Bitcoin...Not again.
Tesla’s investment of 1.5 billion dollars in Bitcoin is not surprising and neither is the company announcing that they will be excepting Bitcoin for some of their products. Elon Musk may act like a fool at times but rest assured, he is no fool and the company’s investment is a clear sign that Tesla believes it will have to be part of this expanding ecosystem.
Before I start, I want to make it clear, I am not a fan of Bitcoin as the emerging currency it is being touted as. I do believe that it is a high risk/high reward type of vehicle and if you have spare change and you want to gamble, Bitcoin is a pretty cool place to do it. However, with that being said, I have major reservations about it being another form of currency for transactions and worry that as we move forward with this wishful thinking, it all could collapse in one big ugly pile of tech hubris. This isn’t sour grapes because I missed this run up and want to cast ill will on those who have taken advantage of it. It’s more common sense than that. People are putting cash, and lots of it, into an environment where they know less and less each day about who or what pulls the strings. I know that is Neanderthal thinking, but don’t forget, the Neanderthals found practical uses for fire and history was never the same.
Getting back to Tesla. My instinct tells me that Tesla did not purchase these shares as an investment but to use as some sort of hedge as they allow their products to be purchased with Bitcoin. This hedge could be simple or very complicated, it all depends on the price of Bitcoin and the direction it is going. Without going into a long, detailed explanation, let’s just say that each time a car is purchased with Bitcoin at a certain price, Tesla may write a put or call option on Bitcoin (backed by it’s ownership of Bitcoin). This way, no matter where Bitcoin trades, Tesla will always receive the actual value for their car. Commodity traders do this all day long, why not Tesla? While the protection from this strategy might seem strong at first, it isn’t endless and it isn’t a guarantee that they will be able to protect each sale. Someone has to take the other side of a position and if Bitcoin is moving violently in one direction or the other, there could be a major problem with the cost of these positions and major losses could result. We have seen option position blow up in very smart people’s faces before, so this is not out of the realm of possibility.
That is one fear I have for this strategy. The other is similar, but separate. The volatility and risk of Bitcoin is real and to build any sort of strategy at this point for your company, around Bitcoin, seems premature.
Let’s just go with a simple risk first. Pricing risk. For example, Tesla sells a Model S for 125,000 cash which equates to 2.5 Bitcoin. The buyer agrees to pay in Bitcoin, puts down 10% while Bitcoin is trading at $50,000 a Bitcoin. Before taking delivery, Bitcoin pulls back to $25,000 a Bitcoin. Who wins? Who loses? Obviously, it’s all about the fine print. Why would I agree to accept that risk if I am the seller. I still have to pay my employees and my suppliers and if I am only receiving half of the original purchase price, that means I am losing a small fortune on each car I sell. If it goes the other way, why would I as a buyer agree to that risk? If the price of Bitcoin doubles before delivery, I am paying roughly 85% more for the vehicle than originally agreed to. Oh, but you say, pay full purchase price at the time you sign the contract. Ok, how many people actually do that? Most people finance and that is the next problem. Banks will have to deal with this Bitcoin risk if they are going to write those loans. Pretty sure Jamie Dimon won’t be happy if JPM loses a billion dollars on a bad bet in Bitcoin financing.
This is where the hedging comes in. Another added risk in a market that inherently has volatility written into it.
Ah, but Capitalism always finds a way and this will be no exception. There will be a large and deep market for trading Bitcoin risk at some point in the future and while those risks might be huge, that market creation will be inevitable. Will that type of market trading mitigate the risks in Bitcoin? I really don’t know but what I do know is that unless there is some market force that can mitigate the huge swings in the pricing of Bitcoin, it will relegated to that high risk/high reward model I spoke about earlier.