Wednesday, June 13, 2018

Bitcoin holders pay some 7% a year as fees to their "fund managers"

In February, I argued that the unbacked cryptocurrencies (almost all of them except for Tether) should be considered to be stocks in "companies" that simply don't produce any dividends (and have no plans to change it). Among other things, this unified treatment would simplify taxation.

People still pay huge amounts of money for these basically worthless stocks because they assume that a greater fool will buy it from them for a higher price in the future. This greater fool's theory dominates the price dynamics of the Bitcoin and others – which is why the P/E ratio is infinite i.e. very different from the expected value of 10 or so. For some reasons, lots of these would-be investors still haven't noticed that the cryptocurrency bubble has been deflating for half a year.

Now, when no one really believes that the Bitcoin is a miraculous guaranteed source of huge and safe profits (although some snake oil salesman periodically impress their sheep with "predictions" that the Bitcoin will be worth a million or a vigintillion dollars very soon), it makes sense to compare the "investment" to the Bitcoin with the investment to the stocks and funds with some extra details. I will talk about the cryptocurrencies' counterpart of the hedge fund fees and other fees.

Just to be sure, there are 1628 cryptocurrencies now whose total capitalization is almost $280 billion. That's a huge number but it's approximately one-third of the peak achieved in early January 2018.

The Bitcoin is the greatest cryptocurrency by capitalization. The number of these "coins" is currently 17 million and they're worth about $6,500 a piece right now, one-third of the peak near $20,000 in mid December 2017. That's $110 billion in total or 40% of the cryptocurrency market. This percentage was very stable in recent weeks – the price ratios of cryptocurrencies have been nearly constant and all the "price graphs of cryptocoins in dollars" look the same.

OK, so the Bitcoin holders are similar to some stock holders or members of a fund who hold a pretty fixed percentage of "something" – just the belief why it's a good idea to hold this "something" is very different in the cryptocurrency case and based on the hype about the global paradigm shift etc.

At any rate, we may ask: What are the expenses? The stockholders earn some dividends and the capital gain. Some percentage is paid in taxes to Uncle Sam – or Uncle Andrej or another uncle who just devours billions and throws them to some pensioners as bonuses to increase the number of votes he expects in the next elections.

There are no real Bitcoin dividends but there are capital gains and the IRS will demand those gains to be taxed just like those from the stock market – although I am sure that a great majority of the cryptocurrency holders haven't paid a penny from their cryptic profits so far. Because the taxation should be analogous in both asset classes, I will ignore this subtlety.

We want to talk about the expenses "before taxes".

Well, the are some fees that you have to pay for purchases and sales of stocks – hopefully below 1%. And if you joined a fund, you pay some fees to the fund managers, perhaps 1% a year. If you joined a hedge fund, you typically pay 2% plus 20% of the profits if those are positive. If the profits are 10% in average, it's another 2%. So in total, you pay some 4% to the hedge fund managers annually.

What about the Bitcoin holders?

First, the payment system demands miners who are producing the blocks every 10 minutes in average. One day contains 144 ten-minute blocks. Each 10 minutes, a miner gets 12.5 Bitcoins for discovering a code. That's 1,800 Bitcoins for miners every day. They get paid in the newly minted Bitcoins but they may instantly sell these Bitcoins so the form of the payment doesn't really matter. You may also assume that new stocks are being issued which reduces the price of each existing stock.

At any rate, the miners get 1,800 times $6,500 a day which is $11.7 million a day. Most of this money is burned for hardware and electricity – I guess that most miners are making a loss for the last year and it's getting worse. Why do they do so? It's still better for them to keep on calculating because the electricity itself is cheaper than the mined Bitcoins – but they won't be able to repay the hardware. The whole mining industry is losing money because there are lots of GPUs employed by kids, parasitic employees, and hackers who run the mining software on machines but don't pay anything for the electricity. It's hard to compete with them if you have to pay the electricity.

But the holders can't really live without the cryptocurrency exchanges and they earn a lot, too. According to this fresh table, the cryptocurrency exchanges earn some $20 million a day these days. I will assume that 40% of these profits should be assigned to the Bitcoin which is some $8 million a day.

In total, miners plus cryptocurrency exchanges get some $20 million for dealing with the Bitcoins every day. There are 17 million Bitcoins so the expenses devoured by the cryptocurrency exchanges plus miners are equal to the ratio 20/17 i.e. $1.18 a day. Multiply it by 365 to get some $430 a year. And $430/$6500 = 0.066 or 6.6 percent. So the total fees that the average Bitcoin holder pays to the miners and the exchanges are approaching 7% and they're much higher than all the (worryingly high) hedge fund fees and fees in similar industries.

Do you expect to make a profit, and one that beats the stock market? The one-year returns of the stock market (including the dividends) may be estimated as 10% (one-half are dividends, one-half are capital gains, and my figure isn't accurate enough so I won't tell you whether this is the real or nominal gain i.e. whether the inflation rate was subtracted).

If you want your Bitcoin holdings to beat the stock market, you must expect the average rise of the Bitcoin price (from the new demand) by some 17%. In late 2017, this looked trivial – the annual increase of the price was comparable to 1,000%, much higher than 17%. But what about now, when even the biggest optimists must see that the change of the price in the positive direction is at most "comparably likely" as the change of the price in the negative direction?

The cryptocurrency game has become a huge dinosaur that devours a huge amount of resources and produces nothing that has a useful value for the individuals or the society. Just the number of hashes computed by the miners seems to double every 3 months – and the electricity consumption may increase almost just as much (although some of the increase of the mining power is due to the increasingly widespread special hardware). The optimists must assume increasingly implausible optimistic scenarios to justify their continued HODLing. Wouldn't it be a better idea for you to think faster? To realize that you're holding some worthless codes that can be sold for $6,500 a Bitcoin if you act quickly? Among smart and skillful people, this game should be all about speed. The Bitcoin price should drop to zero within seconds and the holders who would act most quickly (perhaps with the help of some automated software) would be the winners. Are you proud of being slower than the skillful people by a factor of one million, HODLers?

After some 10 minutes of writing, the Bitcoin price dropped from $6,500 to $6,400. I won't "fix" the numbers. The stuff is so volatile that every text like that is guaranteed to contain outdated figures almost immediately. By the way, during the recent drops, BitmexRekt was showing a dozens of (probably leveraged in all cases) contracts worth $10 million (per contract) that were closed. There are lots of people (or are they institutions?) who don't mind to lose $10 million bets.

These bets seem to be rather leveraged. Brainwashed HODLers have been "buying the dips" and most of them have run out of money to buy "new dips". Well, they assumed some 5% dips but they already got a 70% "dip" – a much better opportunity than most of them expected. And it will get even better for the buyers! ;-)

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