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“Value = probability x price.”

— Steven Crist, horse handicapper

Wednesday Racy Investing Advice

Losing money in crypto is more anxiety-inducing than losing money in stocks.

(Yes, I consider myself an authority on both counts.)

I suspect that’s because in equities, the price of a stock has no bearing on a company’s value, so price and value are uncorrelated.

When a stock goes down (assuming all else is equal), it gets cheaper, which should make you feel better about holding it.

(If you’re not feeling better, it’s because lower prices are making you question your original assessment of the stock’s value.)

In crypto, however, price and value are inextricably entangled — the value of a bitcoin is simply the price of a bitcoin, so price and value go up and down together. 

This applies to most other cryptocurrencies as well, including the ones that look more like stocks. 

If, for example, you hold ETH because you think Ethereum will generate a lot of fees, remind yourself that those fees are denominated in ETH.

So when the price of ETH goes down, the present value of Ethereum’s future fee generation goes down, too.

We can state this more directly: A crypto that has no price has no value.

This is not the case with equities, where the value of any stock is the discounted present value of all future dividend payments. 

Price is not an input in that calculation — the stock market could close forever and your stocks would have the same value (you’d just have to hold them long enough to realize the value by collecting dividends).

If the crypto market closes, however, there would be no value to realize — if you can’t sell your crypto to someone with no market, it’s not worth anything.

That's theoretical, of course. The crypto market won't close (no matter how much Senator Warren and Chair Gensler wish that it would).

But I think it’s useful as a thought experiment, because even for those cryptocurrencies that look the most like stocks, I’m not sure it makes sense to invest as if you’re in the stock market.

You may want to invest as if you’re at the horse track instead.

Never sell?

It is possible to value many cryptocurrencies based on future cash flows — if you make an assumption about the future value of the crypto you are trying to value (beware of circular errors), you can arrive at a discounted cash flow (DCF) valuation, just as you would with stocks.

Not many do that, though — our time horizons are far too short for that kind of valuation work to have any relevance to us.

That does not, however, mean that we have to give up looking for “value” — we just have to look for a different kind of value, perhaps the kind we find at the race track.

Helpfully, the famed handicapper Steven Crist defines value in terms of odds: 

Value = Probability x Price.

This is more intuitive than a DCF model: “Even a horse with a very high likelihood of winning can be either a very good or a very bad bet.”

It’s also universally applicable. 

Crist’s philosophy on betting was recently highlighted by the writer of the excellent Invariant blog, who recommends employing the same thinking in the stock market.

But I think it’s even more applicable to crypto, where there is no finish line to determine the outcome of a bet and no earnings reports to validate a thesis on a stock.

The only thing to settle a crypto bet is price — and price is simply a function of what everyone else is thinking.

Betting odds is also a function of what everyone else is thinking, which means that “Your opportunity for profit at the racetrack consists entirely of mistakes that your competition makes in assessing each horse's probability of winning,” as Crist explains.

To make money in crypto, then, you probably need someone — either the person you bought from or the person you sold to (or both!) — to make a mistake.

That’s not a very WAGMI way of looking at things, I know. 

But markets aren’t for making friends, they’re for making money — crypto markets especially. 

In equities, everyone could win: Investing in a stock is not a bet that someone will pay more for it than you did, but a bet that the company you’re investing in will, over time, create value.

This is the core of Warren Buffet’s investing philosophy (“The stock market is a device for transferring money from the impatient to the patient.”) and the reason why he rarely sells.

Buffet has, for example, realized an 8,000% return on his 1972 investment in See’s Candy in dividends alone.

But no one in crypto has that kind of patience, and rightfully so — the value crypto may or may not create is so uncertain and so far off that Buffet’s aphorism doesn’t apply.

Investing in crypto is more like trading in equities, where your outperformance is, mathematically, someone else’s underperformance.

Or like horse betting, where the only way to win is for someone else to lose.

To make money then, Crist advises that you “adopt a cold-blooded and unsentimental approach” and resist “the ‘sporting’ impulse to be loyal to your favorite horses.”

He warns that this will cause you to “suffer abuse from your fellow horseplayers” — but those are the players, he says, who don’t know what game they’re playing.

What game is it we’re playing in crypto?

Are we all betting against traditional finance? Or against each other?

If (like me), falling crypto prices make you anxious, it’s probably the latter.

― Byron Gilliam

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This week, Darius Dale Founder of 42 Macro joins the show for a discussion on the current state of asset markets. With the recession that never came to be, stock markets hovering around all time highs & Fed rate cuts in 2024, Darius makes the case that markets are pricing in goldilocks & a 2024 soft landing. To hear all this & more, you'll have to tune in!

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