that in order for something to be considered money, which a lot of people consider these cryptocurrencies to be money because it has currency right there in the name, but it has to be a medium of exchange, a store of value, and a unit of account.

06:33

cryptocurrency really only satisfies the unit of account criteria for being considered a

06:41

a money or a currency. And part of the issue is that there's significant volatility that changes the price of that. So you know, if you buy your groceries in the morning when bitcoins were 30,000, but then you go and try to do a transaction three days later when it's at 25,000, that's kind of inconvenient, right? You don't really have to worry about your money changing by 15% in a day that's in your pocket. So I think that that's a downside, right?

07:10

Well there is that classic story of the guy 20 years ago or 15 years ago that bought the Papa John's pizza in Bitcoin and now that would be worth millions of dollars in exchange value. And so that's the other thing. A lot of the original Bitcoins have been lost. I mean, you hear stories all the time about the guy that threw away the hard drive with $300 million worth of Bitcoin on it and he's out there with the bulldozer going through the landfill trying to find this hard drive. I think a significant amount of Bitcoin is actually owned by the government now.

07:40

I read recently that they confiscated something like 5 billion in Bitcoin over the last several years. The thing about Bitcoin that people say is going to drive its value is that there's a limited number of them, right? There's something like 21 million coins available. And last I checked, I think there are 19 million or so of them were outstanding. And the closer you get to that last Bitcoin, the harder the equation gets to solve.

08:03

The major issue with solving that algorithm is that it's highly energy intensive. We have all this talk about, you know, we're going to go green, we're going to move to electric vehicles, but it takes the same amount of power to process one Bitcoin transaction as it takes to settle 850,000 credit card transactions. So the amount of power that it takes to update that ledger one time can run an entire house for a month. So what you really have here is the monetization of energy.

08:33

And so if you look at how much energy it takes to process those transactions, it's about 65% of the value of the coin. So the Bitcoin processors themselves, if they make a billion dollars in a year, 650 million of that just goes to pay the power to run the computers that process the transactions. Interesting. So what we have, you have these smaller countries like El Salvador saying, hey, we're going to do all of our transactions in Bitcoin now, right?

09:03

It's a subsidization of energy from large economies like the US and China to these smaller countries. Right? So- One, didn't China, maybe I'm mistaken, but didn't China basically ban Bitcoin mining for that reason? Yeah, because it was putting a lot of pressure on their energy grid. Right? I mean, so when you're running on coal and you've got all these miners located in one location and you can tell where they're at, right? Because they're sucking so much power out of the system. Yeah, when your factories have to shut down in order for the Bitcoin miners to process.

09:33

I mean, there's a lot of creative strategies. I mean, I've read about one place where they're using a volcano to create the power. There's a lot of people talking about building small nuclear reactors in order to run their Bitcoin mining operations. But the bottom line is it's highly energy inefficient. And really all you're doing is you're converting energy into a fiat currency. And what I mean by fiat is that there's nothing backing it. There's no income unless you're a miner.

10:03

There is no way to put a value on what that should be worth. It's just supply and demand. And when we try to invest based on predicting psychology or social movements, there's no way for us to know where we're at. It takes two points to draw a line. And if we don't have some sort of income stream, then really all we have is an amorphous point and no way to tell what direction that's going to go. Well, it's interesting that you bring up the definition of it, of basically being a fiat currency unto itself, because one of the big arguments you hear in favor of cryptocurrencies in general, Bitcoin

10:33

specifically, is that it's a hedge against the devaluation of fiat currency. This idea that central banks around the world and governments are effectively turning on the money printing press, which-

10:46

We've experienced that here in the US, particularly in the last few years. Something like 40% of all US currency has been printed in the last three and a half or four years. The argument for a lot of crypto fans is that, well, as governments are printing money to prop up...

11:04

you know, some of the social programs and the giveaways and the subsidies that we're doing, that Bitcoin and other cryptocurrencies would sort of rise above that and retain their value. But you're saying it's basically just a fiat currency by a different name. Right. Absolutely it is. And part of the issue is that asset inflation and goods inflation are two different things. Goods inflation is the inflation of a gallon of milk.

11:32

Asset inflation is when the price of your securities go up. And unfortunately, inflation isn't always procyclical for asset inflation. And so you may say, okay, there's going to be inflation, so that means the price of this currency is going to go up because it's outside of the dollar. But if there's not enough money to prop that up, or there's not enough demand because you're spending all of your money on groceries, then the price of that asset will still go down, even if there's inflation. So one of the biggest mistakes is that your going to buy these

12:02

assets with no income in order to protect yourself against inflation. And that's not how it works. When you look at things like artwork or collectibles or antiques or things like that, they don't necessarily go up because there's inflation, because demand gets cut a lot when there's less excess money out there in people's pockets. Conversely, you'll look at something like gold, it typically does appreciate with inflation, because it's what the money is valued in terms of, right? So gold is a hard asset. You can hold it in your hand, 

12:31

It's had value for thousands of years. It's been relatively consistent They say that the price of an ounce of gold should be about 250 loaves of bread so you've got some sort of reasonable methodology for determining what it should be worth but you don't have any of those things with Bitcoin. Well, and I guess maybe we to the casual person you've sort of seen that maybe in action over the last few years because

12:58

certainly, there was a lot of focus on Bitcoin back in 2020, 2021. Not that there's anything going on in the world at that point in time, but there was a lot of stimulus money, we'll call it, being printed globally. Economies were shut down, locked down, businesses couldn't operate, people couldn't work. Government central banks stepped in and essentially, for lack of a better term, handed everybody a check.

13:24

Maybe not coincidentally, then, that's really when we saw the massive run up in price of Bitcoin and the other cryptocurrencies.

13:31

Since then, as maybe those excess savings that everybody got when they got their checks, as that dissipated, we also saw the value of a lot of the cryptocurrencies fall as well. That's illustrating the point that you were making that it doesn't necessarily as inflation goes up in your currency devalues, it doesn't necessarily mean the asset becomes more valuable. People just had less to expend on. Well, the other thing, keep in mind what I said was that it's a monetization of energy.

14:01

So what that means is that it's actually inversely

14:04

proportional to the to the value of the coin, right because what's driving the value of the coin is the miners get paid in coins when they when they process a transaction and they're paying the cost of the energy so as the energy goes as a price of energy goes up the profit margin on processing is going down. It's getting squeezed. The other thing to keep in mind is right now they're getting paid in coin in order to process the transactions But there's something with something like two million coins left to process and once that happens I've heard a lot of theories about

14:34

how that's supposed to operate. Oh, they'll just charge fees. Well, if it costs as much power to run an entire house for a month to process one transaction, and you've got 10,000 different computers all simultaneously spending that same amount to process that transaction, how much is the fee going to be to buy a loaf of bread at the grocery store, right? And it's another thing, you know, these smaller countries are using this to process because it's free right now, but will they be able to do that when it costs $25 to process a transaction? So you're going to get rid of a lot of those smaller

15:04

individual transactions and you're going to get back to the big transactions which are, you know, in a lot of cases arms dealership or you know international money laundering, I'm not saying that that's what is driving it, you know, the coin is used for like some people say hey, we should get rid of it because that's what they're you know, what they're using it for but it is involved right, and those are the larger transactions mean if you want to

15:26

hide a billion dollars, that's what you would use to do it. And so those big transactions will be sort of on their own and those smaller transactions of trying to use it to buy groceries are going to have to disappear once all the coins are outstanding. Right. So one of the things that's been in the headline recently is talk of central bank digital currency. Which

15:48

you know, as I guess maybe the it's a hard no for me, by the way I'm with you on that but you know, what's the similarity between the central bank digital currency argument and Cryptocurrency is that is it really just you know government central bank blessing over the same? Well, it's going to be regulated and directed by a government entity which is the exact opposite of what Bitcoin was, you know, it was sort of created for it was supposed to be this

16:19

this anonymous, you know, anarchy. And you're supposed it's supposed to supersede government boundaries. Well, if the government is issuing the coin, then you've sort of gotten rid of all of that, right? The other scary thing is, and we saw this a little bit in Canada during COVID.

16:37

the government will have the power to shut off your money whenever it wants. And I'm not anti-government, but I am anti-control over my finances. And so the thought of saying something that people don't like and having your money turned off, that's unpalatable to a lot of Americans. And I think that it's one of the reasons why we should continue to have money in our pocket instead of on our computer screen. To some extent, the amenity afforded by cryptocurrency in the early

17:07

days is already being chipped away at. I mean, here in the US, there's already, they're already asking when you file your taxes, did you buy or sell any cryptocurrency? And making the exchanges report to you if you've done transactions over a certain amount. Right. And obviously, proponents of crypto are pushing very hard for major custodians to support it, whether that's a Fidelity or a Vanguard or a Schwab or whomever. But the more it goes mainstream, the more it’s going to be subject to reporting

17:37

which kind of undermines one of the one of the key tenets of it. Yeah, I mean those are the advantages.

17:44

The issue, first of all, their big selling point all those years was the scarcity factor. There's only so many that are going to be processed. Okay, well, that was true until 300 additional coins were invented out of thin air. At one point, even some jokes that were like the Dogecoin, which was started as a joke, actually became mainstream. So, I think that scarcity aspect has been disproven.

18:13

And then just the cost of processing the transactions themselves is prohibitive. The more your price of energy goes up, the more expensive it is to process the transactions, the less money the miners make. And then also, it just puts more and more stress on our power grid. So we already have an aging, sort of inefficient power grid. And when you have a currency that is as expensive to process as 850,000 credit card transactions

18:43

That seems to me to be a step backwards. Right. So what do we tell a person who looks at crypto and says, well, is it an asset that I should be holding? Well, what I say is that our principles specifically state that we don't speculate. And when you have something that doesn't generate income, no matter how you look at it, whether it's a good idea or not, it's a speculative operation because there's no way to place a value on it. And there are no called strikes in investing. We don't have to swing at every pitch. Sometimes we have things that are just too hard.

19:13

And so we discard those and we focus on the things that we can calculate. We need to have income streams in order to value the price of an asset. So kind of going back to the difference between an investment and a speculative. Yeah, I mean, speculation is neither illegal nor immoral and also not very profitable. So the issue is that some people get lucky, some people don't get lucky, but those people that get lucky

19:43

don't know whether that's from skill or from luck. And so if you had, let's say you had a national coin flipping contest and all 360 million people in the US were participating, eventually you'd have 100 people that thought they were really good coin flippers, right? They'd be on the morning talk shows talking about their strategies, you know, I wear the same socks every day when I do my coin flip. But at the end of the day, 100 people had to be there. That's just the law of mathematics. And I think the same is true with some of these speculative operations is that if there's a thousand different speculative things

20:13

two of them are eventually going to pay off. And those people are going to be seen as really smart, even though someone was going to make money on those speculations at some point. Right. So pull out your crystal ball here. Crypto has been the big discussion last 5, 10 years. What's the future of it look like in your mind?

20:31

You know, it's one of those things I just don't spend any time thinking about. I think that it could definitely be around. I have no methodology for determining what the price is going to be though. Maybe it's a million, maybe it's a dollar, but there's no way to determine that. And so there's millions of investments out there literally that I can...

20:52

have some sort of idea what they're going to be worth in a decade. You're talking about one that I have zero context for. And I don't just buy things in the hopes that they're going to be worth more someday. I mean, that violates our principles. Greater fool theory, right? Absolutely, yeah. Eventually I'll find a greater fool to buy this for me. And so that's why we avoid it. Now that doesn't mean other people should avoid it. I mean, if it's in line with your goals and with your tolerance for risk, then that's up to you. But for us, we're going to stay out of that lane. Right, perfect.

21:21

Well, I think that's kind of a good place maybe to draw us to a close. So, you know, certainly it's a complex topic. You know, there's a lot of technical components to it that maybe have some merit. Crypto is a

21:33

you know, as a currency has challenges the same as maybe any other currency out there if you want to call it that. So yeah, I think that's good discussion and kind of good place to wrap them up. So with that, again, we appreciate you taking time out of your busy day to join in to the Point. Hope you enjoyed the conversation today about crypto cryptocurrency blockchain. And of course, as always, if there are topics, questions or things that you're just genuinely curious about that you'd like to hear us banter on about here.

22:03

Feel free to visit our website basepointwealth.com or send us an email info at basepointwealth.com and who knows, maybe your topic will be the one we draw the hat.

22:12

on a future episode. So thanks for joining us today and until next time, take care. Thank you for joining us for this episode of the Point podcast, sponsored by Basepoint Wealth. As always, you can submit questions or topics you'd like to hear discussed to info at basepointwealth.com. Be sure to subscribe so you don't miss any future episodes. Basepoint Wealth LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities,

22:42

investments or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. Be sure to consult with a qualified financial advisor and or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.