John Davi is the Founder and Chief Investment Officer at Astoria Portfolio Advisors; an investment management firm that specializes in quantitative & cross asset investing. We recently sat down with John, who will be speaking at our Digital Asset Strategies Summit (Oct. 16 – 17 – Dallas), as he explained the catalysts behind Bitcoin’s volatility and what’s needed to temper it going forward.
Digital Asset Strategies Summit: Is bitcoin a legit currency or a mere tulip?
John Davi: Neither. Right now, bitcoin doesn’t satisfy the criteria of being a legit currency. There have been too many cases of exchanges being hacked, it’s not overly liquid, bid/ask spreads are wide, and there are limited places that accept bitcoin as payment. Does bitcoin have any value? Yes. Ultimately, Bitcoin’s value will largely depend on what people determine its market clearing price to be worth – this is how the price of gold is determined. Bitcoin and gold are storage of values and neither produce cash flows so traditional stock/bond valuation models (i.e. discounting future cash flows) cannot be used. More Bitcoin users + more knowledge + more access/hedging solutions will empower investors to determine its value in society. Ultimately, Astoria views bitcoin as another form of an alternative asset class but faces significant challenges (little regulatory oversight, difficult to access, etc).
Digital Asset Strategies Summit: What do you attribute bitcoin’s extreme volatility to?
John Davi: From 2011 to 2017, Bitcoin experienced on average 7 times the volatility of the S&P 500. There have been times during this period where Bitcoin was 20 times more volatile. We believe this volatility premium is justified for 3 reasons 1) We are in the early infancy stages for the adoption of digital assets 2) investor knowledge base is low 3) Bitcoin has characteristics of 3 different and distinct asset classes. Let’s dive a bit further into the 3 different asset classes that characterize bitcoin.
1.) Currency: Bitcoin can be used to purchase goods and services – hence, it has characteristics of a currency.
2.) Commodity: There are production costs to create bitcoin which influences its price. Miners are paid for their efforts. Hence, bitcoin exhibits commodity-like characteristics.
3.) Private Equity / Venture Capital: Purely from a price volatility perspective, bitcoin resembles a private equity, venture capital start-up where risk of failure is sky high. There is no cash flow generated from owning bitcoins – which is very similar to private equity and venture capital where future growth is significantly more important than generating cash flows.
Digital Asset Strategies Summit: The SEC recently approved plans for public comment which would make it easier for investment companies to bring new exchange-traded funds (ETFs) to market. Could these new rules inspire a new wave of crypto ETFs?
John Davi: Digital assets remind me of the internet and technology stocks of the late 1990s. People argued these companies were going to change the world and paid insane valuations. Some of these internet companies did indeed change the world but a large number of these startups failed. Only a few select (ie. FANG stocks) maintained pricing power and developed into truly elite companies from an earnings perspective. We think the same protocol will follow with digital assets.
Ultimately, we believe US regulators will allow the creation of pooled vehicles. However, not all 2,000 digital assets will survive (and neither should they).
Digital Asset Strategies Summit: Should investors fear or embrace crypto regulations?
John Davi: There have been many instances of crypto exchanges being hacked. It’s pretty obvious that there are investors who won’t touch digital assets for fear of hacking. Bitcoin fanatics shouldn’t fear more government or regulatory oversight. This will bring more credibility and elevate the stature of digital assets.
Digital Asset Strategies Summit: You have likened the pricing of Digital Assets to stock trading in the early 1900s or emerging equities 15-20 years ago where spreads were wide, volatility was sky high, and information flow was low. Can you discuss what you believe is needed to temper price volatility?
John Davi: More knowledge of digital assets + more education + more technology + more access/hedging solutions should temper price volatility. This will all take time, however.
We don’t doubt that digital assets are uncorrelated to traditional asset classes and can help diversify investor portfolios. But currently the majority of the digital assets are not liquid, spreads are wide, and the costs to trade them are very high. Astoria is pulling for digital assets to evolve as we believe the capital market system desperately needs uncorrelated assets to traditional capital markets. We hope that as the liquidity of digital assets improve, their uncorrelated nature remains intact. Investors should realize, however, that liquidity and correlation tend to go hand in hand (more liquidity tends to result in higher correlation).
Digital Asset Strategies Summit: Thanks John. We look forward to hearing more of your thoughts at the Digital Asset Strategies Summit October 16 – 17 in Dallas.