Cryptocurrency assets have been a remarkably contrarian industry, I’ve never seen our clients disagree with us so strongly on this, and I think part of this has to do with that, the formation of capital around cryptocurrency just hasn’t followed, past cycles. Crypto, like Bitcoin essentially needed $0 dollars to start, so it didn’t start with venture capital or private equity investment and it didn’t go public to raise more money and I think because it’s actually has gone under the radar, it’s created a lot of controversy. So there’s four topics I want to write to you about with regard to digital assets.
The first is really the idea of digital trust and why digital trust is important today, the second is that, this is very largely a Millennial phenomena, so we have to keep in mind that the generation that is going to drive this asset as an asset class isn’t really us, it’s really going to be our kids, or those who are Millennials today. The third is, I think crypto has already established itself as an asset class, so even if you don’t think it’s pertinent to your area of focus today, it’s emerging as an asset class and I can show you how it’s penetration of various financial channels is so small that this is I think in the earliest stages and finally, I just want to share with you 3 reasons why I think Wall Street is going to care, and remember if Wall Street dedicates resources to this space, it’s going to blossom and flourish and become a very important financial market channel, so these are the 4 topics I want to start with.
Now on trust, we tend to be very confident about the financial system in the U.S. because you know it works fairly well. But in a world that’s increasingly digital and if you look at the 5 largest technology stocks in the S&P 500, they’re essentially all native digital businesses. Digital trust is increasingly important. The second innovation that’s taking place today with blockchain and the we’re going to cover is decentralization and as we move towards a decentralized world, you know the question you have to ask is, does money have to be native in paper or could we have a native digital currency and the 3rd is I think we’re starting to see a trend towards tokenization or assets in the real world become native digital and again, digital trust becomes important.
Now to give you an example of why centralized trust systems aren’t working well, consider you may not be aware some of the high profile incidents in the past year, but the Malaysian Central Bank recently wired $50 million dollars to a hacker not realizing that this was a fake entity, so we know that centralized systems aren’t necessarily working well in a native digital world, but let’s look at how people look at trust in terms of government, because monetary systems are reliant on trust.
This is a Pew Research survey, and the question they asked is, “do you trust the government to do the right thing?”
The level of trust in the government is at the lowest levels in 50 years, so never have the average person more mistrusted the government and again, monetary systems are very reliant on individuals trusting their government. But this is a bigger problem outside the U.S. This same survey question was asked outside the US and the shaded area are the countries that trust their governments even less than the US.
So we’re looking at countries like Brazil, Argentina, South Korea, Italy, Greece. Not surprisingly these are the countries where digital currency development is flourishing so there is a very high correlation between the lack of trust in their government and the blossoming of digital currencies and again, what we have to keep in mind is were in the U.S. so the dollar we’re comfortable being the default currency. Outside the U.S. many people would rather not have things denominated in dollars.
Well, what about Millennials?
This is a Facebook survey done in 2016 and they asked Millennials, do you trust banks? 92% of Millennials don’t trust banks. Now part of that is the financial crises, they saw their parents lose their homes, but it just shows you that Millennials don’t have trust in centralized systems. So again I think one of the key themes and why it’s happening today for blockchain is the idea that blockchain is creating digital scarcity and native digital trust that trust doesn’t exist in existing systems today.
But I think a more important phenomenon and I think that is increasingly going to be studied is how important the Millennials are to financial systems. We know Millennials are a big cohort (a group of people banded together or treated as a group) and it’s been important to advertising, but let me sort of size this for you. Millennials are someone born between 1981 and 2000 and that’s roughly 96 million people that is the largest single generation ever in history. It dwarfs the Baby Boomers which peaked around 80 million. In fact, GenX which is my generation is so small that statistically and I’ll show you some charts, we actually barely moved the economic needle and in some ways that’s the reason why economic growth has stagnated for the last 10 years.
So why do Millennials matter? Well I think it’s important for every generation to understand that they need to look at the world if they’re going to understand the world through 20-year old eyes.
So I have an illustration here. For boomers, when Baby Boomers were in their 20’s, they were Tom Hanks. As you can see, Tom Hanks has aged really gracefully but he is no longer buffy. And GenX in their 20s was Leonardo Di Caprio, from Titanic, and in his 20’s, that’s what he looked like, but today he’s a distinguished gentleman. And so, what is a Millennials in their 20s today, I picked Justin Bieber because he’s sort of in that spectrum of cohort of where Millennials sit today.
The reality is, if you want to understand a Millennial you have to think like you were when Bosom Buddies was on TV and you were 20, so you really have to rewind the clock. And so why does that matter?
Let’s think about how each generation experienced technological and social change. So the Baby Boomers in their 20s experienced women entering the work force, a huge increase in their participation rate. The creation mail-order catalogue beyond Sears, so like Spiegel and Eddie Bauer.
Mainframe to PCs, I mean, this was you know the generation that Apple was created in the IBM personal computer and also Microsoft and graphical interfaces. Now GenX which was my generation experienced really 2 important disruptive technologies, wireless which was analog side of the time, but it became digital and it led to mobile email and text messaging and of course the convergence with the internet which you know is really powered the digital economy.
Those two technological innovations, I was very fortunate to be the research analysis for, so during my years of 1993 – 2007 I was a wireless analyst so I witnessed the growth of the wireless industry and covered it and helped the companies raise money, but also saw the convergence and collapse with the internet. So what did the Millennials experience today?
It’s companies like Facebook, Uber, AirBnb, Instagram, Kickstarter, things that we all use and in fact we all are very comfortable with but I’ll tell you that if someone had told you 1990, that there would be a $500 billion dollar market cap company that would be simply you sharing your information with other people and they would charge you no money, everybody in 1998 would say that’s a failure but that’s obviously the Facebook model so clearly social media is a Millennial story. But here’s some other things on that list as you notice, blockchain is a Millennial story and I’ll explain why I think that if Millennials adopt this the way we think they are, this is not the internet bubble, this is a lot more like emerging markets becoming an asset class, I think that’s really the appropriate analog.
Let’s just do a baby boomer illustration to understand why I think generational moves last more than 10 years.
This chart is the Japanese stock market, the Topix from 1950 to 1972 and it rose 40 times over that period of time, and that’s a monstrous, monstrous rise. Think about it – an entire country stock market rose 40x in 20 years. Interestingly, that’s 1972 at the top, that was the year Henry Kissinger invited Japan to the G7 so because the Japanese stock market nearly tripled in one year, they become a developed nation, part of the G7 and unfortunately you can see, after that peak, the Topix actually fell 50%.
Now you could imagine what this guys parents were saying, “Uh, son, we fought the Japs during World War II, why are we helping their stock market? They were in the middle of the Vietnam war, they just fought the Korean war, why would anybody want to invest in these less developed countries?”
Now in 1970, that’s really where Templeton was formed, John Templeton, at the time there were only 5 emerging markets he could invest in, but that was that moment. So let’s see how that advice played out, was it wise to say, let’s give up on Japan.
That chart previously is now on the middle of the page, which rose for another 20 years to 1990, you had a 40 year rise in the Topix with a 400x total return, for a country! This is not a 0.20 stock, this is an entire countries stock market cap.
So the point is, it’s a good thing that the boomers didn’t listen to their parents which was a silent generation. Okay, so let’s think about where the Millennials are today.
The average millennial is 26, which means they already started to drink and started to buy cars, we’ve known they’ve already transformed the alcohol market, there’s a preference for whiskey over beer and they’re already transforming the automotive market which you may not appreciate, Millennials are also driving a huge revival in the RV market. The last time RV sales were as strong as they were last year, Lucile Ball was on TV, so it’s been nearly 50 years since RV sales have been this strong.
44% of the buyers today are Millennials. Well, what are Millennials going to be doing over the next 30 years? Something you can see a mile away.
I have a population tree here and I’ve lined up each of the generations. The Millennials are now just entering two critical periods, the home buying years and their investing years. So let’s think about housing. I’ve lined up each generation from when they were age 21 to 35 and I colored each, the red is the Silent Generation, the Baby Boomers are light blue, GenX is blue and the Millennials are dark blue.
This tells us housing is going to likely boom through 2030. So stay long housing I guess, it’s really bullish. But let’s talk about investment years, savings flow, the investment pool of prime income earners is running about a trillion dollars a year today, so every year there’s about a trillion dollars that the people age 35 – 60 allocate and today, it’s dominated by Baby Boomers and GenX, but the Millennials are now just entering these Prime Income years. So what did the Silent Generation do when they dominated the prime savings flow?
They actually bought gold. Gold was $40 dollars when we went off the gold standard in 1971, it was the first time individuals could buy gold, and when the Silent Generation cohort peaked, gold was $600 dollars, 15x in a decade. Just by a single generation buying gold.
The Baby Boomers we know bought equities. What was the first year the Baby Boomers turned 35? 1982. That shaded blue area is the first boomers, to the peak size of the cohort, 1982 to 1989, coincidence? That was essentially the stock market boom and the question is, what about the GenX which was a smaller cohort, which you can see in that middle period, the stock market didn’t go anywhere. GenX wasn’t big enough to power the stock market higher. But here we think Millennials are going to drive equities they like, growth stocks, so we think it’s going to power stock market boom through 2038.
GenX liked hedge funds, as you can see that essentially peaked with GenX.
But here’s what I think Millennials are going to do, now remember Millennials are going to soon have a trillion dollars of savings flow.
Bitcoins rise in 2016 coincides with the first Millennials entering their prime savings years. Today, cryptocurrency, for every billion dollars that goes into cryptocurrency it’s turning into roughly $25 billion dollars of price appreciation. If Millennials put 10% of their savings, $100 billion into cryptocurrency, that’s a $2.5 trillion dollar rise per year and cryptocurrency is roughly a $500 trillion dollar market cap.
So we think you may end up seeing Bitcoin at the end of this cycle as high as $10 million dollars per Bitcoin. So I’m going to walk you through why cryptocurrency is an asset class. First of all, the St. Louis Fed actually published a white paper and it looked like it’s quite a viable asset class and you might say, “well, isn’t crypto breaking all of the rules that we know about?”
I went to Wharton and we had the 10 commandments or evaluation etcetera, but I think over the last 20 years a lot of rules have evolved. It used to be that 92% of the companies that went public had to make money. Today only 20% do, we already broken that rule.
Private equity used to only be 1/3 of the public market. Private equity now is 84% of the public market. It may be possibly in a few years, private equity is bigger than the public market. Bonds used to pay income, 84% of bonds have a negative income rate. So I think rules have already evolved, and just to give you some perspective, the S&P today, 77% of the S&P is intangible, if you liquidated the S&P today, you’d only get $0.20 on the dollar. The value of major brands today is built on trust, so here’s where we come to store of value.
People think gold is the only store of value out there, we published a piece of what’s the true store of value, with gold being one store of value, but it’s including collectible art, real estate, negative interest rate government bonds, cars and collectibles. That’s a $280 trillion market is used today to basically park money, excluding financial assts.
Bitcoin is $200 billion dollars. If Bitcoin ends up just being 1% of the store of value in the future, it’s $150,000 per coin. So again, from a mile away, I can see this value transferring towards Bitcoin and cryptocurrencies.
So now let me jump to why Wall Street is going to care. So there’s 3 reasons why Wall Street is going to care, the first is, there’s a lot of money being made in the crypto space. The biggest exchange for trading financial assets today is ICE, “Inter-Continental Exchange,” the only NYC, NASDAQ and their global, thousands and thousands of securities traded, they made $1.6 billion dollars last year. We estimate Coinbase could make $600 million dollars this year, it’s a cryptocurrency exchange, only has 4 currencies on it, and it’s about 3% of global trading, in 18 months, Coinbase may be more profitable than ICE and that is just mind-blowing.
I don’t think anyone could believe that ICE, the biggest exchange in America could make less money than Coinbase and that may be the future, so one, there’s a lot of money to be made and Goldman Sachs, Morgan Stanley, even ICE understand this and I think they’re building infrastructure into gateways into crypto. The second is that the crypto market is already large, it’s $500 billion dollars today, it would rank as the 20th largest country, so if you think about the emerging markets analogy, crypto is already the same size as Brazil, Spain, Singapore, Russia, it’s bigger than Ireland, Spain, Israel, Greece, Turkey, Vietnam. Wall Street has thousands and thousands of bankers, research traders, everybody, hedge funds dedicated to these other countries, this is going to start to focus on cryptocurrency and the third reason is that as a portfolio strategy, cryptocurrency is uncorrelated alpha. Now what does that mean?
Take a look at this, if you look at each of the those lines at the top, that represents the correlation of Bitcoin to stocks which is blue, to bonds which are red, gold which is gold and hedge funds which are light blue. Crypto, Bitcoin and crypto are uncorrelated to other markets right now, it’s uncorrelated. That is almost a holy grail for portfolio allocation, and to understand why this matters, the bottom line on that chart is if you had a trip typical 60/40 body equity portfolio.
If you put just 2% into Bitcoin, your returns would have gone from 6% to 8% and your drawdown would have actually been smaller and your annualized wall is lower. Bitcoin reduces your portfolio volatility, believe it or not. And that top chart, the blue one where it went stratospheric is a 5% allocation. So what we’re saying is, you don’t need to bet your firm on cryptocurrency to see uncorrelated alpha.
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