SLP273 Andy Edstrom – Bitcoin and Leverage: Don’t Get Rekt

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Andy Edstrom rejoins me on the show to talk about Bitcoin, leverage, and not getting Rekt! We chat: 

  • What’s changed in the market in recent years
  • Why use leverage
  • Risks and costs with leverage
  • Supercycle or not
  • SWR and FIRE crossovers with collateralization 
  • Bitcoin side hustles or jobs

Andrew Edstom links: 

Sponsors: 

Stephan Livera links:

Podcast Transcript:

Stephan Livera:

Andy welcome back to the show.

Andy Edstrom:

Stephan, it’s great to be with you, man. How are you?

Stephan Livera:

Doing well! I am following the space very closely and we’re seeing a lot of development around this idea of leverage and collateralization and I know you wrote recently on this topic as well, around how to, or basically you’re writing, don’t get rekt. So what spurred you to write that piece?

Andy Edstrom:

Yeah, happy to talk about that. And before I do that, I’ll just remind you that when we did our first episode last year, I did my, I think my best Aussie accent. And you told me it sounded like a Kiwi accent and I was deeply distraught by that. So I left with my tail between my legs. It’s taken me months of preparation to get back into it. I’m surprised you invited me back after that embarrassing episode, but I’m glad to be here.

Stephan Livera:

That’s right. Well the Australian accent, it seems like a lot of well, most of my listeners are not in Australia, so that’s an interesting

Andy Edstrom:

There’s not that many Aussies in the world, let’s be honest. I mean, I’m sure you own that market. But in a global market, such as we have with Bitcoin, there’s — I’m not surprised to hear many of your audience, most of your audience are all across the world. You’ve built quite an audience and quite a platform here, and I’m just happy to be involved.

Stephan Livera:

Yeah, that’s awesome, man. But let, yeah, let’s hear it from you. So you know, not getting rekt. Why is that an important thing to think about?

Andy Edstrom:

Yeah, so you’re right. I did write this article for BTC Times it was published in March and basically the idea was we’d had the first major up move of the bull market. And I was thinking about leverage and I was thinking about how things could go wrong for people. And honestly, I wrote this article for the plebs, right? Including myself. And the idea was you can be right about Bitcoin, right? You can be class of, I don’t know, 2016 or 2017 or 2018 or even earlier or later, and have managed to wade through all the noise of the bull and the bear and the altcoins and all that stuff, and figured out that Bitcoin is the thing. And yet still blow yourself up by using leverage and leverage is not a new concept to Bitcoin.

Andy Edstrom:

And I don’t think it’s that new a concept to many Bitcoiners. I mean, let’s be real, anybody who’s been in the space, has watched and talked about you know, what goes on in BitMEX and perpetual swaps and whatever, a 100x leverage, but in a bull market like this, I think for the first time, many Bitcoiners are actually going to have to make hard decisions about how do I access Fiat to pay my expenses, right, without parting with too much of my stack. And this topic is all the more pressing right now, because at least in the US you know, we got this new tax proposal, which is going to raise the capital gains tax and look, none of us who are in this thing with any conviction want to sell any of our stack.

Andy Edstrom:

I mean, we want to HODL forever, within reason. Some of us may have you know, speaking purely hypothetically, some of us may have three kids and be the only you know, the only source of income in the household and have Fiat expenses. And you know, the reality is after a big bull move, some of us may be making hard decisions about whether to part with some amount of our stack at some number somewhere in the six figures, let’s say in terms of USD price. And so, and so, yeah, it’s all the more pressing thinking about tax, and I’ll just make this even more personal potentially. So I live in the state of California. So the state of California basically has the highest income tax schedule in the country with the possible exception of New York state or New York city.

Andy Edstrom:

Who’ve also got city tax, but basically you’ve got really high tax rates. And then plus you got the capital gains rate for federal, and they’re talking about raising that. And the nub of it is if you sell — if you have any kind of significant income and you sell any, let me put it this way. California state tax above $57,000 of income is 9.3%. So you’re basically at 10% max bracket, 13.3%. So you add that to the capital gains. They’re talking to you about taking the capital gains rate into the twenties at the max bracket as high as almost 40%. And then you add the Medicare surtax. And now, now mid sentence, I’ll give the disclaimer that none of this is tax advice or investment advice, but you’re talking about giving away half of what you sell, because let’s be honest, right?

Andy Edstrom:

Capital gains tax applies only to gains above your cost basis, but if you’ve been stacking since $10,000 Bitcoin or lower, so multiple, and so basically you’re talking about anything you sell is substantially all gains, right? So any amount you sell in a lot of cases, half goes to the tax man. Well, that’s pretty brutal. You’re in a position where you’re going to want to borrow so that you avoid the tax. But yeah, I wrote this piece in order to get people’s juices flowing, thinking about possible scenarios in which borrowing results in — let’s say in a bad outcome. And the scenario I lay out is we had the first move of the bull market. Then some consolidation in the 40s and the 50s, I’m talking about thousands of dollars per BTC, by the way, the article has a bit of a misprint. It says consolidated in the 40 to $50,000 range.

Andy Edstrom:

And the reason I know that’s a misprint is because the price was already over 50K when it was published, but it was meant to say in the forties and the fifties, which is basically where we are and then the big move into the six figures. And I’m hopeful that we have a Supercycle or that we don’t have a big bear market, but it’s easy to construct a scenario in which there’s some proximate catalyst, maybe it’s an exchange hack. Maybe it’s some concerted government action. Maybe it’s just a bear market in stocks, right? I mean, let’s be honest. BTC has had significant correlation with risk assets. So if you had a big sell off in stocks that could trigger it for you know, for Bitcoin, if it comes from a high enough level.

Andy Edstrom:

And if it comes from a time in the cycle I don’t know what the magic number is 16 months post halving or 18 months post having, and the OGs look at the chart and they think, Oh, I’ve seen this movie before. Right? it’s X number of months past the having, and we’ve gone up a multiple and maybe you’ve had a parabolic move at the end. Like maybe you had a doubling in price — I’m making up numbers, but like maybe you went from a hundred to 200 in the span of a few weeks, and then you have the negative catalysts and then the OGs and large holders in the whales figure out, Oh, this is probably the cycle repeating. And so that’s the next leg down. And then obviously the newbs and the weak hands that don’t really have the conviction to hold, they start folding out.

Andy Edstrom:

And then you start to eat into the leverage, right? Then you get to the people who have borrowed against their BTC. They are starting to get to get margin called, right. Cause price is down, whatever 60%. And then those margins create the cascading liquidations that we know to fear. And you know, that’s kind of the scenario where I worry about Bitcoiners, who got everything right? They got the thesis, right. They got the HODL conviction right. They’re not intending to sell and they had the long-term view, but God forbid they took out debt and the stack or the portion of their stack that they pledged as collateral against that debt is insufficient to avoid a margin call. And basically they get rekt.

Stephan Livera:

And that’s we saw this also in March, 2020. So just context for listeners, we are recording this the 3rd of May, 2021. The price right now is call it 58,000 USD, Bitcoin as a market is something like 1.1 trillion just under that. Right. And now just a little bit over a year ago, there was a big move down. And at that time in March, 2020, it went from, I can’t remember, off the top of my head. It’s like nine or 10,000 down to like 4,000. Right. And there were people who got rekt on some of the platforms now, of course BitMEX and some of the the degen leverage casinos. Yes. A lot of people got rekt there, but also some people on some of the other actual just collateralized platforms. And so I think that also brings up the conversation around how much safety and how much collateral should people be pledging.

Stephan Livera:

And I guess what’s a useful way to think about this. Like, should we be thinking, okay this amount is, say 100% of my stack, and let’s say, as an example, if I’m borrowing the fiat equivalent of call it, you know 5% of my stack. And then I would put up as an example, 15% of my stack as collateral. So that I’m 3x coverage. And would that be enough? Or maybe I should actually be going to 20% of my stack you know, as a way to give myself protection on a big sudden downside move. So what are some of the ways to sort of think about that and what kinds of levels do you think are reasonable for people to think about?

Andy Edstrom:

Yeah. So I kind of want to say a couple of things and I kind of want to back up and sort of reframe the whole issue. And in the market, the first thing I’ll say is there’s no safe level. And I really want people to understand this. Why is there no safe level? Well, first of all, there’s no floor on the price of Bitcoin, right? Because as you know, with — even if it only goes down by whatever the number is 70% for an instant, they can yank the rug on you. Item one. Item two prices can deviate wildly. Do you remember, was it Kraken? I can’t remember. It was one of the major exchanges recently where the price like went totally haywire. It was like a flash crash basically. Right. Okay. So what happens if your entity that you’ve posted your collateral with and taken money from, basically has a flash crash on their books?

Andy Edstrom:

Cause honestly all these guys, anyone who’s lending against Bitcoin collateral either has a trading desk or sort of intimately linked to a trading desk. Right. Because actually in a lot of cases, that’s how they make their money. Right. They may provide services included in the lending, but you know, they basically, they send, they make it easy to buy and sell BTC. And so they’re basically a sales channel, right? For the, for either the desk that they are affiliated with or is there a third party. Okay. So that’s a concern, right? Like how do you know that the quote, unquote price won’t go haywire on the ticker that your counterparty is measuring against? Okay. Third consideration, suppose you go to post more collateral to defend your position.

Andy Edstrom:

Right. You get the margin call and they’re like, Hey you’re, you’re about to get liquidated. You know, post more BTC go into your cold storage or wherever you got more collateral post up with us so that we don’t liquidate you. Okay. Well now you’re assuming that you can make that transfer. You’re assuming that their systems are working. What is the uptime for, let’s just say, exchanges, entities, companies that buy or sell or, or allow customers to buy or sell Bitcoin? Well, they work most of the time except for when you really need them to work.

Stephan Livera:

And another interesting point to add there as well is that you might be, so let’s talk about the dynamic there. So during a price crash, what happens miners shut off? What does do it drops the networks hash rate or hash power. What does that mean? Blocks slow down. Which, what does that mean? It means it’s harder to now get into a block because blocks are happening less often. There’s more congestion. So you’ve got this double whammy effect where at the precise moment that you need to be putting more collateral in the network is actually in some sense, slowing down. So it’s actually harder for you. So you might even be paying higher fee transactions in terms of Bitcoin transaction fee. Assuming you can quickly get to your cold storage or maybe you have some in a warm storage, and you’re trying to send that in so that they don’t liquidate you. Well, these are also like a double whammy thing. That’s another double whammy effect to consider.

Andy Edstrom:

Absolutely, Stephan you’re spot on. It’s the moment of maximum stress in the system when you most need it to work properly. Yeah. That you’re forced to transact. So these are all considerations. So the short answer is there’s no safe limit. Now I’ll make some general comments, which is there’s different providers in the market and they have kind of — they make various trade-offs. I’m not sure I’m going to talk about specific names. Some of them maybe sponsors of your show, there’s pros and cons. You know, some of them are new to the market. Some of them have high minimums in terms of amount you have to post as collateral or how much you can borrow some of low. And some of them have very tight margin call.

Andy Edstrom:

Let’s say, thresholds, that’s something to be very wary of. In other words, even if you have, let’s say you post whatever, a hundred grand and you’re only borrowing 40, okay, you’re borrowing at a 40% loan-to-value, or maybe even just 30%. There are some providers that even if you’re going at a low LTV will still have very tight thresholds for when they margin call you. Right. So even though you’re very over collateralized, they will still make you potentially post collateral. If the price moves down whatever 20% or something, which happens routinely with Bitcoin. So that’s one thing to be aware of. And then obviously there’s other economic trade-offs, which I think are worth talking about in the abstract. And, if you’ll humor me, I’ll back up a little and sort of take the big picture view.

Andy Edstrom:

So this comes from my experience working for the vampire squid known as, I mean, investment bank known as Goldman Sachs. I’ll never forget we had a PowerPoint slide, right? You know all the PowerPoint decks. And by the way, I worked in the in the leveraged finance department. Leveraged finance as a euphemism for for junk bonds and junk loans. Which makes me think that we should adopt the moniker of junk coins, in the sector, altcoins is like the term high yield, right? It’s the sanitized version of high yield bonds rather than junk junk bonds. But then we also don’t have to use unclean language to describe some of these altcoins. We just call them junk coins. We don’t have to call them shit coins. Anyway, they’re gross. So the slide we would have is it would talk about the basic terms of whatever piece of debt we’re talking about, issuing whether it was a bond or whether it was a loan and there’s some, and that was corporate debt, but it really does translate to a large degree to personal debt.

Andy Edstrom:

So what are the major factors when you’re thinking about taking out a piece of debt, borrowing money? Okay. One obviously is the interest rate, major concern. Another is the loan-to-value, right? How much can you borrow against collateral, which by the way, assumes that there is any collateral at all. It doesn’t have to be. Loans can be unsecured. They can be based on credit in the case of companies they can be based on the company’s credit in the case of people, it can be based on personal credit like your credit score or your history of repayment or what have you. There’s term, how long will the lender extend you that loan on the agreed terms for. There’s repayment provisions, both your ability to repay without penalty and sometimes a redraw, right? Like with a revolving loan structure, like a credit card, or with the lender’s ability basically to call the loan away from you. Okay. So these are a couple of major characteristics. Now let’s talk about, what’s generally available to people, right? Personal credit in the market. And there are a few things that examples that come to my mind. Okay. So I, for example, may have a Schwab account

Andy Edstrom:

Or some other brokerage count Robinhood, whatever. And I have access to margin debt. Now margin debt is what Bitcoin lending looks like today. You have an asset — it’s in an account that’s controlled or custodied by this third party, you get to borrow against the assets in the account. But if those assets fall in value, you get a margin call and they could sell the collateral. So it’s most comparable to a brokerage account with margin, but what’s interesting about a brokerage account with margin is today, margin debt is stupid cheap, okay. Interactive Brokers, Schwab I don’t know for Robinhood, but in most cases, margin is, debt is basically free. You know, you’re borrowing it certainly less than 2%. And in a lot of cases, close to zero now go to the other end of the spectrum, unsecured personal debt.

Andy Edstrom:

I personally have a couple of credit lines with banks, and these are revolving lines, which is great. Cause like with a credit card I can borrow or repay when I choose the interest rate is high. Okay. It’s like, I don’t know, 9 or 10% annualized, but not only can I borrow and repay when I feel like it, but there’s no collateral posting, it’s unsecured. It’s based on my personal credit. You know, in some cases it may have to do with, okay, relationship with the bank. Like maybe I’ve had an account with them for a while, or maybe they ran my credit report and they have access to my credit info. And so, because I have decent credit, they say, Hey, we’re willing to lend you some money unsecured. Yes. The interest rate is high, but there’s no collateral, okay. Somewhere between the, we can liquidate your account margin.

Andy Edstrom:

And the unsecured line is mortgage debt and mortgage debt is obviously a gigantic market everywhere across the world, especially in the US and in that case, you are pledging collateral. Okay. But, and by the way, your loan-to-value tends to be quite high. I mean, you could go to 80% in a lot of cases, you get a long term, right? They’re not going to yank the rug out from under you, or they’re not going to terminate the loan after whatever three months or six months or a year, 15 or 30 year maturity. And the price is really rather attractive. I mean, you can borrow at 4% now what’s the catch? Well, there’s a couple of catches. One is, it is a subsidized market. Let’s admit, at least in the US right. The Fed is still buying $40 billion of mortgage debt every month.

Andy Edstrom:

And that’s obviously directly subsidizing my mortgage and everybody else’s out there. Nevertheless, I think when you look at foreign countries, non-American countries around the world, I think in jurisdictions where there’s less subsidy or no subsidy okay maybe instead of 4%, it’s 6% interest rate, but it’s not 10, it’s not double digits. And then the other thing is, or the other caveat is that’s based on personal credit. So I look at these scenarios and I apologize for being long-winded here, but I think it’s important. I look at these structures of debt and I look at the Bitcoin market and I say, this is pathetic because what’s available in the Bitcoin market today is the worst combination, of these basic scenarios. Okay. It’s fully liquidateable right? Like they can yank the rug when you get a margin call, even though you have collateral posted, which is, as we know, the world’s most pristine liquid collateral asset in the world.

Andy Edstrom:

And they’re charging you through the nose in terms of the interest rate. And they’re not giving you significant maturity with some exceptions which we can, we truly can get into, but here’s, what’s interesting. I’m not aware of any lender out there that offers a better product based on personal credit. In other words, what I would say is, as a potential borrower, based on Bitcoin collateral is look, be like the mortgage lender, do your proctology exam on me run my personal credit make me send you bank statements and payment histories. And make me tell you how — what money I moved where over the last couple of years, here’s my tax returns, do some due diligence on me. As a borrower, as a result of doing your credit analysis, charge me something better than double digit interest rate and give me a reasonable deal on better terms. I believe that the lending market for Bitcoin will get there, but we ain’t there yet, as far as I know, which is unfortunate because the borrowing need is now and what I’ve described in terms of a product, correct me if I’m wrong. I’d love to know if there are lenders out there that are actually doing credit analysis on on borrowers, but I think we’re at least one cycle away from that product, which is really the product that this market needs.

Stephan Livera:

Yeah. That’s an interesting way to put it. So I guess there’s a few different things to think about though, I guess the main rejoinder would be that the reason that cheap credit exists in the fiat world is because of fiat money in central banking and moving into a hard money world, it may just not be feasible to have that level. And I think they will come down a little bit. One of my recent episodes with Parker Lewis episode 263 we spoke a little bit about what will happen with those interest rates. And I think, I think there will come down maybe into the high single digits. That was what his view was. And I think over time, as you rightly point out as these worlds collide or mesh, the Bitcoin world meets the normal Fiat finance bank places start giving people the option of having Bitcoin collateral or recognizing the Bitcoin asset aspect of it. Whereas right now, if I take my Bitcoin and try to apply it to a normal Australian bank for a loan, they won’t consider that Bitcoin, but…

Andy Edstrom:

That’s right.

Stephan Livera:

Given time they would.

Andy Edstrom:

And to Unchained’s credit to Parker’s credit, they do offer loans with significant maturities. I mean, I think they go at…

Stephan Livera:

Three years, I think, yeah.

Andy Edstrom:

Two or three years, I want to say. It’s expensive, it’s quite expensive, but at least they’re offering maturity. And yeah, what I’m saying, it’s sort of a call to arms. I mean, I’m a little bit channeling Michael Flaxman here. I’m not naming, but I am shaming. I’m saying, look guys it’s like with the hardware wallets, it’s like guys, we need this feature. You know, we need to be compatible with multisig — the analogy, right? If you’re a lender come up with an, with a product where you’re actually doing credit analysis or checking the credit of your customers so that you can offer a reasonable interest rate and a reasonable maturity and repayment terms, rather than just kind of living in this world of, Oh we’re just going to treat it like margin debt like you have in a Schwab account or in a regular securities account because pricing difference that that structure does exist.

Andy Edstrom:

But in that world, you really ought to be offering cheaper pricing. And I pushed back at the argument that, Oh, this is Bitcoin land, so interest rates are higher.

Stephan Livera:

The other point would just be that, well, we’re still so early that Bitcoin is growing at ridiculous rates. Right. So if you look at the typical CAGR right compound annual growth rate for the last 10 years, it’s something like 160%. So, and for people who would otherwise be paying a tax, call it 25%, call it 30 or 40% if they’re paying call it in terms of interest, they’re paying 10 to 14% instead of paying 30 or 40%. Well, then I guess it can kind of make sense, but obviously the volatility is a big factor to consider. And obviously these big down moves can really, you can get rekt and then it can be in that scenario. It can be the worst of both worlds because now not only have you had to sell at that lower price, you now would have to pay –

Stephan Livera:

You might still have a capital gain at that level. So now you’re going to have to pay tax to the government, whichever government, the taxes for that also. So there are certainly risks, but I think it’s one of those things where there’s opportunities too, right. We have to recognize kind of both sides of this, that people who have a — if they have a big enough stack. And of course, like you said, there’s no truly, fully safe, but you can think of it. Like there’s reckless 100x on BitMEX and then there’s relatively conservative well, collateralized positions where you are like, as an example, if you’re doing 5x times the amount, then generally speaking, most people would say, okay, 5x times you’re relatively unlikely to be liquidated at that level. But I think it’s also interesting as well because the market for this has grown so recently, right? Like some of the providers in this space only came up around 2018. Maybe they were getting started in 2017. And so I think that’s also an interesting factor as well, because what happened in March 2020 last year, the market was a lot smaller then than it is now, isn’t it?

Andy Edstrom:

Yeah. And I think this is one of the points I made in the article too. And I think I may have singled out BlockFi, but the point I made was in March. So year ago, most of these lenders were relatively small operations, at least compared to what they are now. And so the decision it was sort of anecdotal and I don’t think we really have any good data on who got liquidated in what size at which different lenders, right. Which different companies, but anecdotally some treated customers better some made every effort to not liquidate people certainly BlockFi claims that, and my point is, okay, well, that’s great when you’re a hundred million dollar valuation crypto startup, let’s say like they are, because it’s nascent enough that A.) you can’t afford to destroy your customer base at that stage, because then you’re just like out of the game, like you’re zero, right.

Andy Edstrom:

As a company and B.) It’s not that difficult to go to your LP base. Like, let’s say as a lender, you partially destroy your capital base because you didn’t liquidate your customers in time. And you had leverage on your balance sheet and basically you blew up your equity cushion. Well, you can go potentially to your VC backers and have them write checks. And the checks aren’t that big. Fast forward, right. Wind the clock forward to the year 2021. We know that the lending margin is — or market is burgeoning. You know, it’s 10x bigger at least. And so now your loan book is multiples larger. And so you have market power against your customers. And if and when you have a downturn you’re basically the gorilla now you’re at a multi-billion dollar valuation, which means you can probably afford to liquidate X percent of your customers number base, number one.

Andy Edstrom:

And number two, if you don’t do that well, going back to the well, to your VC’s, your equity backers, right? It’s like the check to make you you know, to make you whole and make the balance sheet solvent. Might’ve been a few million bucks back then. Now it’s a lot bigger. And it’s a lot harder to basically fund rescue capital to one of these lenders that’s insolvent as a result of not liquidating enough of their customer base. So yeah, I just think it’s a different dynamic. It’s a different risk. And so when people say, Oh, we’ve lived through the disaster scenario a year ago when BTC was down 65% in a day or two, and I say, the market structure’s changed don’t be too confident in that event as precedent. And assuming that a similar downturn in price is going to result in a similar outcome in terms of you know, borrowers getting liquidated.

Stephan Livera:

Yeah. And so the other conversation that’s coming now is this whole idea of Supercycle, or are we entering the final cycle now? I’ve sort of, I don’t believe that, I don’t think we’re going into that. I think it’s one of those things where we’re just not there yet. And a lot of people want to feel like this time is different and now you don’t have to worry about it and just it’s all good. We’re not going to have another 70 or 80% drop where sadly, it’s not. I’m not saying I want this, but I’m just saying, I think it is the likely outcome that there might be a lot of people who plan things out on the basis that Oh see, we’re only going to say, 20% drops or 30% drops along the way up. So I will collateralize my loan on that basis and I’ll be fine. And then actually, yeah, a lot of them will just end up getting rekt because we’ll end up overextending at some point. What do you think?

Andy Edstrom:

Yeah. So a couple of things say there, I have conversations with our friend BitcoinTINA, and he always, after I come off of one of those conversations that I’m always extremely bullish and believing, we’re going to have a we’re not going to have a big bear market. You know, that history won’t repeat, but you know, my base case scenario is still like you, in other words, I say, okay, I allow for some percentage chance that either we go up and stay up, or we go up steadily and don’t have a significant in a bear market like we’ve had in past cycles. So what percentage because the market structure has changed, which is a fair point. I mean, you can definitely make an argument that with a stronger steadier bids, let’s say from institutional money, maybe the market structure has changed.

Andy Edstrom:

So that may be true. What probability do I sound assigned to that outcome? I don’t know, 20% maybe. And so I still, like you, have a base case, which is assuming that the cycle repeats that will have a significant downturn. So, and yeah, I mean, the reality is you just don’t know what the spot momentary wick downward will be. One of my favorite lessons as a professional investor through my career has been whenever you’re pitching an investment idea to the investment committee, okay. At the investment fund, you always do scenario analyses and you have your middle expected case and you have your upside case and you have your downside case, right. For this, whatever investment stock, whatever it is, is going to perform. And the downside case is frequently the quote unquote, it’s based on the quote unquote worst case, what’s the worst case.

Andy Edstrom:

What people always do is they take the worst case available in history and they use that as some kind of benchmark. What’s the problem with that analysis? Well, the worst case in history was always the worst case until you had an event that was worse than the prior worst case. Right. People learned that in the in the global financial crisis of 2008, 2009. So look, I don’t mean to be a Cassandra — I don’t mean to just totally rain on this per parade. I mean, I’m quite bullish on Bitcoin. And I’m not expecting a disaster. I’m just observing that there’s some albeit tiny, still present possibility or probability that things could go against you in a way that you just have to assume that there’s a possibility that whatever portion of your stack you’re borrowing against is going to get taken from you now.

Andy Edstrom:

So that gets to, okay, well, if I understand that, if I’m aware of that, then there are of course ways to mitigate that. At least somewhat, you can do it with a small portion of your stack. You can do it at a, as you said, a low loan-to-value. I would still argue that the same logic applies with respect to any use of leverage. I mean, I’ve never traded on BitMEX, but for the, for the degen traders who were playing the BitMEX casino or the Binance or the FTX casino, it’s like, look, you want to mess around with leverage fine, but just contain the damage. Ring fence X percent of your assets that you’re risking in that game. And that’s fine if it’s a small percentage of your total stack it, won’t basically — the cancer won’t spread to the rest of your asset base.

Andy Edstrom:

If you size it appropriately. And I think that’s one way to look at it. And then another consideration is think about counterparty risk, which always applies. So if not your keys, not your coin is true with an exchange. Well, by definition, it’s true with any counterparty that you’re posting your Bitcoin as collateral and you’re borrowing from, and yeah, idiosyncrasies can happen with that particular party. They can get hacked, anything bad, basically that can happen to an exchange can probably happen to them. In many cases, they are exchanges themselves. So it’s worth considering also diversifying. In other words if I’m risking, and I’m pulling out a number of 10% of my stack to borrow against, maybe I do it with more than one counterparty, right. Maybe I divide it into two pieces so that I don’t have any single counterparty risk. And I can kind of diversify that risk in the same way that if one were diversifying risk across exchanges, one would have more than one exchange account.

Stephan Livera:

Very good considerations there. And I think it also comes down to what you’re doing with this as well, because the other thing is, if you are borrowing for the sake of doing a business, then it’s now tax deductible, or potentially you’d have to look up everyone has to look up for themselves on whether that’s tax deductible, but it’s potentially tax deductible, meaning your net interest cost might come down a bit. And so that’s like another idea. And then let’s say that income that’s coming in, maybe one example would be, let’s say you were use a collateralized loan with a small portion of your Bitcoin to buy some Bitcoin miners. Then you are earning some Bitcoin, and then you can have that Bitcoin come into the collateral. So over time, your collateral position is still rising because you’re earning Bitcoin. Then it’s sort of making you safer from the liquidation risk.

Stephan Livera:

But as you said, there’s still the custodial element of it. And then I guess another consideration would be, do you still have income? Or are you planning to like, literally, let’s say you’ve been saving for years into Bitcoin and now you want to retire and now you just want it. But now, I would say, if you have income still, then you’re in a better position because now you can use that to make payments or try to pay down in Fiat terms. If your income is in fiat versus if you don’t have income, well, then you need to be even more conservative. Right?

Andy Edstrom:

Yeah. You make a great point there. Stephan, it really does matter what your earnings profile is. And there’s, yeah. There’s certain folks among us who have little or no income because I don’t know you’re a hardcore Bitcoiner, but you’re retired. Right. And so in that scenario, saddling yourself with a double digit percentage rate on that debt that you have to pay is a little bit dicier than, Oh, you got a cushy Fiat job. You know, you got money coming in the door. I like your idea, of course, of taking some of the proceeds and using it to earn. I mean, understanding that there’s embedded risk there. And of course, understanding that the longer the Daisy chain of transactions that you construct, the more risk you have of when trouble strikes and you need to fund collateral or you need to move assets it’s just one more link in the chain.

Andy Edstrom:

That could be broken — it can go wrong under, under duress. But yeah, you make a good point. There’s other ways. I mean, there’s also of course using options, basically posting collateral, finding ways of generating income for instance, maybe you’re willing to post collateral with a counterparty, you’re borrowing some amount, but you’re also generating income by, I don’t know, writing calls — selling calls, which if price goes up your Bitcoin may get called away with you or from you, but maybe you’re okay with that, for some portion of your stack, because it’s allowing you to generate income now and yeah, you’re giving away some of the potential upside, but if it doesn’t work out, the price, doesn’t go up. Well, then you collected the premium from the options.

Andy Edstrom:

And meanwhile, you still have your Bitcoin and it didn’t get called away from you. You know, likewise, you can kind of construct these outcomes with futures. You know, people talk about the contango trade, right? The simple post-bitcoin long — have your long Bitcoin position posted with your counterparty, sell the futures contract, right. Possibly to premium. So if spot Bitcoin today is whatever 60K and you’re selling the six month futures contract at 70K, there’s an opportunity to capture that spread. And if price basically it allows you to capture, if you’re ready to potentially part with a portion of your stack, depending on how price moves, that’s a scenario that may allow you to lock in a little bit extra rather than doing the hedge fund move of sort of doing this trade, this cash and carry trade over and over in series, you may reach a point where you say, ah, bitcoin’s 200K and I’m okay. You know, locking in that price generating a little bit of extra spread on that carry trade and if I get called out on one side of the contract or if I’m forced to sell some portion I’m okay with that.

Stephan Livera:

Yeah. I think it’s an interesting conversation. And also it really depends what phase of your life you’re in, because if you’re in your twenties or thirties, you’re very much in an earning and accumulating wealth phase. Whereas let’s say if you’re in your 60s, 70s, well now you’re starting to get more to a, how do I draw down some of that wealth? And you have to think about, well, what if I just directly sell and spend some of that Bitcoin, right? Like we don’t live forever. Maybe that is actually what people have to do. And people say, “No, Stephan! That’s too bearish. You should never sell only borrow”. I don’t know, I guess you’ve got to decide for yourself what level of risk you’re willing to take. And just that factor of sometimes if you need to be able to spend now for living expenses or to buy that house for your family that you always wanted or whatever it is, I think you have to sort of weigh that up. And yeah. So I guess in your mind, how are you thinking about that in terms of demographics and how that influences your decision?

Andy Edstrom:

Yeah, that’s a great point. I mean, we are, there are those among us who are hardcore Bitcoiners do have a significant other maybe, maybe married, maybe have a wife maybe realize that Bitcoin is the investment opportunity of a lifetime. And maybe that significant other, that life partner has been very supportive and generous. And despite that, the fact that every fifth word coming out of your mouth is Bitcoin has said, you know what partner, I’m with you. I believe in you. I don’t understand this stuff as well as you do, but I agree we should HODL. You know, we’re all in and years go by. This is the bear market, let’s say, right, it’s 2018 and you accumulate and you HODL and you got those diamond hands, but number goes up and you know, maybe it’s time to consider having a family, maybe your long suffering, loyal spouse needs.

Andy Edstrom:

Maybe you need to give her a shot at at home ownership when you’ve been renting your tiny studio apartment and pushing every last piece of Fiat that comes into your bank account you know, into Bitcoin. So yeah, everyone’s situation is different. It’s all a matter of your personal preference. But I do think you make a good point about if you’re younger, you can afford to take more risk, arguably you know, if you’re older and or retired, the opposite is true. I think people do the good thing about long-term HODLer is if you’ve lived through a full cycle, you’ve experienced the pain, you’ve experienced the volatility, you’re battle hardened. I would say that If you haven’t been listening to Stephan Livera Podcast, since episode one came out, maybe you’ve listened to the whole catalog, but maybe you only started listening nine months ago.

Andy Edstrom:

And you haven’t been through a full cycle then maybe you should consider your personal psychology and just acknowledge the fact that you haven’t lived through a bear cycle yet. There’s nothing quite like the visceral feeling of number go down, which has happened from time to time. Although the NGU technology is intact for the long term. As we know there can be short-term periods of downward movement. And if you haven’t been battle-hardened, then you should just consider, Oh, how tight is my grip? How convicted am I? If I haven’t lived through that, then maybe I should be somewhat conservative in borrowing because one of the basic premises of investing and personal investing and personal asset management wealth management is the worst possible thing you can do is take more risk,

Andy Edstrom:

Let’s just say, take on more volatility you can live with, and then you panic sell the bottom. And this is that has nothing to do with Bitcoin that has to do with stock investing other financial asset investing. The worst possible outcome. I can say from personal experience as a wealth manager, is that your client overestimates their risk tolerance. And then in a panic, they’re like, okay, they capitulate, they sell at the worst possible time, and that is the surest way to impairing your financial security for the long run. So again, sorry to be the wet blanket, but yeah, these are some things to consider.

Stephan Livera:

I think you’re right. These are important things about our own psyche, about how the sentiment goes. It’s important to, if you’re relatively new to Bitcoin and you have not been through a bear cycle or multiple bear cycles, you really have to understand that right now it’s May 2021, there’s all this bullish news. There’s like some new company that bought Bitcoin or this new company who’s et cetera. But you’ve now got to think, what is, what sort of news articles are we going to be seeing in the bear down cycle? Right? And in that time period, it’s like, there’ll be people who hate Bitcoin. It will be a lot more people who are indifferent to Bitcoin, so they might have heard of it, but they just don’t care. And I know it sounds weird because we’re saying this right now in the middle of the bull run, we’re probably about to get into the really crazy part of it in the months to come later this year, but it’s just there to warn people and get them to think about what’s going to happen if that cycle or if — or when that cycle turns.

Stephan Livera:

I guess now it’s probably fair to say that at least in my experience, right, I’ve been around since 2013. It feels to me like the bear markets are getting progressively less cold, if you will. Or the winter is, are getting less cold, right at the 2014-2015 bear market was brutal. It was so brutal. Whereas, the call it 2018 bear market. I mean, yeah, it was kind of hard, but it wasn’t like, it wasn’t like 2014-2015. And so who knows maybe the bear cycle of 22 or 2023 might not be that bad, but it’s just something to think about.

Andy Edstrom:

Yeah. I think it’s a really good point because there’s two sort of measurable or quantifiable, I think factors there about the bears getting less severe one is just the draw down, right? I mean the peak to trough drawdowns have been decreasing. I’m hitting whatever. The first one was 95% and the next one was 90. And then the last one was 83%. I want to say. So there’s still severe, but yeah. Peak to trough has gotten less severe in each downturn. So that’s one quantifiable factor. The second thing you mentioned about the news cycle, which is a really good point. I hadn’t thought about it before, which is I wish I’d been in Bitcoin in 2013. I have to imagine that when the excitement went away, the space was so small, like the number of companies and the amount of activity and the news coverage must have been an order of magnitude smaller than what’s going on now.

Andy Edstrom:

Right. So there must have been weeks at a time or months at a time when pretty much nothing happened, right? Like there weren’t new product launches there weren’t lots of new startups getting funded. Exactly. There wasn’t as much stuff getting built just because the space was so much smaller. Yeah. And so at least one would think that after, gosh, I dunno after all the mainstreaming and you know, all the payment apps and the banks supporting Bitcoin now, I mean, it’s possible that they just all reverse themselves and go away, but it seems unlikely. So it seems like you’re still gonna have news. I know Stephan that you’re going to be reporting and others are going to be putting out great content in a way that just didn’t exist. You know, back in 2013, 2014, there was, I can only imagine there wasn’t constant flow of good Bitcoin content to keep people warm to keep people engaged, keep people hopeful for the future.

Stephan Livera:

Well, yeah. We’ll see. Hey I think that’s the other thing as well for listeners out there whether you’re a new HODLer or you’ve been around and you’ve been in the game for a while, you really have to think about, am I willing to go through another four year cycle? Right? That’s at the end of the day, that’s what you have to think about. And ultimately most of us are in like –, those of us who are hardcore are in this for the long — we’re playing 10, 20, 30 years out at the minimum, you really need to be thinking four years. Can I wait another four years? And do I have the income to sustain myself for that time period? Or otherwise you need to start thinking about, well, do I have some kind of buffer in terms of assets or something to sustain yourself because that’s also been a thing where some earlier Bitcoin has had to basically spend a lot of their Bitcoins during the worst possible time of the bear market. And so then they’re spending a lot of their coin at that worst possible time.

Andy Edstrom:

Yeah, that’s right. That’s absolutely right. And I still — I go back to my example of the patient spouse. They’ve been with you for a few years and you’re going, and you’re saying, ah, sweetheart, I need another four years. We’re not going to be starting a family that we’re not going to buy a house. You know, we’re just going to have to hang out and let her stack grow for another four year cycle. And the hardest core HODLers will say, well, if she’s not willing to stay with you, then you know, you picked the wrong one and you should move on. But I tend to think that some people have already made life partnership decisions prior to finding Bitcoin. And yeah, you just have to decide how much relationship stress am I willing to live with as you suggested you know, how much selling of that asset am I willing to do in the depths? You know, if I don’t have enough fiat income to you know, to support my expense base or how much am I willing to cut budget, right? How many of my chairs am I willing to sell all my chairs? Or am I only willing to sell some of my chairs

Stephan Livera:

Trick question! You should have already sold all of them! Now, but I’ll tell you what, and another thing that’s interesting, and I follow the years ago, I used to follow the FIRE community a bit more, right? So that’s this whole idea of financial independence retire early, right? And I think I was always one of those people who was interested in saving and personal finance. So I was kind of interested in that idea and they have this concept called safe withdrawal rate. Right? And so this idea is just as an example, let’s say you have saved up over the course of your life, a million dollars, and you’re operating on a 4% safe withdrawal rate. Then you can spend approximately 40,000 per year and not go busto before you die, basically. And so that was calculated based on what was known as the Trinity study and kind of looking at stocks and bond returns.

Stephan Livera:

And it was sort of looking at like a 30 year pathway from retirement till death. And so I guess that might be an interesting conversation when that comes up in the whole Bitcoin world, if you know, what would a safe collateralization rate be? And I don’t know, maybe we’re too early, or maybe it has to be extremely low right now, like 1% or 2% of your stack. And otherwise you’re just not going to make it, I wonder what your thoughts are on that and kind of how long it would be until that kind of becomes a Bitcoin, a common Bitcoiner conversation.

Andy Edstrom:

Yeah, no, I love this topic. So the 4% rule is like a classic in wealth management, right. It’s like, okay, you can do all these fancy projection models about rates of return and inflation and living expenses. And you can do Monte Carlo analysis and you can do all this fancy analysis basically. But yeah, the 4% rule was kind of the rule of thumb. Like yeah, probably you can afford in many cases, depending on how long you live, which is a big caveat, you could probably afford to spend 4% of your capital over time and as you say, not go bust. Okay. But that has a few key assumptions embedded in it, which may not be true. The first is what is the rate of inflation? You know, consumer let’s say, and without getting into arguments about definition, but let’s say, what’s going to happen to the price of your consumer basket over the long run that’s one, two is how long are you going to live?

Andy Edstrom:

I mean, I think that study, I don’t remember what the longevity assumptions embedded within that were, but medical technology is an amazing thing and we’re all living longer than we used to. And so, yeah, you might have to have a lot more runway, a lot more years of life to fund than basically we would have assumed in the past. And then the last piece is, yeah, what is a reasonable — there were rates of return investment — rates of return embedded in that analysis. I’ve been telling clients for, I don’t know, five years ago that for five years or so that 10% annualized return in the stock market is a thing of the past. I mean, that, that was true for decades, but given the debt levels in the world, it’s going to be hard for that to happen over time unless of course they just print so much money that yeah, stock number goes up, but eventually get inflations to offset it.

Andy Edstrom:

Now, in fairness, if there’s one asset that I think can really outpace the rest in terms of performance over the long run, it may be Bitcoin. So if you have a big chunk of Bitcoin in your portfolio that could potentially make a major impact on your ability to fund that 4% living expense withdrawal rate on your overall asset pool. So yeah, I have to allow for that caveat, but I guess what I would say is this notion that you can retire at, pick a number age 40, right? I mean, I don’t know, I don’t know what these FIRE guys usually assume, but they’re not talking about retiring at 70 instead of 75 right now they’re talking about leaving the workforce at age 40 or 45, right. That implies just assuming that your asset-base is going to earn a real inflation adjusted return over, I don’t know, 70 years, right?

Andy Edstrom:

70 more years of life, 80 more years, I don’t know, long time. And like with any model or assumption the longer the timeframe, the less certainty you have and yeah, I think it’s a kind of a risky proposition in general to assume that, Oh, I don’t have to generate any economic return on my labor or my time spent for the majority of my life. I hope that’s true. I hope it’s I think it was Keynes. I can’t believe I’m going to quote, who said, like, who projected? I don’t know, a hundred years ago or eight years ago that by now we’d all be on the beach. Right. Because…

Stephan Livera:

Technology growth and so on. Yeah.

Andy Edstrom:

Exactly. The machines would be doing all the work and we could all be writing poetry or we’d all be working five hours a week.

Andy Edstrom:

It doesn’t seem to have played out so far who knows what the future holds. But yeah, I don’t put too much stock. I think it’s risky basically to cut yourself off from earnings early in life. Now, I guess the one thing I’ll say about that is there was a time when leaving the workforce was relatively permanent because you did your studies — you developed a specialty, you picked a career or even a company, and you stayed in that career with that company for basically your whole earnings life. I guess you could argue that, okay. In a world where it’s likely you’ll have to make multiple career changes where you need to be basically flexible and learning and trying new things doing new side hustles, I can come up with a pretty good argument for trying a different side hustle — leaving sort of the steady job and maybe experimenting maybe you know, maybe starting a very successful and ultimately very successful Bitcoin podcast for instance. But yeah, I don’t really recommend leaving the workforce early and assuming you’re going to make a 4% plus unless you’re heavy Bitcoin and Bitcoin works out for a long time to come, which I think is quite likely, but you know, as a fiduciary investment advisor. I have to point out that there of course are risks and there’s a possibility it doesn’t turn out that way.

Stephan Livera:

Of course. And I think the other concept that is discussed in some of those communities is this idea that, okay, maybe you could you might try to quote unquote retire early, but really you’re also keeping an eye on what’s happening to that investment portfolio and you’re willing to go back to work. Right. So let’s say that the portfolio starts dropping a bit and you’re like, okay, now my spending is more than the 4% level. Okay. It’s time to go back to work or trying to do a side hustle and earn some money that way. So I can spend that instead of spending down my capital. That’s one way to think of it.

Andy Edstrom:

So let me just make one comment in that regard. And I think that’s a good point, but I do caution again, I’m always the wet blanket over here. I do, because I’ve faced this with clients, which is, yeah, they think they have enough assets and they’re going to retire and they’re like, eh, I can always go back into the workforce. The reality is it is difficult to take a couple years off and then just jump back in to your former role, because in all likelihood, it’s going to take you a while to get hired your personal contacts, the industry will have atrophied somewhat over time. You know, your knowledge of the industry may not be quite up to snuff as it was before. And so the reality in my experience is actually people end up taking easily, a 30% pay cut.

Andy Edstrom:

You leave the workforce, you leave whatever job you had, you’re gone for a few years and you go back and boom, you’re earning 30% less. Oh. And by the way there’s always the more competitive and or professional, the job that you left, right. The longer usually is the hiring cycle. It’s not like you show up. I mean if you’re working in the fast food counter, for example, yeah. You can probably get rehired in a couple of weeks, if you’re a professional manager, the rehire cycle is in months. So just some considerations there, you’re probably going to take a pay cut. It’s probably going to take you longer to get back into the workforce.

Stephan Livera:

Yeah. Very prudent this like examinations or observations there. I think these are all things we will have to think about. I think the other one could be, people might say, okay, look, I’ve saved up enough of a nest egg. Now it’s time for me to start my own business. Right. I want to take a bit of a chance because I think this business that I’m going to start, or maybe, they want to go work in the Bitcoin industry somewhere. Right. Just go. And like, maybe they’re taking a bit of a pay cut to do that, but they think I’m so much more passionate about Bitcoin and my overall life satisfaction might be kind of worth it to me to kind of take that paycut that so that I can work with something that I really enjoy.

Andy Edstrom:

Totally. No, I think this is spot on. I mean, how many people love Bitcoin are true Bitcoiners. They’re working their fiat job and they’d really rather be working in Bitcoin part-time or full-time as the case may be. And the bull market happens. And we we go to six figure USD equivalent, BTC price, and you’re like, great. Maybe I can buy some freedom. Right. Maybe I can buy some runway to leave the Fiat paying job or partially leave that job and focus on what I really like to do. And yeah, I take a pay cut, but it’s totally worth it because I’m working on something I believe in and I’m helping build this industry and this ecosystem. And so yeah, in that case some people will have to either borrow a little against their stack or they may have to sell a little bit.

Andy Edstrom:

Of course you have to remember that if you are substituting a portion of your investment portfolio, which is Bitcoin, and you’re putting your labor into Bitcoin now you’ve really doubled down. Right. You’re truly all in, you are fully invested in the asset and your earnings are, are tied to the industry. So yeah, that’s just a, risk. It’s a risk factor to consider. It’s sort of the op it’s the opposite of the old financial advisor rule of, Oh, don’t keep all of your 401k in your company’s stock. Right. Because all your income is generated from that company and you’ve got this investment, so something bad, half the company you know, you lose on both sides. Fortunately Bitcoin is bigger than, than any single company. Right. That’s good. It is a global protocol. So in that sense it’s less of a risk, but yeah, just just one thing to consider.

Stephan Livera:

I think at the end of the day, I guess, to give a fair treatment here, it’s not that like all leverage is bad and never use it. I think it’s more just like there are opportunities, but just understand there’s risks as well and risks and costs to that. Right? You’re paying interest. There’s a risk of liquidation. There’s custodial risk, but the opportunities are, well, you can potentially, if you are conservative, you can borrow against that stack and use that to fund a business or fund various projects. Let’s say you want to do Bitcoin mining or live off some of that stack as well, purchase more freedom in other ways, maybe. So I guess that’s kind of how I would summarize it, but yeah, if you’ve got any other kind of thoughts to close out this idea of leverage and not getting rekt.

Andy Edstrom:

Yeah. I mean, it’s the usual thing, think through the disaster scenarios, pull out the old spreadsheet, run some run some numbers think about, Oh, what happens? You know, what percent of my stack have I risked? You know, what happens if price goes down by such and such percent what does that margin call scenario look like? Or the liquidation scenario look like? You know, what does it look like to have, to actually fund double-digit interest? You know, over a period of let’s be real let’s say four years, right? Let’s say it’s four year winter, et cetera, et cetera. You know, putting numbers in front of you can make it a little bit more real. It can also make it more real, not only for yourself, but for other people that depend on you, right?

Andy Edstrom:

Like your family, like your spouse, maybe you run the numbers and you go to your wife and you say, look, this is what it looks like. If I risk this much, we’re not ruined. We’ll be fine through a cycle, it can give some potential confidence about Oh, what’s the, what’s the worst case scenario. And the other thing I would close with his yeah. Is call-to-action, to lenders in the space, show us a product that may God forbid have a deeper level of KYC and you know, knowing your customer, knowing your borrower. But I think we are missing something in the market, which is based on a little more credit analysis of credit scores or reports or payment history, or tax returns, whatever it is. I think that there really ought to be a product which has better terms for the borrower in exchange for some greater credit history and or yeah. Credit information or credit support.

Stephan Livera:

Excellent. so listeners go and find Andy, his Twitter is @edstromandrew and the website, AndyEdstrom.com anywhere else that you’d like people to find you, Andy?

Andy Edstrom:

No, those are the main places. Obviously I constantly show my book Why Buy a Bitcoin and of course, Swanbitcoin.com/andy to stack your sats.

Stephan Livera:

Fantastic. Thanks Andy.

Andy Edstrom:

Thank you, Stephan.

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