By Byron Gilliam, Markets Strategist at Blockworks.
“There is no such uncertainty as a sure thing.”
— Robert Burns
Betting on a Sure Thing
In his course on Decision Analysis, Stanford Professor Ron Howard would ask his students to assign a probability to the answers they gave on exams: The higher the probability they assigned to an answer, the more credit they’d get if it was correct.
They were warned, however, to never assign a 100% probability: An incorrect answer with a 100% probability would result in a grade of negative infinity — and negative infinity on even one question meant failing not just the exam, but the entire course.
Despite that explicit warning (and despite these being Stanford students and despite those students being in a class entirely about how to make good decisions), every semester, some of Professor Howard’s students would assign 100% probability to their exam responses. And then some of those responses would be incorrect.
As promised, those students failed the course.
The purpose of Professor Howard’s grading system was simply to impart the life lesson that we should never assign 100% certainty to anything: From the subatomic world of quantum particles to the everyday world of decision-making, everything is probability.
It’s a lesson that needs continual re-learning, especially in financial markets.
And most especially in financial markets for crypto.
The Infinite Downside of True Believing
In the equities market, you can invest in two types of gold miners: those that sell their production at spot prices or those that sell at forward prices.
The miners that sell at spot (i.e., the market price at the time when the gold has been dug up) have more upside, but at the price of more volatility.
Those that lock in future prices via forward contracts (i.e., agreeing to sell future production at some, usually lower, price) have less upside, but more certainty.
Some miners — along with producers of oil, gas, and other commodities — do a mixture of both spot and forward selling.
What you don’t have is miners who choose not to sell.
Because that would be crazy — almost as crazy as if Apple chose to stockpile its iPhones rather than offer them for sale.
Or choosing 100% certainty on an exam question.
Some crypto miners, however, decided to risk it: They were so certain that bitcoin was a sure thing, they introduced a third option to the business of commodity production: never sell.
There was some logic to this: HODLing is core to the ethos of Bitcoin, after all.
And miners listed on the stock exchange were better able to attract investors by pitching themselves as a levered bet on Bitcoin: HODLing makes for a better elevator pitch than mining.
And in one sense, that’s an innovation: Bitcoin is a commodity with no carrying costs, so why not just carry it!
But miners do have operating costs, of course. And those costs are denominated in fiat.
So, you’d expect miners to sell enough bitcoin to cover those costs at least — but not all did.
In its last set of results, Riot Blockchain took a $132 million impairment on the bitcoin it HODLs, which was in excess of its revenue for the quarter ($126M).
And in its last quarterly filing with the SEC, Marathon Digital reported that, after meeting several margin calls, 9,490 of the 11,440 bitcoin it holds had been pledged as collateral against its borrowing.
This has left them in a tight spot: “There is no assurance that if there are continued marked decreases in the price of bitcoin that our remaining unrestricted bitcoin will be sufficient to cover further increased collateral requirements.”
The mining industry assumed Bitcoin was a sure thing and now that it’s seemingly not, many of them are at risk of failing.
100% Outcomes
Miners are of course not the only crypto market participants guilty of poor decision analysis.
Recently, Cameron Winklevoss posted a scathingly critical open letter to DCG’s Barry Silbert.
In it, he described DCG’s subsidiary Genesis Capital’s practice of lending money to 3AC so that 3AC could recursively buy bitcoin, swap it for GBTC, and post the GBTC as collateral with Genesis to buy more bitcoin and swap for more GBTC.
This left Genesis with all of the downside of the GBTC “arbitrage” and none of the upside: “Astonishingly,” Winklevoss wrote, “it appears that Genesis never participated in the wins because it apparently always ceded them — the GBTC share premium — to 3AC. This meant that Genesis only participated in the losses, turning what would otherwise have been a zero-sum trade into a negative-sum trade.”
“Crazy town,” he opined. And it’s hard to disagree — what could they possibly have been thinking???
Winklevoss attributed this behavior to “greed.” But I’d also attributed it to a failure to think in probabilities: DCG seems to have put a 100% probability on bitcoin continuing to trend higher.
It might have worked out, too: We shouldn’t judge best by their outcomes.
But in crypto, as in Professor Howard’s class, the outcome of missing on a 100% bet is always the same: failure.
About the Author:
Byron Gilliam traded international equities for investment banks and brokers in Frankfurt, London, Paris and New York before becoming the Markets Strategist at Blockworks.
Now in Chapel Hill, NC, he writes a daily newsletter on crypto and markets. Byron has an undergraduate degree in history from Binghamton University and a master's degree in hard knocks from 20 years of trading.