Implementing Bitcoin into the Permanent Portfolio

[Marc De Mesel]

Edit 7 june 2013: I cancelled the idea and made a video why: Why I Cancelled Bitcoin for Permanent Portfolio (For now)

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Original post:
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I made a serie of video's why I am implementing bitcoin into my permanent portfolio for 20%. So 20% stocks, 20% bonds, 20% gold, 20% cash and 20% bitcoin.

You can find them here:
http://europeanpermanentportfolio.blogs ... anent.html

I realize this is controversial and I might miss some important stuff. I made an effort to go through the different counterarguments that came up for me and debunk them.

If you find errors in my reasoning or if you think I am forgetting/overlooking certain things I would value highly that you tell me. 

Thank you for your valuable time. Hope you enjoy it.

[ozzy]

Bro, your [edited out inappropriate comment. CraigR] are part of a Variable portfolio, not a Permanent portfolio.  They are a pure speculation, and that’s what the Variable portfolio is for.

[Marc De Mesel]

An ignore button would be nice. Some forums have that and it allows to hide comments from certain people making the experience much more pleasant.

[AdamA]

An ignore button would be nice. Some forums have that and it allows to hide comments from certain people making the experience much more pleasant.

Although he may have been a bit more polite, I think he's making a valid point.

Why mix these in with your PP?

Why not just consider them part of ur VP? 

[Pointedstick]

Whoo, I made it into the video! 

I've only watched the first video so far, but here's my take:

I'll admit I'm not sure what you're hoping to gain by adding Bitcoin to your PP. If you've bought into the idea that we have these four assets that correspond to economic conditions, then Bitcoin doesn't make sense since it's not responsive to any particular economic condition; it's really more of an independent currency. In this case, you've just made currency speculation a fifth of your portfolio. You could do that with any other currency. Why not just add it to your VP instead?

It could perhaps make sense if you're thinking of it as a fifth uncorrelated asset, since it moves independent of interest rates, inflation, and the stock market. But again there are lots of other uncorrelated assets. Why not pork bellies, copper, natural gas, wholesale electricity, or pollution credits? And again, the VP would be the right place for these.

If you transact in Bitcoins, then maybe it could make sense to add some to your portfolio in the cash part.

If you're just trying to juice returns (I know you are very pessimistic about PP returns) then adding Bitcoins is really dangerous since it has these crazy wild swings. The built-in deflationary bias is not enough to guarantee returns, just scarcity. Scarcity only translates into higher prices if the demand outpaces it. You're just betting on the success of bitcoin.

Which brings me to my next point: I don't share the assumption that Bitcoin can't go to zero. As you say, it can only go to zero if nobody values it; but why couldn't that happen? Since the Euro, the French Franc went to zero. The German Mark went to zero. The Portuguese Escudo went to zero. They all did. It's absolutely possible for currencies to go to zero.

The notion of enduring demand for a fiat cryptocurrency that can be used to transact in illegal goods makes sense, but that in no way implies that Bitcoin will always be that fiat cryptocurrency. If a better one comes around, there's nothing to guarantee that any demand remains for Bitcoin.

[melveyr]

Interesting idea.

Personally, I like the vanilla PP because it has clear macro drivers that can explain the price movements of the assets. From my observation, bitcoin has unique price movements that are more related to speculative mania/depressions than the actual economy.

Personally, I would worry about it becoming worthless over time. I don't see how it couldn't be replaced by any other crypto-currency, or why anyone should place any value on it at all. I think people are enamored with its scarcity, but scarcity does not necessarily mean value.

[craigr]

I would like to see Bitcoin take off, but here is my take:

I place a 95%+ probability that the governments will go after bitcoin and the people that accept it to make it illegal/onerously taxed and/or almost impossible to be widely accepted. I think it will remain a marginal currency unit at best and worthless at the worst except for very fringe applications.

Governments hate anonymous money and they definitely hate money they can't control. Don't be surprised to see bitcoin labeled as only used by "child molesters" and "terrorists" when the propaganda starts.

I wish the above weren't true, but this is my very jaded 20+ years experience in the computer security field and having tracked crypto currencies for some time. I'd be careful about wading too deep into the Bitcoin waters right now.

[Marc De Mesel]

Whoo, I made it into the video! 

I've only watched the first video so far, but here's my take:

I'll admit I'm not sure what you're hoping to gain by adding Bitcoin to your PP. If you've bought into the idea that we have these four assets that correspond to economic conditions, then Bitcoin doesn't make sense since it's not responsive to any particular economic condition; it's really more of an independent currency. In this case, you've just made currency speculation a fifth of your portfolio. You could do that with any other currency. Why not just add it to your VP instead?

It could perhaps make sense if you're thinking of it as a fifth uncorrelated asset, since it moves independent of interest rates, inflation, and the stock market. But again there are lots of other uncorrelated assets. Why not pork bellies, copper, natural gas, wholesale electricity, or pollution credits? And again, the VP would be the right place for these.

If you transact in Bitcoins, then maybe it could make sense to add some to your portfolio in the cash part.

If you're just trying to juice returns (I know you are very pessimistic about PP returns) then adding Bitcoins is really dangerous since it has these crazy wild swings. The built-in deflationary bias is not enough to guarantee returns, just scarcity. Scarcity only translates into higher prices if the demand outpaces it. You're just betting on the success of bitcoin.

Which brings me to my next point: I don't share the assumption that Bitcoin can't go to zero. As you say, it can only go to zero if nobody values it; but why couldn't that happen? Since the Euro, the French Franc went to zero. The German Mark went to zero. The Portuguese Escudo went to zero. They all did. It's absolutely possible for currencies to go to zero.

The notion of enduring demand for a fiat cryptocurrency that can be used to transact in illegal goods makes sense, but that in no way implies that Bitcoin will always be that fiat cryptocurrency. If a better one comes around, there's nothing to guarantee that any demand remains for Bitcoin.

Thanks for your good feedback.

The reason why bitcoin and not porc belies is that - if - bitcoin succeeds in becoming the next mainstream currency the permanent portfolio will fail. A lot of value will be sucked away from gold/cash and even stocks and bonds.

Another reason to add bitcoin is that the world has changed and storing gold outside the reach of your government has become much more difficult, especially for US citizens. Countries that are truly sovereign, like Switzerland, simply refuse US citizens these days. Also transporting your physical gold and physical cash has become very difficult due to the also very new body scans these days. Bitcoin allows you to store assets truelly out of reach of your government, also for US citizens, as well as flee the country, pass security checks, and have access to it anywhere (brainwallet).

These two reasons I find sufficient to include it in the Permanent Portfolio. I hope to gain more security and be better protected in different economic climates.

What are your thoughts on that?

(It is true that certain currencies have gone to zero and you are right that bitcoin can go to zero too, my counterargument would be that it's not because something can go to zero that it does not deserve a place in the pp, since cash is also allowed and can also go to zero.)

[WildAboutHarry]

The German Mark went to zero.

PS, the German Mark is still convertible into Euros.  So, I think, is the Austrian Schilling.

[smurff]

Bitcoin also depends on electricity not going to zero.  It requires a high tech infrastructure that is properly maintained over decades adventures. 

In recent years I have seen many periods when electricity went to zero.  If you had a pocket full of of credit, debit or prepaid debit cards, when the power went off, you were were functionally destitute.  If you had a pocket of physical currency, you could function.  If you had a pocket full of gold, you were so rich it would be unwise to reveal this to anyone.

My prediction:  One way or another, the government will crack down on bitcoin itself.  They have already clamped down on Mt. Gox.  They can crack down in all kinds of indirect ways, like taxing any transaction involving bitcoin, requiring regular banks that receive funds from bitcoin banks to hold extra reserves in the home currency, extra "know your customer" requirements, withholding high taxes when bitcoin is converted, etc.  They can do all of this without banning bitcoin outright.

[Marc De Mesel]

An ignore button would be nice. Some forums have that and it allows to hide comments from certain people making the experience much more pleasant.

Although he may have been a bit more polite, I think he's making a valid point.

Why mix these in with your PP?

Why not just consider them part of ur VP?

He did not give any counterargument to my arguments in favor of implementing bitcoin into the PP. Neither did you. And indeed he acted rude on top.

[Marc De Mesel]

Interesting idea.

Personally, I like the vanilla PP because it has clear macro drivers that can explain the price movements of the assets. From my observation, bitcoin has unique price movements that are more related to speculative mania/depressions than the actual economy.

Personally, I would worry about it becoming worthless over time. I don't see how it couldn't be replaced by any other crypto-currency, or why anyone should place any value on it at all. I think people are enamored with its scarcity, but scarcity does not necessarily mean value.

Thanks

I sympathise with your worry that bitcoins become worthless over time. And that certainly can happen. Indeed a competing crypto currency can do the job, though if you study that deeper, that is highly unlikely as that competing currency would need to provide some serious improvements over bitcoin, as just one or two improvements will not overcome the network effect bitcoin has in it's favor.

True that it is not clear in what economic climate bitcoin will outperform as the history is too short.  Though I think it is rational and logic to conclude that if bitcoin succeeds in becoming a mainstream currency it will suck away a lot of value from the PP.  What are your thoughts on that?

[Pointedstick]

In general Marc, I think you are a bit too optimistic and have too much faith in Bitcoin's resilience. In theory, Bitcoin is very resilient, but in practice, it's never really been tested. Bitcoin has never had a powerful government mount a full-scale attack on it. Like others, I am skeptical about its ability to resist. In this case, it might not go to zero, but it could go to 0.01.

Government doesn't even need to destroy it (probably impossible), just make it risky or inconvenient enough that it loses so much popularity that it destroys itself. A currency without buyers and sellers is in a similar situation to a social networking site without users.

Next, Bitcoin turns out not to be a great means of payment, in my experience. I run a high-tech internet business that accepts Bitcoins as a means of payment. My customers are very tech-savvy types who have probably all heard of Bitcoins and many have some. To date, I have only had two customers pay with Bitcoins.

In my opinion, the deflationary bias is too strong, and results in people holding their bitcoins rather than exchanging them for goods or services. As a result, it behaves more like a speculative commodity and less like a stable, gently deflating currency. People don't like to transact in volatile assets. It's scary. For better or worse, a fiat currency that fluctuates between 2 and 7 percent inflation during normal times seems inherently more palatable than a fiat currency that fluctuates between 70% deflation and 300% inflation. Bitcoins absolutely needs to gain some stability for it to be a viable means of payment.

[Marc De Mesel]

I would like to see Bitcoin take off, but here is my take:

I place a 95%+ probability that the governments will go after bitcoin and the people that accept it to make it illegal/onerously taxed and/or almost impossible to be widely accepted. I think it will remain a marginal currency unit at best and worthless at the worst except for very fringe applications.

Governments hate anonymous money and they definitely hate money they can't control. Don't be surprised to see bitcoin labeled as only used by "child molesters" and "terrorists" when the propaganda starts.

I wish the above weren't true, but this is my very jaded 20+ years experience in the computer security field and having tracked crypto currencies for some time. I'd be careful about wading too deep into the Bitcoin waters right now.

Thanks for responding Craig. I agree with you that chances are high that the government will not allow bitcoin to happen. Though we differ on how high. You estimate 95%, I only estimate 50%. I think it's only 50% because our world does become more free over time. What the government would outright have forbidden 50 years ago, they might allow to happen today.

And indeed many are surprised how far bitcoin has come today without any outlawing. At worst some departments have asked for regulations (ECB) or started applying existing regulation also on bitcoin (FinCen, SEC). Some authorities however have outright confirmed that any currency, including bitcoins, are legal to use (Central Bank Finland).  The reality today is that it is not being outlawed. Agreed that this can change in the future but that remains speculation.

What I like about the PP is that it can answer any 'If' question. 'What if'? And to any if question there is a decent believable answer that shows that you are protected. I think the current PP cannot answer the question 'what if bitcoin succeeds in becoming a mainstream currency?'

[AdamA]

An ignore button would be nice. Some forums have that and it allows to hide comments from certain people making the experience much more pleasant.

Although he may have been a bit more polite, I think he's making a valid point.

Why mix these in with your PP?

Why not just consider them part of ur VP?

He did not give any counterargument to my arguments in favor of implementing bitcoin into the PP. Neither did you. And indeed he acted rude on top.

I guess my point is more semantic than anything.

It would be psychologically difficult for me to alter my PP, but if I was concerned that bitcoins would detract from the PP's value at some point, I would definitely consider buying some. 

I just don't think I would rebalance into bitcoins with gains from my PP.  In my opinion, that can become a slippery slope (psychologically).

[craigr]

What I like about the PP is that it can answer any 'If' question. 'What if'? And to any if question there is a decent believable answer that shows that you are protected. I think the current PP cannot answer the question 'what if bitcoin succeeds?'

There is a lot of interest in bitcoin in Silicon Valley now from what I've been seeing. So perhaps it will get legs. But there has been interest in other crypto currencies in the past as well. I am cynically optimistic (a new phrase?) that it will work. But based on my exposure to crypto currencies in the past I just think it's going to attract a lot of bad attention from governments soon enough.

The fact that Finland supports it isn't the main issue. What is more interesting is what the U.S., EU, China and other major players decide to do. Based on past history, they are going to go after it with the full force of the press propaganda machine and politicians.

But sure it's something to think about for the Variable Portfolio if someone wanted. I would wonder if this isn't a pure currency speculation and why for instance it wouldn't be just as good idea to load up on exposure to the Chinese Yuan with other investment vehicles, Etc.?

And again, I'd love to see Bitcoin succeed. I'm just jaded by history on these things. The only way an electronic currency is really going to take off and be allowed to flourish is if every major central bank/government has a hand in seeing who is using it, who is accepting it, what was used to buy it, etc. Fundamentally, without intrusive access to the control freaks of the world, any electronic currency is going to have problems.

[craigr]

I'll also put on the moderator hat and ask that members be polite in their responses.

[Marc De Mesel]

What I like about the PP is that it can answer any 'If' question. 'What if'? And to any if question there is a decent believable answer that shows that you are protected. I think the current PP cannot answer the question 'what if bitcoin succeeds?'

There is a lot of interest in bitcoin in Silicon Valley now from what I've been seeing. So perhaps it will get legs. But there has been interest in other crypto currencies in the past as well. I am cynically optimistic (a new phrase?) that it will work. But based on my exposure to crypto currencies in the past I just think it's going to attract a lot of bad attention from governments soon enough.

The fact that Finland supports it isn't the main issue. What is more interesting is what the U.S., EU, China and other major players decide to do. Based on past history, they are going to go after it with the full force of the press propaganda machine and politicians.

But sure it's something to think about for the Variable Portfolio if someone wanted. I would wonder if this isn't a pure currency speculation and why for instance it wouldn't be just as good idea to load up on exposure to the Chinese Yuan with other investment vehicles, Etc.?

And again, I'd love to see Bitcoin succeed. I'm just jaded by history on these things. The only way an electronic currency is really going to take off and be allowed to flourish is if every major central bank/government has a hand in seeing who is using it, who is accepting it, what was used to buy it, etc. Fundamentally, without intrusive access to the control freaks of the world, any electronic currency is going to have problems.

I don't think you answered the question 'what happens with the PP if bitcoin succeeds in becoming a mainstream currency?'

Your answer is basically 'it will not happen' but ofcourse that's the same as answering to 'what happens with the PP if we get a great depression?', 'it will not happen'.

What if it happens?

[Marc De Mesel]

I'll also put on the moderator hat and ask that members be polite in their responses.

If you ever get the chance to implement ignore function I think that would be a great improvement. The bitcoin forum allows this. That way their needs to be no censoring as right now people have no idea whether he was actually rude or not.

[Pointedstick]

This forum has it too. It's just kinda hard to find:

Profile -> Account Settings -> Buddies/Ignore List

[smurff]

If bitcoin succeeds in becoming a mainstream currency, that by itself would have no effect on the PP.  Your cash allocation would still be in the currency where you are living/working/spending.

Bitcoin in the VP is perfectly fine.  Unless a major country dumps its own currency and substitutes bitcoin,  I don't see it as part of the PP.

[l82start]

I don't think you answered the question 'what happens with the PP if bitcoin succeeds in becoming a mainstream currency?'

Your answer is basically 'it will not happen' but ofcourse that's the same as answering to 'what happens with the PP if we get a great depression?', 'it will not happen'.

What if it happens?

i have asked the same question about what would happen to the PP if faith in fiat dollars failed, and we had a silver based currency take its place, i was hoping for more educated answer than i could come up with myself... but my working understanding at the moment is, the pp would suffer during the transition but not  as much as a un-diversified port folio (in case of silver, gold holding down the losses or possibly preventing them) your success would depend on how soon you began the transition from the failing currency into the new currency. being there ahead of time has an obvious benefit but i tend to agree with others the bet (either bit coin or silver taking over) is a long shot on a black swan event..

[Marc De Mesel]

In general Marc, I think you are a bit too optimistic and have too much faith in Bitcoin's resilience. In theory, Bitcoin is very resilient, but in practice, it's never really been tested. Bitcoin has never had a powerful government mount a full-scale attack on it. Like others, I am skeptical about its ability to resist. In this case, it might not go to zero, but it could go to 0.01.

Government doesn't even need to destroy it (probably impossible), just make it risky or inconvenient enough that it loses so much popularity that it destroys itself. A currency without buyers and sellers is in a similar situation to a social networking site without users.

Next, Bitcoin turns out not to be a great means of payment, in my experience. I run a high-tech internet business that accepts Bitcoins as a means of payment. My customers are very tech-savvy types who have probably all heard of Bitcoins and many have some. To date, I have only had two customers pay with Bitcoins.

In my opinion, the deflationary bias is too strong, and results in people holding their bitcoins rather than exchanging them for goods or services. As a result, it behaves more like a speculative commodity and less like a stable, gently deflating currency. People don't like to transact in volatile assets. It's scary. For better or worse, a fiat currency that fluctuates between 2 and 7 percent inflation during normal times seems inherently more palatable than a fiat currency that fluctuates between 70% deflation and 300% inflation. Bitcoins absolutely needs to gain some stability for it to be a viable means of payment.

You did not address, let alone debunk, my main arguments in favor of implementing bitcoin into the PP. If you can debunk them I would value that highly.

On a sidenote I will reply that I think it's normal that people prefer - to pay - with fiat over bitcoin whenever they get the option. As bitcoin is more valuable so even people that have bitcoin, choose to pay with fiat. I think the pull will come from people/businesses that want to - get payed - in bitcoin only.

I like to compare it with the golden era. Let's say you live in a society where they accept shells but gold has started to be introduced but is quite new. The value of that gold has gone up in contrast to the shells. You can choose to pay with shells or gold, what do you pick? Shells ofcourse. However, howcome gold became mainstream and shells out of use? I think because some merchants over time wanted to get payed in gold only. And if you wanted those valuable goods or services you needed the gold. I think the same will happen with bitcoin.

[Marc De Mesel]

This forum has it too. It's just kinda hard to find:

Profile -> Account Settings -> Buddies/Ignore List

Thanks

[Marc De Mesel]

I don't think you answered the question 'what happens with the PP if bitcoin succeeds in becoming a mainstream currency?'

Your answer is basically 'it will not happen' but ofcourse that's the same as answering to 'what happens with the PP if we get a great depression?', 'it will not happen'.

What if it happens?

i have asked the same question about what would happen to the PP if faith in fiat dollars failed, and we had a silver based currency take its place, i was hoping for more educated answer than i could come up with myself... but my working understanding at the moment is, the pp would suffer during the transition but not  as much as a un-diversified port folio (in case of silver, gold holding down the losses or possibly preventing them) your success would depend on how soon you began the transition from the failing currency into the new currency. being there ahead of time has an obvious benefit but i tend to agree with others the bet (either bit coin or silver taking over) is a long shot on a black swan event..

Thanks for validating. I would agree that if silver becomes the mainstream currency this is already solved well in the PP as gold will in that case also strongly rise in value.

So eventhough those that own only silver would see the value of their holdings go up enormously in value, the PP would still succeed in preserving it's purchasing power because the losses in cash and bonds would be neutralized by the gains in the gold.