Seth Klarman Compares Bitcoin to Trading Sardines

In his recent letter to Baupost Group investors, Seth Klarman compared bitcoin investing to the allegory of the sardine trader. To wit, he wrote:

“There is the old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, ‘You don’t understand. These are not eating sardines, they are trading sardines.’

Like sardine traders, many financial-market participants are attracted to speculation, never bothering to taste the sardines they are trading. … trading in and of itself can be exciting and, as long as the market is rising, lucrative. But essentially it is speculating, not investing. You may find a buyer at a higher price — a greater fool — or you may not, in which case you yourself are the greater fool.”

As you can probably guess, I strongly agree with Klarman. My basis for doing so is that, in the entire history of civilization, mediums of exchange have only sustained value if they are backed by either collateral or taxing power. The United States Dollar is valuable because it is the chosen medium of exchange by a government of 300 million people that can extract percentages of wealth from its citizenry at will, and dollars are the medium that it uses. If we used feathers as a currency, the United States could demand 30% of every feather we earn. It doesn’t matter what is being exchanged as having value–the government could collect a portion or incarcerate an individual upon refusal. This “pay the assessed tax or go to jail” model is the reason why currencies across the globe have value.

Alternatively, gold has value because it is a secured asset–you get the metal. Same thing with silver or oil. There is an asset, which has commercial value, that is being traded.

Bitcoin comes with no such security. No entity can demand five bitcoin from your labors. If the currency plummeted, you can’t convert your bitcoin into jewelry or electrocurrent rods. By definition, a cryptocurrency is a digital abstraction that cannot serve as security.

You read about crazy things in history–most famous of all the tulip bubble–and you wonder how people could be suckered into it. Part of the answer is that, what seems like a long time to you, is not even a lengthy enough period for a full market cycle to develop. Bubbles are capable of lasting three to five years, or even more. That is not even a blip on a historical radar. But, for an individual, it can amount to 1,500 days straight of seeing stories about his neighbor getting rich. What feels like “long term” and what actually is “long term” for purposes of deriving investment insights are often two different time periods.

And secondly, there is the simplistic reason that I don’t think investors are sufficiently introspective when they reflect on whether they only consider something a good investment because it recently went up in price.

When there is a new technology, people lose their mind. Cisco–which makes networking hardware and is a real business–caused so much enthusiasm during the tech boom that its price flew from $0.50 per share in 1992 to approximately $80 per share in 2000 (seventeen years later, it trades around $38 per share). And that’s a real business that produces more and more each year! When new technologies evolve, people abandon rationality. At some point–it can take months, years, maybe even a decade–the fundamentals re-establish themselves and take no prisoners.