Let’s say we bet a dollar on a coin flip. If you win you get $1, if I win I get a $1. We both have roughly a 50% chance with equal upside potential. This is an example of a perfectly symmetric risk.
Now let’s say that if you win you get $2 and if you lose, you lose only $1. I’d imagine you’d be more interested in playing this game. This is an example of an asymmetric risk opportunity.
Asymmetric risk is why I believe Bitcoin is the biggest investment opportunity we are likely to see in our lifetimes.
What are the chances that Bitcoin fails?
There are going to be some Bitcoin maximalists that say there is a zero percent chance of Bitcoin failing and it will eventually take over as the reserve currency of the entire world.
There is also the Warren Buffets of the world that say Bitcoin is worthless.
You can imagine infinite possibilities of Bitcoin becoming something in between global reserve currency and completely worthless. Many have aptly pointed out that it will likely either be worth a lot more or a lot less as time goes on.
Regardless of what opinions are out there, every 10 minutes Bitcoin miners continue to validate new blocks of transactions on the Bitcoin blockchain and have done so for the past 10 years.
In order for Bitcoin to completely fail, users, holders, and miners would all have to unanimously agree that Bitcoin was not worth anything on a global scale.
However, one can also suppose that failure in Bitcoin could it mean it survives at a lower price with fewer users and overall less utility than the current state.
This would certainly make bitcoin a failure in terms of an investment. In another article, we can tackle some of the various use cases of Bitcoin, but for now, let’s focus on it playing a role as digital gold.
I particularly like this scenario as I see it as the minimum effective use case for Bitcoin.
Bitcoin Upside
Many have referred to Bitcoin as Gold 2.0 and rightfully so. The two share many common attributes.
Both can act as a hedge to fiat monetary inflation. Both gold and Bitcoin are difficult to counterfeit.
Both share a limited supply.
Of course, it is a little hard to store, divide, and transport huge quantities of gold. Nevertheless gold shares many of the same qualities as the orange coin.
How does the market for gold and Bitcoin compare?
The current value of all of the gold stores in the world at the time of writing is approximately $8,825,553,117,597.38*.
The current value of all Bitcoin in circulation is approximately $178,869,508,179.
The value of all gold is more than 49 times that of all of the Bitcoin in the world.
If Bitcoin were to reach parity with the total value of gold, the value of 1 Bitcoin would be equal to $420,254.
Assuming that Bitcoin fulfills a role similar to gold, the USD value of bitcoin would $420,254.
Asymmetric Returns and The Kelly Criterion
In 1956 JR Kelly, Jr a researcher at Bell Labs, discovered the optimal formula for maximizing your returns given a set of probabilities. The formula is known as the Kelly Criterion. The formula essentially informs the risk-taker of the optimal bet given a set of probabilities and payouts.
- f = the fraction of the bankroll to bet
- b = the decimal odds – 1
- p = the probability of winning
- q = the probability of losing, which is 1 – p
Let’s break it down in practical terms with our coin toss example.
The chance of winning our prior coin toss is 50%.
Imagine we were able to somehow through mental telepathy influence the toss and win 60% of the time.
That means:
- b = 2 – 1, which is 1
- p = 0.60 probability of winning
- q = 1 – 0.60 = 0.40 probability of losing
So the calculation is as follows: (1 × 0.60 – 0.40) ÷ 1 = 0.2
Therefore, the formula suggests that you wager 20% of your money. If your telepathy skills were less effective, at 53%, the Kelly Criterion recommends wager 6% of your total investment funds.
If you repeatedly bet too much (over 20%), there’s a good chance you’ll eventually go broke.
Conversely, under-betting (less than 20%) should produce a modest profit.
If you change the odds, you can also find out if you should make a bet. In our previous example, we said that you could make $2 to and stand to lose $1 with a 50% chance of success. Plugging into this calculator here, You will find that you should take the bet and that your bet size should be .25 cents.
What is the probability of Bitcoin succeeding?
This is really anyone’s guess. Many of my Bitcoin friends on twitter envision the probability of Bitcoin succeeding being 99%.
In that case, they should allocate nearly all of their available capital if they want to back up these beliefs.
On the flip side, if you were very pessimistic on Bitcoin, you might argue it has a 1% chance of success.
At this point, I believe it would be difficult to argue it has a 0% chance of success given historical context. Let’s define success as reaching half of the gold parity or $210,000 in value. Let’s say that represents roughly a 20X gain.
Let’s assume you assign Bitcoin a 10% chance of success and you have a $100,000 portfolio. Plugging our numbers into the calculator, in order to maximize your investment, you’d bet $5,500.
Take note you would be expecting 90% of the time for your investment to fail. Many gamblers and speculators suggest that a “Full Kelly” is too aggressive and generally serves to maximize returns rather than preserve capital. A more prudent might be a Half-Kelly or even a Quarter-Kelly. These smaller position sizes generally serve to reduce risk and preserve capital while still ensuring the wager is worth your while.
I’m not suggesting that you should use the Kelly Criterion as your guide to investment in Bitcoin and that you should use it to determine your position size.
What I am suggesting is the Kelly Criterion gives reason to suggest that Bitcoin is an asymmetric bet that is based on the principles of math. To truly take on Bitcoin as a position you’d have to evaluate many other factors such as your appetite for risk, financial situation, other investment opportunities, and personal goals.
The main point is, if Bitcoin stands even a slight chance of success, mathematically it makes sense to allocate some funds here.
Can you Afford Not to Buy Bitcoin?
Taking even the most defensive stance it seems the Asymmetric risk/return opportunity with Bitcoin is hard to pass up.
If the Bitcoin price does begin to climb into the stratosphere, it will naturally attract more and more users. Based on its price history, it has already undergone several bullish price runs.
Would it be completely irrational to believe that it couldn’t happen again?
Even using pessimistic probabilities it is clear that Bitcoin presents a huge asymmetric opportunity for reward. So much so that the question needs to be asked, what if I don’t get on the Bitcoin train and it leaves the station without me?
Please read our disclaimer here regarding investment advice and risk. Disclaimer: This should not be construed as or relied upon in any manner as investment, legal, tax, or other advice. Please consult an appropriate tax or financial professional to understand your personal tax and financial circumstances. I may get compensated by some platforms mentioned below (because of referral links). Do your own research
Source https://en.wikipedia.org/wiki/Kelly_criterion
Source https://www.goldeneaglecoin.com/Guide/value-of-all-the-gold-in-the-world
Source https://tradingview.com