Cai Kailong: Reunderstanding Bitcoin and Its Investment Philosophy

This article was published on April 19, 2020, on the Chain Catcher public account and organized by Hu Tao.

The COVID-19 pandemic, as the biggest black swan event of the year, has further complicated the already murky cryptocurrency industry. Investors are at a loss when facing the third halving of Bitcoin, while the continuous issuance of stablecoins like USDT is also driving changes in the industry. For an industry that heavily relies on the cryptocurrency market, how to peel away the chaos to see the essence in the current environment has become a key issue.

Recently, the eighth session of the Catcher Academy, hosted by Chain Catcher, invited financial commentator, senior researcher at the Renmin University of China’s Financial Research Institute, and former Chief Strategy Officer of Huobi, Cai Kailong, to share on the topic of "Halving Trends and Stablecoins Under the Pandemic."

Cai Kailong is a fintech and financial columnist, a senior researcher at the Renmin University of China’s Fintech Research Institute, and has served as the Chief Strategy Officer of Huobi Group and a lecturer for blockchain and digital currency courses at Sina University. He has a comprehensive and profound understanding and reflection on digital currencies and global fintech.

Share by Cai Kailong

Hello everyone, the theme of my sharing today is stablecoins and halving trends under the pandemic. Recently, many people have asked me how to layout cryptocurrency investments in the current environment? Will the so-called halving trend come? And what is my view on stablecoins like USDT? Today, I will share around these three aspects and the potential impacts of their overlap.

1. Discussing Cryptocurrency Investment: Bitcoin is Not a Safe-Haven Asset

First, let me explain the basic concept of investment (medium to long-term investment). Investment essentially tests a person's cognition, including investment cognition and self-positioning cognition. Investment failure may be the price of insufficient cognition, also known as an IQ tax; conversely, if the cognitive scope is broad and deep enough, the chances of success will be relatively higher.

In fact, for investors, the degree of understanding of investment direction and targets determines investment philosophy, and a correct investment philosophy can fundamentally determine whether one can gain from investments. This investment philosophy is not only applicable to stocks, foreign exchange, gold, commodities, etc., but also to digital currencies.

Taking Bitcoin as an example, the most discussed topic in the early days was "What is Bitcoin?" Now that Bitcoin is 11 years old, the hot topic has shifted to "How can one make money through trading?" However, in reality, how to operate depends on the individual's understanding of Bitcoin, which is to say, what Bitcoin means to you. This determines whether you can make money or avoid market crashes like 3.12.

What does Bitcoin mean to you? I have summarized the common understandings in the community into four categories.

1. Safe-haven asset. Newcomers generally believe that Bitcoin is a safe-haven asset. Most of them entered the market during the financial market fluctuations in February, rarely considering that it was a market peak, blinded by the safe-haven perception.

2. Digital gold. Some believe Bitcoin is similar to digital gold, inevitably recalling the saying "In prosperous times, collect; in chaotic times, buy gold," and due to the instability of the global financial market, they choose to invest in Bitcoin.

3. Digital currency. This refers to investors using Bitcoin as a standard to measure the price standards of various currencies in the entire digital currency industry. From this perspective, Bitcoin's price is relatively stable. Therefore, in turbulent markets, some investors choose to sell other currencies and switch to dollar-cost averaging or only hold Bitcoin. Additionally, due to its high liquidity and cross-border attributes, it allows investors to operate more conveniently when they need to transfer assets urgently. Thus, the more turbulent the environment, the more they buy.

The last category is people like me. I have always believed that Bitcoin belongs to alternative assets within the category of financial assets, such as commodities and real estate, which are all considered alternative assets. Their characteristic is extremely high volatility and high risk. Therefore, when the pandemic and financial volatility occurred together in early February, I was the first to sell Bitcoin. Although its price might rebound first after the economy recovers, given the situation at that time, it was the right choice to make.

Facts have also proven that Bitcoin's price fluctuations are indeed greater than those of gold and stocks, and it has not demonstrated safe-haven properties. But remember, Bitcoin emerged after the 2008 financial crisis, and in the past decade, it has not encountered such significant financial volatility as that caused by the COVID-19 pandemic. This is also a key moment to test whether it is a safe-haven asset; unfortunately, its safe-haven property failed in the first test.

The butterfly effect caused by the shattering of the safe-haven myth has led to extreme panic among investors, who have rushed to sell Bitcoin for self-preservation, resulting in capital flight and a stampede. However, if everyone had a clearer understanding, perhaps it wouldn't have been so bad.

In addition to understanding Bitcoin, the most important thing is to have a clear understanding of one's own positioning. First, digital currencies do not have the support of the real economy like the stock market, so they are generally considered a zero-sum game. At this point, one needs to think about a question: In this game, whose money do you want to earn? What role do you need to play? This determines how you will operate later.

Similarly, I have summarized several common roles in the community, which can be categorized as follows.

1. Value investors. These individuals generally believe that Bitcoin has the characteristics of long-term investment and will appreciate, so they will hold regardless of the price point.

2. Technical traders. They earn from the emotional fluctuations of others; when emotions are high, they short, and when emotions are low, they buy. These individuals have a strong understanding of information and events, and their logic is relatively accurate.

3. Pure traders. They mainly provide brokerage services, helping those who do not have time to watch the market, earning service fees.

4. Arbitrage traders. They earn from price differences between different trading markets. The same applies to foreign exchange.

5. Exchanges. They earn from all traders' service fees, ensuring stable income.

6. Stablecoin issuers. They earn from everyone in the industry.

Therefore, to invest in digital currencies, one must first establish two cognitions: one is the understanding of investment direction and targets; the other is the understanding of the role one plays, thereby establishing an independent investment philosophy, which can serve as a basis for operations.

2. Discussing Halving Trends: Severely Overestimated

Since the third quarter of 2019, the industry has been discussing halving trends. So, is there really a halving trend? Quoting a famous saying by Shakespeare, "There are a thousand Hamlets in a thousand readers' eyes." If you are bullish, you should believe there is a halving trend; if you are bearish, you will definitely think there is no halving trend. This is subjective interpretation.

Personally, I believe that even if there is a halving trend, it is severely overestimated. I will analyze the reasons from three aspects.

The first aspect is the "Price In Theory of Vegetable Sellers." If even vegetable sellers know about the halving trend, the value of that information may need to be redefined. Moreover, for the vegetable seller to make money, they need to find someone with less understanding to take over, namely newcomers who are unaware of the industry, commonly referred to as new leeks. At this point, we should look at the number of newcomers. According to our statistics, the number of people entering the cryptocurrency space is decreasing compared to 2017 and 2018, with activity levels continuously declining. From this perspective, the halving trend is overestimated.

The second aspect is that the halving only affects the remaining 1/7 of the supply. The total amount of Bitcoin is 21 million, and currently, 18 million have been mined, which means 6/7 has already been mined, leaving about 3 million, or 1/7 of the total amount, yet to be mined. This halving is only concerning the remaining 1/7, and compared to the quantities of the past two halvings, this halving's amount cannot create a drastic impact on the market, nor can it be understood solely from the supply-demand perspective.

The third aspect is the misunderstanding of mining costs. Many people believe that with the halving, the miners' costs will double, and naturally, Bitcoin's price will also rise by double. However, the reality is that mining costs cannot be calculated linearly, as they are influenced by multiple uncertain factors such as hash rate difficulty, electricity prices, and mining machine iterations. When multiple factors act together, mining costs fluctuate non-linearly. Therefore, if you think mining costs directly determine prices, you are gravely mistaken.

In addition, many people refer to the historical halvings to make judgments, which is also unreasonable. The following chart shows the historical halving trends of Bitcoin.

The first halving occurred in 2012 when very few people knew about Bitcoin, and the trading volume was low, making its reference value negligible; the second halving was in July 2016, where it can be seen that the price was still falling two months after the halving, and it only started to rise six months later. However, due to the long interval, it cannot be determined that this was the market trend brought about by the halving. Thus, referencing historical halvings cannot yield effective conclusions. Moreover, hypothetically speaking, does the fact that the previous two halvings led to price increases mean that the third halving will definitely lead to a price increase?

Clearly, it does not necessarily follow. It is like the logical relationship between a rooster crowing and the sun rising; although the sun rises when the rooster crows, does the rooster crowing mean the sun will rise? Not necessarily; it may just be a coincidence. We cannot assume there is a direct causal relationship between the two.

3. Current Status of Stablecoins: Replacing Some Original Functions of Bitcoin

Having discussed the understanding of cryptocurrency investment and halving trends under the pandemic, let’s talk about stablecoins. In the long run, stablecoins will have a greater impact on the entire cryptocurrency landscape than halving trends, and their duration will be longer than that of the pandemic. Why do I say this?

Let’s look at a piece of data. Stablecoins are no longer a small force; since their emergence, their market size has shown a linear growth trend, and daily trading volume has surpassed that of Bitcoin, which has, in a sense, changed the landscape of the cryptocurrency market. Therefore, anyone studying the cryptocurrency landscape cannot ignore such a powerful currency.

Taking USDT as an example, its issuance has surged in recent months, with the total amount exceeding $6.9 billion, increasing more than threefold in about a year. Especially in the last two months, there has been a crazy surge, with an increase of $2 billion, and the rate of issuance is terrifying. So, what is the current status of stablecoins? We can look at the following chart.

Not only USDT, but all stablecoins have been continuously issued, with a total increase of 18% in market value over three months. Since USDT accounts for over 80% of the entire market share, it represents 80% of the total issuance of all stablecoins.

Previously, we believed that Bitcoin still had functions of payment circulation, measurement standards, and safe-haven properties, but this understanding has been disrupted by stablecoins. It is now widely recognized that stablecoins have replaced Bitcoin's original functions of payment, circulation, measurement standards, and safe-haven properties. In short, stablecoins have taken over some of Bitcoin's original functions.

However, a problem arises: stablecoins are issued through a centralized mechanism, which is fundamentally different from Bitcoin's decentralized design by Satoshi Nakamoto. We all know that Satoshi Nakamoto's purpose in inventing Bitcoin was to ensure that the total issuance was not subject to human control through decentralization, writing the rules in stone to combat inflation caused by government over-issuance of currency.

The backing of stablecoins is a company, and behind the company are the chairman and CEO, representing a very centralized issuance mechanism, with weak credit. Those familiar with USDT know that its issuer, Tether, has a poor reputation in the industry, and its relationship with regulators is quite concerning, so it cannot be considered a compliant enterprise, nor does it have a legal license, falling far short of central bank or national credit. Yet it is currently holding the entire cryptocurrency industry hostage, which is the current state of stablecoins.

If we assume there were no pandemic and only the total issuance of stablecoins increased by 18%, what would happen to Bitcoin's price? The answer is that Bitcoin's price would rise by 18%, because the market is currently priced in USDT. Therefore, I personally believe that the rebound in the March market was caused by the issuance of stablecoins.

So, what impact will the continued issuance of stablecoins have on the industry? Especially under the current situation of many uncertain factors, how should we prepare?

I believe that the large-scale continuous issuance of stablecoins is, on one hand, driven by market demand, such as the aforementioned safe-haven, circulation, and arbitrage needs, but there is a lot of water in it. Continuous issuance will affect Bitcoin's price, thereby impacting investors' judgments and operations.

On the other hand, we are now in a duel between Bitcoin and stablecoins, especially USDT, which has already taken the entire cryptocurrency industry hostage. Therefore, investors can only hope that Tether's credit can be maintained, as a significant portion of BTC's price is supported by USDT's credit. If Tether collapses, it will deal a heavy blow to the entire cryptocurrency industry.

Finally, I suggest that everyone should have a clear understanding of the truths behind the uncertainties such as halving trends and stablecoin issuance during the pandemic, and not be simply misled by prices; secondly, pay attention to diversifying investment risks and prepare for the worst-case scenario.