Portfolio Rebalancing Is Dead And Bitcoin Killed It

The genesis of this piece is the fact that Bitcoin, and a host of other crypto assets, have outperformed just about any other asset class over the past decade. This has continued into 2021, even as we are in the midst of a significant selloff in May 2021 as I finish this content.

🤦 TLDR SUMMARY

• 10x investments are generally rare, and historically largely unattainable for retail investors.
• Crypto flipped the script on access to this type of outsized risk/return opportunity.
• The significant upward momentum in Bitcoin’s price over the last several years has increased it’s weighting in holders hodlers portfolios.
• The crypto (mainly Bitcoin) portion of my portfolio has increased from 4% to nearly 30% in the last 18 months.
• A decade into this unprecedented experiment, there is still more uncertain than certain in regards to what Bitcoin/crypto will become.
• In the face of this uncertainty, and sitting on significant unrealized gains, is it time to close out or trim the Bitcoin position?

---

OK, admittedly the “portfolio rebalancing is dead” is maybe a bit clickbaity. But let me explain why I think an asset like Bitcoin, and crypto at large, should not be treated the same as an individual company’s stock or fixed income asset when it comes to portfolio management.

It’s important to start with the context that bagging a 1,000%+ return on an investment is not typical, especially over just a few years. And for the retail investor it’s even more uncommon.

Opportunities with that type of massive upside are more typically found in investments at the earliest stages, e.g. venture capital. That outsized opportunity is, generally, reflective of the outsized risk associated with a company at the earliest stages of its lifecycle. Historically, asset classes like venture capital are only available to the very rich. Hence why these high risk, high upside opportunities are few and far between for retail investor-type folks.

Bitcoin and other crypto currencies have shared this possibility of asymmetric returns with venture capital in recent years. But, since day one, crypto had a feature that an asset class like venture capital does not have — accessibility.

Crypto assets did not just provide access to these extraordinary upside opportunities for the individual investor; these assets actually flipped the script.

This time it was the very rich lacking access to the asset class. Institutional investors, venture capitalists, and hedge fund managers have had a difficult time accessing Bitcoin due to regulatory issues as well as general societal constraints.1Even if they believed in the technology, money managers weren’t recommending their high net worth clients or institutional clients buy Bitcoin pre-2017 or even pre-2020. Why? The stigma associated with doing so. Conversely, retail investors have accessed Bitcoin with relative ease for several years.2Ease meaning without having to be overly technically savvy…

By the time the third Bitcoin bull run hit circa 2016 (cycle 3 in the chart above), there was enough of a track record plus increasingly robust and reliable information for a new cohort of retail investors3E.g., less technical to get involved.

During the latter part of cycle 3, a popular talking point was the idea of putting “1% of your portfolio” in Bitcoin. Place that small bet. Set it and forget it. You might even call it schmuck insurance. This is essentially what I did during 2016 and 2017.

In the pie charts below, you can see that this portfolio’s concentration in crypto assets has jumped from 4% one year ago to ~20% as of early in Q1 of this year.

As the 4th cycle picked up steam, crypto’s weighting increased to nearly 30% of the portfolio.

After “setting and forgetting” for years,4I did sell once. More on that in a minute. the percent of the portfolio allocated to crypto, mostly driven by the price action in Bitcoin and Ether, has increased meaningfully.5Bitcoin is the vast majority of the crypto holdings. If we add Ether to the Bitcoin portion of the holdings, that would approach 99% of the crypto assets in the portfolio.

I am going to refer to the crypto portion of the portfolio as “Bitcoin” throughout portions of this piece, as it is the predominate asset in that space.

Lastly, remember, as I’ve written before, the outsized cash position in Q1 2020 was a bit of an anomaly. A well timed one. 🙃 But an anomaly nonetheless.

The obvious question is… “Since it has become such a large part of the portfolio, should I be selling Bitcoin in an effort to rebalance?”

🥧 PORTFOLIO MANAGEMENT

Investopedia describes the reason for rebalancing as follows:

Primarily, portfolio rebalancing safeguards the investor from being overly exposed to undesirable risks.

Tim Ferriss and Kevin Rose chat about this very topic in a somewhat recent podcast in an approachable way.6Listen to about a minute and a half of this clip — from 29:20 to 30:45 — to hear the anecdotes I will refer to below.

A key concept is broached when Kevin Rose says, “If [the asset] does 5X or 10X from here, it is no longer going to be [X]% of your portfolio.”

That’s the precise situation that has brought this portfolio’s concentration in Bitcoin from 4% to nearly 30%.

Using traditional portfolio management techniques, and aligned with Kevin Rose’s advice, I would likely be compelled to trim the Bitcoin position. I’ve done exactly that in the past. While cycle 3 was in full swing, approximately late 2017, I sold part of my Litecoin position. It remains the only crypto I’ve ever sold.7During 2017 the first mainstream wave of euphoria in the crypto market was hitting a climax in November and December. It was obvious we were in a bubble. However, it was not obvious when the bubble would reverse course. It never is.

I chose to take part of my investment off the table, pay the tax man, to lock in an approximately 1600% return at the time.

With crypto, individual investors have access to these 10X+ opportunities. These ultra high risk/reward types of investments are fundamentally different than the assets retail investors are used to.

These assets break any traditional portfolio rebalancing model. This is how I’ve been thinking about it…

₿ITCOIN IS DIFFERENT

The best venture capital firms don’t often trim their home run investments at the first opportunity. The home run seed investments are the ones that call for follow-on investment in the Series A, and so on. That’s because the home run investments are the ones that become grand slams. The grand slams are what pay for the strike outs. Bitcoin is that potential grand slam.

Revisiting the Tim Ferris and Kevin Rose clip above — Tim says, “…you sure as hell better have a plan for if and when you are going to redeem to some type of fiat.”

I disagree with part of that premise. A plan is a great idea. However, I can’t see selling Bitcoin to move to a fiat currency like USD just because the relative Bitcoin to USD price has increased resulting in a feeling that Bitcoin is “richly” priced.

I feel this way because while equities, for example, are sometimes pegged to fundamentals like future cash flows — Bitcoin is not. For that reason one could argue Bitcoin cannot be priced “too richly” in the same way an equity can be.

Bitcoin’s price is based on the underlying technology/features,8I feel strongly there is a use case for an asset that has a completely fixed supply. monetary policy,9This M2 chart is why I feel strongly there is a potential use case for an asset that has a completely fixed supply… societal concerns and, yes, speculation. The current market capitalization is an amalgamation of all of those things.

Instead of simply moving to fiat, selling Bitcoin today should probably mean you’ve found another compelling investment opportunity that requires more cash than you otherwise have. A.k.a., you have no other choice but to sell.

🏁 CONCLUSION

Bitcoin is likely to see future drawdowns of greater than 50% if history is any indication.10As I wrap up this piece, and May 2021 rolls on, we could be in the midst of such a sell off. And while any asset can go to zero, the probability of that happening to Bitcoin is likely much higher than the average retail investment.

As new Bitcoiners come into the space, I hear a lot more about it being “hard to sleep at night” due to the volatile nature of the asset. If you are losing sleep over an investment position, it’s the principal investment that was too rich keeping you up. It’s not the magnitude in the fluctuation of the unrealized gains.

If you’ve invested an appropriate amount up front,11And have actually done your best to understand the monetary policy and underlying technology of Bitcoin… even knowing that very literally in this case the asset can go to zero, price action no longer dictates your ability to rest easy.

The Investopedia definition of rebalancing talks about “undesirable risks.” I knowingly signed up for a volatile asset when purchasing Bitcoin. Because of Bitcoins unique properties, as of now, I find that risk to not only be within my range of tolerance but downright desirable.

I will not be trimming the Bitcoin position at all.12Insert strong hands meme here. So, what does one do if they do not wish to sell their Bitcoin?

Well you hodl, of course.

---

APPENDIX: Emerging Bitcoin Trends & The One Thing That Does Concern Me

A couple of important trends are starting to surface that could shape the future of Bitcoin and specifically how it fits into the investment portfolio.

➡️ New products are being created that can provide liquidity to holders of these assets

Recently Coinbase offered me a loan against my Bitcoin holdings. It is certainly an interesting glimpse into a potential future.

Through these new products, Bitcoin could become an asset that can be used to access other asset classes as needed but without liquidating your position.13This works if the asset is appreciating (or potentially just holding its relative value) at a rate higher than the fees charged for this product. In a scenario where products like this gain traction, Bitcoin will be less likely to be sold to move to fiat. Rather, Bitcoin may be more commonly used to access other hard assets, e.g., land, real estate.

Another emerging trend is less a tangible product and more psychological.

➡️ Denominating this asset in Satoshis may become more common14I started writing this piece in January 2021. I was planning to offer this up as a prediction. By the time April turned to May, this idea was already picking up traction.

Denominating Bitcoin in Satoshis is something akin to a stock split. Like a stock split, the underlying value of the asset is not changing. So why talk about this financial alchemy?

One reason for a company to split a stock is to allow easier access to the asset. Conversely, that’s the reason Warren Buffet refuses to split Berkshire Hathaway’s A shares — he wants investors that are very longterm oriented and see it as something of a barrier to entry.

I would argue the popularity of Bitcoin loans are at least partially driven by the high relative price of a Bitcoin to USD. Shifting to Satoshis could create new Bitcoin use cases and thus new products and services.

Lastly, I want to mention what might be my largest concern when it comes to Bitcoin, and it’s not talked about often at all:

➡️ What happens if/when Satoshi moves the million or so coins that it is believed they control?

They have not been heard from publicly since logging off BitcoinTalk on December 13, 2010.15Outside of the public domain, 2011 emails between Satoshi and Mike Hearn have surfaced. But December 13, 2010 was the last time Satoshi did something publicly … with the exception of a potential 2014 post to the P2P Foundation claiming they are not Dorian Nakamoto in response to a Newsweek article.

Satoshi publicly stating the experiment is over and cashing out — this is what, if anything, might “keep me up at night” in regards to Bitcoin.