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I’m going to make 3 assertions in this article. Together, if true, they break the world of finance. It will take a decade or two for the financial world to catch on & adjust accordingly. But you get to read about it here today. The assertions: - Bitcoin is actually a low-risk asset - Bitcoin will continue delivering fairly high annualized returns - Every capital allocator on earth is using the wrong hurdle rate for their investment decisions (Note: this article was published this week via Once-in-a-Species. Formatting here is not ideal (no links, limited images), but Twitter doesn't want me to link you to original - you definitely won't find it in my pinned tweet on my profile...) The concept of a hurdle rate What do you do with a dollar? The smart thing to do is to find a way to invest that dollar into a project that you forecast will deliver an attractive return on investment. But how do you choose between an endless stream of possible ways to invest that capital? From my Bain consulting and Stanford MBA days, I can say that the most common managerial framework to evaluate various capital projects is to forecast ROIs and draw a line. Any capital projects with a forecasted ROI below that line are not worth considering; those above may be worth pursuing. Where you draw that line is your “hurdle rate.” Projects that clear the hurdle merit further consideration, those that do not are filtered out. But exactly where you set your hurdle rate at is a mixture of art and science for individuals and companies. How firms set their hurdle rates There’s a surprising amount of variety in how hurdle rates get set. Debt-financed projects need to consider the weighted average cost of capital (WACC), whereas investors working with their own capital have a bit more flexibility. Some take the “risk-free-rate” in global capital markets – US Treasury bonds – and add a risk premium befitting the specific investment they’re considering. Perhaps the most common approach is the “opportunity cost of capital” — in other words, what kind of return could you get for taking on similar levels of risk elsewhere in the market? While neither definitive nor exhaustive, here is a rough list of the opportunity cost of capital by investment category, based on returns from the last few decades. (see article for sources, link in pinned tweet) Overall, investors earn greater returns for taking on more risk & for locking up their capital in increasingly illiquid assets. Private equity and venture capital funds typically lock up capital for ~10-year durations. And of course, there’s a lot of risk involved in venture capital. Funds either get exposure to one of the decade’s big winners and deliver above-average returns or… they don’t. Because of the big risks involved, average venture capital returns have to be very attractive to incentivize capital allocators to take on that commitment. On the other end of the risk curve, we have US Treasuries. Currently, 30-year US Treasuries are yielding 4.3% of low-risk nominal return in a highly liquid asset (no 10-year lockup, not even a 10-minute lockup). The mistaken assumption that everyone continues to make is that US Treasuries are the correct low-risk reference point for the opportunity cost of capital. What the finance world has not yet realized is there’s another (much more attractive) low-risk asset in the global asset landscape — it’s just widely misunderstood as a high-risk asset. Bitcoin is low-risk, like US Treasuries I realize this sounds crazy to most people. In the public consciousness, Bitcoin is wildly speculative and uncertain. However, after 6 years focused full-time on this asset, I have come to view Bitcoin as a mechanical inevitability — every 4 years, the next Bitcoin halving ensures the asset’s increasing scarcity and resulting value appreciation. It is just supply and demand playing out in pure free market fashion. This is where the understanding gap comes in. People associate Bitcoin’s volatility with risk, but risk is ultimately a measure of uncertainty. This strange new asset is widely viewed as terribly uncertain, and yet, its fundamental mechanics deterministically create the opposite result (when viewed on a 4+ year timeframe). Bitcoin’s increasing scarcity is as certain as the laws of math and the forward march of time that its entire design is predicated on. In my book, that puts Bitcoin’s degree of risk somewhere in the range of US Treasuries (if not considerably lower). In that sense, Bitcoin could (and should) serve as a low-risk alternative to US Treasuries when evaluating what the low-risk opportunity cost of capital should be when setting a hurdle rate. Of course, the challenge becomes forecasting what Bitcoin’s annualized return will be going forward. With US Treasuries, the expected return is nominally certain, but never fully known in real terms. With Bitcoin, the mechanics driving value appreciation are certain, but the exact scale of that value appreciation is never known in advance. That being said, we can attempt to make some reasonable estimates. Bitcoin’s mechanics will continue delivering value appreciation While past performance is not indicative of future results, past performance is instructive for forecasting future performance… when the mechanics that drove past performance will happen again (i.e., Bitcoin’s halvings). Here is Bitcoin’s annualized performance over various trailing time periods: As you can see, the Compound Annualized Growth Rate (CAGR) has been diminishing over time. Going forward, we don’t know what the CAGR will be, but we do know that the mechanics that drive Bitcoin’s value appreciation will be set in motion again in April 2024. (Here’s a deep dive on how those mechanics work & how they deliver reliable value appreciation: onceinaspecies . com/p/bitcoins-halving-is-less-than-a-year ) For conservatism, let’s assume the diminishing CAGR continues over the next 4 years — 45% CAGR may not be in the cards, but I wouldn’t bet against a 25% CAGR. (I actually think that the next 4 years has a strong chance of being bigger than the last 4 years, see this recent analysis for why… onceinaspecies . com/p/next-cycle-could-be-bigger) Bitcoin wrecks your hurdle rate If Bitcoin delivers 25% growth per year (on average, over a 4+ year timeframe), what does that mean? Sounds like a fairly modest number. And yet, if these returns are low-risk because they are based on Bitcoin’s unique and certain supply mechanics… this 25% CAGR upends how every capital allocator on earth approaches hurdle rates. Bitcoin offers venture capital returns with US Treasury risk & liquidity. In other words, it beats the pants off of every other asset in the investable landscape. Since a hurdle rate is rooted in the opportunity cost of capital, holding Bitcoin becomes the relevant benchmark by which to compare every other capital allocation decision. The sensible question for investors this decade is not “will this potential investment deliver US Treasury returns plus a sufficient risk premium?” Instead, the right question becomes “will this potential investment deliver better returns than simply holding Bitcoin?” In most cases, the answer will be “no.” And yet, if the analysis here is correct, it will still take a decade of misallocating capital before traditional finance embraces this unorthodox, yet stupidly simple North Star for prudent capital allocation: the default should be holding Bitcoin. ---- If you enjoyed this, check out Once-in-a-Species. 1 quality piece of Bitcoin analysis per week, delivered to your inbox. 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