Gold vs. Bitcoin
PLAN B: 10 billion Bitcoin is transported every day, it changes hands every day, 10 billion every day.
If you look at the transportation of gold, that would be an enormous amount of money as well, maybe even more than the electricity spent on the mining.
If you look at the Sharpe ratio and the possible correlation play, it becomes harder and harder to ignore. That will create something we as humans have never seen before. An asset risk, a stock to flow ratio of 100.
RAOUL PAL: Plan B, finally we get you on Real Vision. We've been hunting each other down. I've been traveling, you've been traveling, and I really wanted to get you here because I came across you on Twitter, what I was trying to grapple for an understanding of how to get back into the Bitcoin theme and I really understand what was going on after we had the forks, and then we had the bubble. I'd sold out during that phase probably a little too early, as most people know. Then I was trying to figure out, "Okay, how can I get in?" Dan Tapiero and others were telling me, look, I need to start looking at this again.
Then on Twitter, I came across your Twitter feed, and the astonishing work that you've done. I realized it was really doing the proper work, the proper mathematical work behind what I looked at in 2013. I thought, wow, okay, this is something I can now understand in frame. I reached out to you, and we started chatting immediately. I thought I really need to get you on Real Vision. I'd love to just introduce a little bit about yourself, why you're anonymous and a little bit about how you got into this journey as well.
PLAN B: Yeah, thanks for having me on the show. I've lost. Great talking to you. Yeah, sorry about the fact that I'm anonymous. It's, on the podcast, it's not a problem but now, on video, you see this bird dog? The reason I do that is because I'm an institutional investor based in Amsterdam, and I'd like to be anonymous for a while. Maybe I'll come out one day, maybe not. That's the main reason, and also Satoshi Nakamoto himself was anonymous, and it has a lot of benefits as well, because I think it's important that-- and it's all about the arguments and the logic and the works and not about the people or the person behind it. That's about my background.
The article, you mentioned your article in 2013, that was about the time I jumped into Bitcoin. I actually read your article about gold and you were doing some back of the envelope calculations back at the time. I started that a little bit later. Since my background is in investing and also in quant investing, I need numbers for the analysis. I really liked the Bitcoin story, the narrative of a peer to peer digital cash, but I need numbers before I can invest in something.
I was looking for something that could be measured. Along the lines, you were writing gold, how can you compare it to those assets. One of the things that got me right away was this scarcity thing. The digital scarcity thing, that was the real invention of Bitcoin, I think, the 21 million hard cap on the supply and how that can be in the digital world. That was my starting point, basically.
RAOUL PAL: Talk us through a little bit about what the model is and what you found from it, or was that the first variation of it, or do you have some MVP version of something else that you came across? How did you stumble across figuring out a stock flow model and talk a bit about what it is you actually managed to do.
PLAN B: Normally, I make models of assets or derivatives with cash flows, but there's no cash flow in Bitcoin like gold and the other metals. Then usually, if you look at gold, you go to the cost of production or something and that was one of the first steps I took, like, how much does it cost to make a Bitcoin and is there any relation with the price, but then I came across Saifedean's book, The Bitcoin Standard.
RAOUL PAL: I've just read and it's extraordinary.
PLAN B: It is and it's not even about Bitcoin 80%. It's about money and the evolution so it's really interesting. Actually, my first idea was to put gold and silver and Bitcoin and all the measures about supply and stock to flow basically, the stock is the reserve, the stockpile that's there of gold or Bitcoin and flow is the early production. I just put those numbers in there, put it on a chart and bang, the straight line. It was amazing with an R squared of 99.5%. Yeah, you don't see that very often. Of course, there's only a few metals in there so gold, silver, Bitcoin and I started to add more like palladium and platinum.
RAOUL PAL: That was really interesting. When I started seeing your work about, okay, so testing a hypothesis that what you figured out is that gold and Bitcoin were trading extraordinarily similarly as hyper rare assets, I guess. Is that right?
PLAN B: Yeah, or at least they were-- they had a sensible stock to flow. Gold, the stock to flow thing is something that is talked about in the gold world a lot. In Bitcoin, it wasn't until I read the Saifedean book, I just put them in a spreadsheet and see what was there. Basically, that was that was the first thing but then from there, there was a suggestion of one of my followers, hey, maybe it's a good idea to make a time series model for Bitcoin, how it evolves over time. Can you see how the stock to flow evolves over time?
That's the time series model that you can see that Bitcoin is undervalued if you compare it to gold and all the other metals, but it gets closer every year, and it will cross the line at a certain point. The time series model is the one that the second reincarnation that I wrote the article about, and the medium article and that's when everything started, all the comments, all the other analysis so the time series one, it has the R squared of 95%. That was the one that most people know.
RAOUL PAL: That's right. It really struck me that you could understand both these assets in the same way. Therefore, they probably had similar attributes which was something that the gold world didn't want to accept about Bitcoin, which was interesting, because there it was, I thought mathematically proven that these assets trade in similar ways, that it's a stock flow model as opposed to something else, because I think what was interesting is when you put in more industrial metals, you didn't get the same results. Is that right?
PLAN B: Yeah, exactly. Actually, it's like there's two worlds. There's the world have the utility value and the world of the monetary value, if you will. The utility world with palladium, platinum and copper and zinc and all the other the industrial metals, they all have stock to flow ratios around one. There's one year of production in stock, but not more. Then there's gold and maybe diamonds, but that's very difficult to measure and silver used to be in that category. It's very interesting what happened to silver but you could talk later on that.
It's like what makes it that people hoard or hold a metal or Bitcoin or golden in this case and you have to escape this utility world where the stock to flow is one. How do you escape from there? That's actually very difficult. Nick Szabo wrote about it, Saifedean Ammous wrote about it. I just measure it, and it's very, very interesting and in a way, the stock to flow then measures, not only the scarcity, but the inability for producers to inflate the stock because with the only industrial metals, it's very easy for the producers to inflate the stock. It's like they only need to produce a little bit more to inflate the stock and inflating the stock of money, of course, is a bad thing. You saw that in Weimar Germany 1923 [indiscernible].
RAOUL PAL: What makes-- the question is that some people don't understand is it does take a leap of faith to say, "Okay, I now believe that this is a scarce asset that should be valued and highly as opposed to this is a scarce asset that shouldn't be." There are some scarce assets, somebody can make a one-off piece of furniture that may not be valuable. Even things that have some utility but are rare don't necessarily have a value. What is it that gave Bitcoin the value you think? Is it just the adoption that happened that gave it the value and then it started to have to exhibit the stock flow? What is it?
PLAN B: That's a very interesting question. I suspect it's the network effects, Nick Szabo wrote a lot about this, he called it unforgeable scarceness, or unforgeable costliness. I think that has something to do with it. It's very important that there is absolutely no way to inflate this stock. If you, for example, look at other cryptocurrencies that have a company or CEO behind it or a pre-mine or not the proof of work behind it or the hash power behind it, or the miners, then it can be very easy to change the supply and the supply rules, then stock to flow becomes less interesting to look at. I think it's very difficult to find other assets or other things even that have a high stock to flow ratio. I've been looking and looking but really, there is not much out there that people are willing to hoard.
RAOUL PAL: That's right. It's the willingness to hold for whatever reason it started, it's there now, price rise helps a lot. I've thought of it, and your model really bears this out, is I think of the entire world has been short calls in Bitcoin, because the further the price rises, the larger the market cap, the larger it is as a currency. I think somebody tweeted out two days ago that it's already in the top 30 largest currencies in the world. The further it goes, the market cap goes up, the more people have to own it in case it is the future of the financial industry. It's super fascinating.
PLAN B: It is. It's the negative gamma. Yeah.
RAOUL PAL: That's right. It's negative gamma. It's exactly what it is or negative convexity in bond terms.
PLAN B: Yes, I think you're right. If the stock to flow model, and let's say that also very clear, it's a hypothesis. It has the high R squared and we know it's not spurious because we did the cointegration study as well. It is there. It's real. I have little doubt that it will continue at least one or two of things away, but look at the numbers. We're now at 200 billion total market cap Bitcoin, maybe a little less since the last couple of days. If you look at the whole thing, if that really goes a 10 x and then the next halving, another 10 x, we're talking 2 trillion then 20 trillion, those are numbers that really means something.
RAOUL PAL: It suddenly goes into the top 10 largest currencies in the world and then suddenly becomes one of the largest. That's an extraordinary thing. Talk about the halving for a second, I think most of us understand what the halving is. But in financial markets, share going x dividend or a bond going x coupon is a knowable forecastable understandable thing so it tends not to be in the price, it tends to be discounting the price ahead of the event. Why is it not so much the case with the halving in Bitcoin? Is it just the nature of how deep the markets are and the skill sets of them are? What is it?
PLAN B: I have the same question. It's really all-- this is not front run or priced in or-- in a reasonably efficient market, and I think Bitcoin is a reasonably efficient market, if you look at the exchange rates, you can buy Bitcoin for dollars and sell them for euros and then you end up with the exact exchange rate, there's little much arbitrage there like in the early years. It's really efficient.
Then, so either people don't believe that the halving is very relevant for the price, don't believe the stock to flow model as well, or the market is not very efficient and we are very early and have some inside information, if you will, or information that not much people have, because normally, if you notice something goes 10 x in a year, you would buy it, and the price would be higher than it would be now.
RAOUL PAL: I've got another idea, what happens if it is-- because we're not adjusting for volatility, if you think of an expected path of an equity market or a bond between here and-- when is the halving? Six months' time, how many months?
PLAN B: Yeah, May 2019.
RAOUL PAL: Okay. The expected path of the bond and equity or even the equity market, even currency, is actually the main variance is pretty low, because they're not very volatile assets. The problem is, is the variance within Bitcoin over a six-month time horizon is enormous. Therefore, how can you even price what's discounted and what's not? It's difficult to have a linear discounting mechanism in a highly volatile asset. Maybe it is a jump adjust, is there any way you can do it? I don't know.
PLAN B: Yeah, and maybe it's also because we don't know scarcity that much. Maybe we have to feel what scarcity is. Imagine if the gold supply would half in a year, what that would be like. It's the dynamics, the demand and the supply dynamics on the market would change dramatically from one day to another. You can anticipate it but also you can't, it's very abrupt. We also don't know if Satoshi method this rate. He could have programmed it gradually, but for sure, it does make for nice trading.
RAOUL PAL: These things over time, as you and I know having been around financial markets, is these things do appear from time to time where the market doesn't figure out for a while or not enough capital is employed to take advantage of it or it's too difficult to take advantage of. Then over time, everybody figures it out. If you remember, only two years ago, there was massive arbitrage opportunities in Bitcoin.
PLAN B: Yes, yes. True. In a way, I think this abrupt step function is needed to look in the stock to flow, the scarcity. It doubles. It's very difficult. For gold, it took like hundreds of years and the gold was-- we got it from South America, we got it from everywhere on the planet, and it's there right now, but Bitcoin is recent. How do you grow the scarcity, the stock to flow? It's maybe the stepwise function is the only way to do that properly?
RAOUL PAL: I don't know. Also, with your quant background, you've also modeled other stuff on Bitcoin and pricing structure because now, you've got this roadmap as it were. As you say, you don't know how exactly it is but it looks like it's very statistically significant. You built a roadmap from it looking at okay, now we understand that there are pullbacks on this roadmap and were overshoots versus the roadmap and then you've started putting some technical analysis on to that as well. Talk me through that, because I've actually done these RSIs in stuff like this looking at the price.
PLAN B: Yeah, the technical analysis is something I'm interested in and something I did a lot in my early days of my career but I think it's from a totally different order than the stock to flow economic model. I do that basically for fun, and I don't do trading in Bitcoin myself. I do some tactical asset allocation though, so when it peaks above-- when Bitcoin peaks above the very high above stock to flow mo, I sell like a little bit and if it's really below the stock to flow line, then I buy it, but it is interesting to look at some technical indicators because they seem to be very useful in this market.
RAOUL PAL: Extremely. It's a very technical market, I think. Personally, I love blending something like this econometrics model with technical analysis because I know, it's like the worst thing in the world to some people. I love the flexibility of combining two approaches that don't necessarily normally combine. I think it gives you some edge because as I said, it gives you a framework and then it has the ability to trim your positions or increase your positions at various opportunities.
When you're looking at the two worlds combined and we'll show some charts over the course of this interview, but talk to me a bit about how you see the road ahead right now, because you've got your roadmap, you've got some of these technical indicators. What are you looking at? We've just had a nice sharp selloff which was we were trying to form this wedge pattern on the chart, it fell to the downside which many people thought it was worth, I didn't, but how do you see this now playing out into May? How does it usually play out around these halvings as well?
PLAN B: Yeah. Well, if we look at the stock to flow model, the only thing I can take from that is that I'm taking the cointegration into account is that somewhere between a year and a year and a half after the halving so say before Christmas 2021, Bitcoin should be or should have been above $100,000. If that's not the case, then yeah, well, then all bets are off and the model is-- it probably breaks down. The cointegration, I don't expect that to happen but that's the big test that's going.
I think a lot of people are waiting for that. I'll just, yeah, seeing how that plays out. The halving will obviously be a very, very interesting event. What I also see is more interest from-- well, for example, from the gold community. I don't invest professionally in gold because it's all mortgages and fixed income and stuff but I do know a couple of well-known gold and commodity funds and managers and I talked to them frequently because all those gold people are also looking at the digital gold, the Bitcoin, and the discussions. I really like those discussions.
You saw the incremental report last year, the In Gold, We Trust report. I had a paragraph in there for the first time about Bitcoin. Everybody's looking at this thing and especially the more open-minded the gold investors are, maybe thinking about rotating a little bit into the digital gold and there's lots of interesting topics there about gold is mined once, energy is spent once, and Bitcoin needs continuously energy. There's a big thing, issue there.
On the other hand, 10 billion of Bitcoin is transported every day, it changes hands every day. 10 billion every day. If you look at the transportation of gold, that would be an enormous amount of money as well maybe even more than electricity spent on the mining to transport the 10 billion, which is 1,000th, 0.1% of the total stock, the total gold stock, every day. Then there's the verification part of gold as well. If you ever invested in gold, it's always scary if it's real gold and how do you