I warmed up to Bitcoin back in November of last year and called the bottom back on April 2nd and then Bitcoin proceeded to go on a furious tear hitting a local peak of $14K on June 26th. It’s retraced from that peak to the $11K range today but still up 250%+ off the $3K bottom. This big move begs the question, is it too late to buy Bitcoin now?

I can’t tell you what to do as I don’t know your personal financial situation and level of sophistication, but I will share the decision-making process that I went through to make the decision to buy Bitcoin. I’ll go through some of the factors I evaluated, like my expected return on Bitcoin vs other potential investments, my thoughts around the current state of fundamentals and technicals, in addition to what makes an attractive entry level.

Every investment should be evaluated based on it’s expected risk/reward (RR) and compared to the universe of available investments. Our estimate of RR of course is subjective, but we will make some conservative assumptions. Bitcoin is very volatile and moves up and down in short and longer- term cycles. Without great risk/volatility you cannot have great reward. Each year Bitcoin survives, the network becomes larger, and Bitcoin becomes stronger. @josh_rager posted this fantastic log chart on Twitter that clearly visualizes these longer- term cycles (3 completed cycles, we are in the 4th) and the associated returns of each previous cycle. We can see that the cycles have lasted from 245 days to 1200 days — the trend seems to be that they are getting longer. The returns for each cycle, however, are compressing from 319K% (yes, thousand) to 12K%. Extrapolating this curve gets us to a 2400% return over a period of 1200 days off Bitcoin’s $3K bottom in early 2019. It’s highly unlikely that it will play out exactly this way, but I tend to think the longer term trend will play out, albeit with a flattening cycle.

If we simply extrapolate the log scale trend line of Bitcoin’s upward trajectory from 2011 this gets us to a Bitcoin price of $58K by the end of 2020. This amounts to about a 400% return over 18 months. Of course, as I mentioned the chart implies the cycle is elongating but I will use this 400% return over 18 months to be conservative running our RR calculation.

We’ve examined the potential upside, what about the downside? We’ve talked about what can go right, now let’s address what can go wrong. Worst case scenarios for Bitcoin here could be a significant regulatory crackdown, a financial markets crash, a large-scale hack, or some kind of software bug that significantly impacts Bitcoin price. I would categorize these as demand shocks and I will go through them individually but while they could cause a huge draw down in price, these factors would be transitory, and Bitcoin would recover. Of course, the fundamental backdrop could change (Central Banks tightening?) or a technologically superior coin could take share and Bitcoin and in these cases, Bitcoin could potentially go to zero but I don’t see it happening quickly.

Let’s quickly run through each of these risk factors, starting with a change in the regulatory environment. I think a significant regulatory crackdown in the US or globally is unlikely — first regulators would have done it by now, which brings me to my second point — it would hurt too many investors and the job of the regulators is to protect investors. US regulators have shut down some smaller exchanges and more recently they seem to have intimidated the world’s largest crypto exchange, Binance, into opening a US subsidiary to cater to American clients with proper KYC/AML. I would love to see more regulation of the shadier exchanges and ICOs but I don’t see a large scale crackdown at this point. I believe regulators are focused on improving KYC and AML provisions, and I think that his exactly what they should be doing. There are cities and countries, mostly in Europe, that are embracing the cryptocurrency ecosystem. Plus established companies in the US like Facebook, Fidelity, eTrade, CME, TD Ameritrade, and the ICE Exchange to name a few. Do I think regulators could block Facebook’s cryptocurrency, Libra? Sure they could and it would be a near term negative, but I don’t think this would derail Bitcoin’s course longer term.

Significant hack of a Mt Gox magnitude. The reason Mt Gox hack was so significant was that at the time there was only one crypto exchange in the world. Today, there are hundreds of exchanges and legacy players like ICE, Bakkt, e-Trade, CME, and TD Ameritrade entering the space. We saw the largest crypto exchange, Binance, get hacked recently with minimal disruption. Bitcoin is very robust, remember, it’s never gotten hacked. When thefts of Bitcoin happen it’s exchanges, wallets, and phones that are being hacked. The analogy is banks being hacked or robbed by traditional bank robbers. My on-line banking website seems to go down quite frequently these days, so it was no surprise to me when I saw this quote, “Cyber risk is probably the biggest risk the financial system faces,” from JPMorgan CEO Jamie Dimon. I believe the traditional banks are under siege from hackers and much of the theft is just not reported. I’m not saying that your money in the bank is at risk right now, but the problem is getting much worse. And, back to my point, banks getting robbed doesn’t reduce our confidence in the USD, so why should it reduce our confidence in Bitcoin? Especially when Bitcoin itself has never been hacked.

Finding a significant software bug or the Bitcoin network crashing. This goes hand-in-hand with the previous paragraph on hacking as usually some kind of software bug enables the hack. Bitcoin is open source and folks have been trying to hack it for 10 years now without success. If there was a fatal software bug and the network crashed or went awry, I believe the blockchain would be rolled back. The network could crash from a global power outage but when has this ever occurred?

Bitcoin is a risk asset so a financial markets crash would have a significant impact. The easy monetary policy we’ve had this century can be characterized by the old saying, a rising tide lifts all boats. When we have a financial markets crash- and we will- we will find out who is swimming naked. We are in the longest expansion in US history and I’ve started noticing commentary from high profile investors, bureaucrats, and execs that “this time it’s different” and that we’ve figured out the magic formula to endless economic expansion. I have 100% certainty we will have a financial markets crash and that Bitcoin will be affected. The magnitude of the impact to Bitcoin partially depends on how much leverage is employed when it happens. From what I’ve seen in the past, Bitcoin tends to go down a little less than stocks and recover faster but Bitcoin is too young to have been tested in a stock market crash.

Bitcoin has no intrinsic value or valuation support, it can go to zero. There is no intrinsic value- assets or cash flows- to support the price. Even in the worst-case scenario, if Bitcoin does go to zero, it doesn’t mean you have to hold it all the way to zero. I’m not saying that you should put tight stop losses on your Bitcoin investment but stops 30–40% from the current price that you shift up over time are advisable. The reason I don’t advise tight stops is that there are frequently big pullbacks in Bitcoin price in the 30–40% range. Many of these draw downs are initiated by “whales” or manipulators that hunt for stop losses as a trading strategy. They look at order books across exchanges- which are today available through APIs- combined with where trades have been grouped historically to forecast where the most stop losses are grouped and then drop big market orders at times when trading is thin. Very recently, on June 27th we saw a peak-to-trough pullback of almost 35% in one day. The price peaked ~$13,900 on June 26th and dropped to ~$10,300 the following day so if you had a stop anywhere in that range, it would have been tripped. Of course, if this happens there could be tax liabilities triggered also.

For the risk reward calculation for Bitcoin, to be conservative, I will assume the downside is 100%, you lose the whole investment, and a 400% base case upside scenario over the next year and a half. Now we need to handicap our probability of these occurring to get our expected return. This also is very subjective, but I think it’s better than even for the upside scenario. I think it’s 80:20 but let’s be conservative and assume it’s 60:40. This gives us a probability adjusted expected return of Bitcoin on Bitcoin of 200% over 18 months, conservatively. But don’t go throwing your life savings into this because this is an “expected”, not a guaranteed rate of return. There is no diversification benefit to owning a single asset and the downside scenario, which there is still reasonably high odds of coming to fruition, could cripple your investment portfolio!

Now that we have our RR for Bitcoin, let’s figure out the RR for the alternatives starting with stocks. We are in the longest expansion in US history, recent decades have been marked by asset bubbles that give us a decade — give or take — of good returns followed by a large crash. The hubris and excess in the financial markets today is starting to remind me of the 2000 dotcom bust when I was working at Lehman Brothers covering Semiconductor and Computer Hardware stocks. The 2008 Great Recession was driven by excessive risk in mortgage lending, and when the mortgages went South it almost took down the whole financial system. While stocks lost 50%+ of their value in 2008, I wasn’t seeing the excess and hubris that marked the 2000 Tech Bubble in the stock market. Today’s bubble is a debt driven, “everything bubble”, driven by extremely loose monetary policy and currency wars. Ray Dalio, in his new book Big Debt Crises — warns we are in the late innings of a 75 year debt super cycle that has the potential to lead us into a depression. On this matter, I will defer to the Mr Dalio, who is the founder and co- CIO of the largest and one of the most successful hedge funds (it’s a macro hedge fund so this is their specialty) over any politician, CEO, or economist. Today, like in 2000, unprofitable companies with huge market caps run amok — Uber has a $78B market cap and lost more than $1B last quarter. EBITDA and price to sales ratios and other “creative” valuation metrics are popular again — millennial darling Beyond Meat trades at 100x sales. The Softbank $100B Vision Fund invests hundreds of millions at a time with little due diligence- they just invested $300M in a dog walking app. Currently 21% of Russel 2000 companies lose money while 22% of them are “Zombie” companies that can’t afford to pay their debt — that means their 12 month trailing interest expense exceeds the EBIT average over the last three years. That being said, it’s very difficult to predict when this bubble will burst and usually the tail end of a bubble has the most extreme price appreciation. So, I will say 50% chance of 40% return over 18 mos and 50% chance of a 50% drawdown for stocks. This nets out to a probability adjusted expected return of -3% for stocks. Even in the case where stocks don’t have a big drawdown and they return 40%, this will likely occur due to continued ultra-loose monetary policy, which will benefit Bitcoin much more than stocks.

I’ve summed my views on the various asset classes and potential rates of return for the next 18 months on the below worksheet. As you can see just a 5% allocation to Bitcoin over an 18 month period improves the return from -2% to +8%. But don’t take my word for it, if you disagree with any of my assumptions (I’m sure lots of folks don’t think stocks will go down 50%) here’s a link to the sheet so please feel free to enter your own assumptions.

The main fundamental driver for Bitcoin, concerted global Central Bank easing is alive and well. Christine LaGarde was just tapped to be the next President of the ECB. From her commentary we know that she is supportive of both crypto currencies and negative interest rate policies (NIRP). The most recent fed meeting had dovish commentary and expectations are for a 25 bps rate cut this month in the, “strongest economy ever”. Both of Trump’s latest Fed nominees hold dovish viewpoints. The Fed has backed itself into a corner- consumers and businesses are now addicted to low rates. By cutting rates further the Fed knows they are encouraging more risk taking and the continued Zombification of our economy. The level of inequality is so high right now that the vast majority of any kind of fiscal or monetary stimulus doesn’t stimulate the broader economy, it is immediately captured by the wealthy and invested in stocks. And, needles to say the majority of these public companies (except the Zombies of course) don’t need capital or further inflation of their stock prices. What they need is customers who can afford to buy their products and services. Central Banks are forced to keep cutting rates and increasing deficit spending, each dollar less effective than the last, until it ends in a spectacular crash, that no one could possibly have foreseen coming.

At what level do I buy Bitcoin? That is the million-dollar question as choosing your entry can be challenging. Ideally, you want to buy it above a support level and then you pray for that support to hold. Also, keep in mind that Bitcoin historically has always presented us with large pullbacks in the 30–40% range, which tend to be good entry points (see below chart). We recently had one of these where Bitcoin went from $14K to $9.6K. Right now, we are sitting just above a weakish resistance band around $11K.

When/where do I sell? I don’t believe in round tripping investments, but I also don’t believe in over trading a vehicle like Bitcoin. I’ve talked to several people who became full-time Bitcoin traders during the bull-run of 2017, who regret dedicating so much time to the short-term trading. They seemed to think they could have done just as well, or close to it, by buying and holding. This is where the HODL mantra comes from, don’t overthink it, just HODL. The time to sell will be when we’ve had a parabolic advance, leverage and funding rates are high (leave that one to me), and everyone, including your mom, dad and Uber driver own Bitcoin. Remember December of 2017? Bitcoin was the topic of conversation at every Holiday party (much like real estate in 2008) plus there was a permanent Bitcoin ticker on CNBC. We are nowhere near that stage; this first inning of this bull market has been more driven by whales and family offices IMO. I think institutions are in the process of doing their research and due diligence and will soon come in as a source of funds, and retail will FOMO in around $20K. Today, I just don’t have a lot of folks asking me out of the blue what is going on in crypto which is a good sign.

In summary, we are in the early stages of Bitcoin’s 4th bull cycle. I think the cycle could last between 2–4 years with returns in the range of 400–2200%. Based on this expected return vs other asset classes, I believe most people should consider allocating a small portion of their investment portfolio to Bitcoin. Be careful on the entries and stop losses, prepare for BIG 30–40% pullbacks, and most important of all, don’t over trade, just HODL!