Immediately after returning from London’s CoinGeek conference, much of our attention turned to anticipating the impact of coronavirus. Since that time, and despite our (increasing) long-term bullishness on bitcoin (BSV), this near term uncertainty made it prudent to begin reallocating portions of our BSV position into instruments that protected our investors from macro influenced downside risk. More specifically, over the past weeks Unbounded Capital has been reallocating from BSV into cash and bespoke swaps with highly correlated, but utility-bereft, crypto assets. The cash position allows us to invest in equity of promising BSV businesses as well as the opportunity to re-enter our BSV position at more attractive prices. The swaps protect us from broad crypto downward movement while preserving upside if BSV outperforms other assets despite the macro movements.

What was it that motivated us to adjust our portfolio in anticipation of this recent decline? Importantly, it was not because we had perfect information. To the contrary, much of the information regarding coronavirus has been unverifiable and contradictory. Instead, we were able to adjust because we appreciate the existence of tail risk and always invest such that we are able to benefit from the asymmetry of potential outcomes.

Coronavirus Sensemaking

The context for our initial concern about the risk of coronavirus stems from a combination of:

an understanding of the fragility of interconnected systems,
existing concerns about broad risk factors in both the US and global economies,
the naivety of relevant “expert” empiricism compared to sophisticated risk analysts, and
suspicion about Chinese risk management and Wuhan Virus banks generally.

The fragility of a highly interconnected global supply chain is obvious. When the virus was initially “contained to just China”, this still posed a big risk to the global economy. Long before the Western corporate media was telling its viewers to panic, discerning reporters and information hubs (largely on podcasts and Twitter) were warning about the active risk to supply chains. Reliable information from inside China is hard to come by but trustworthy sources we closely follow with better predictive track records than the corporate press were concerned about the risk.

The other interconnected system is human travel. It was strange to see Western governments not immediately shut down all travel from China. This made us suspicious that they were not taking the problem seriously. This suspicion was routinely confirmed by the perspective of associated “experts” who would make naive claims about how the risk of coronavirus was “less than driving a car” or “no worse than the normal flu.” These types of comments indicate a complete misunderstanding of tail risk and exponential growth. When we don’t overcomplicate things and outsource our sensemaking to “experts”, tail risk is intuitively clear to everyone. To illustrate this, ask yourself the operative questions of “what is the likelihood that car accident deaths will double from this year to next year?” versus “what is the likelihood that coronavirus deaths 1000X from this month to next month?” The respective answers to these questions indicate a different empirical domain in terms of tail risk. People who miss this are nonetheless heralded as “experts”, given positions of power, and prone to conclude that Ebola, SARS, and other relatively small historical events were “false alarms” when in reality they were more likely “near misses.” These outcomes look similar in hindsight but are wholly different in real time.

The suspicion regarding China and Wuhan is related to their apparent misunderstanding of risk along these lines. The Chinese embrace of top-down tinkering in complex systems that pose systemic risks via technologies like CRISPR-Cas9 has always been worrisome. A bureaucratic and scientific ethos that encourages practices like the editing of human and animal genomes where once an edit is made it will grow and spread exponentially with reproduction is indicative of a mindset that imagines it possible to sufficiently “understand the genome” and other complex systems. This thinking falsely assumes that edits will have linear and predictable outcomes. Under these dangerous assumptions it is not only likely, but inevitable, that someone will eventually do something with unintended consequences that can pose tail risk. And since we are so interconnected, this Chinese tail risk quickly becomes systemic, global, and possibly existential tail risk. Wuhan in particular is the home to one of the largest Virus banks in China (tweet from 2018). Are we comfortable with their approach to risk management with these viruses? Adding to our tail risk evaluation were the recent simulations of a novel coronavirus at Event 201 conducted by the Bill and Melinda Gates Foundation and Johns Hopkins. While we treat all “conspiracy theories” with proper suspicion, the simulation of a novel coronavirus resulting in the deaths of 65 million worldwide conducted around the time of an actual outbreak of a novel coronavirus increased our tail risk estimate.

Although it's hard to trust numbers from China, it appears as though they could be “over the first hump.” This decline in the acceleration of new cases seems corroborated from more trustworthy South Korea. This does not indicate that the virus’ spread “is over” as a new wave of cases could spring up once routine contact and normal work schedules resume. Unfortunately, this temporary relief doesn’t appear to be the case in Italy or other western governments that afford their citizens more freedom of movement and were less serious about controlling the flow of people in the early days of the virus. The spread of the virus in the west appears to be growing exponentially and is causing bottlenecks at hospitals, where in Italy they are allegedly creating make-shift ICUs in hospital hallways.

Because of all of this, we thought it was prudent to anticipate the early stages of a global bear market. While the coronavirus may not justify such a massive correction in isolation, we saw it as a solution to the coordination problem of popping a bubble. The prolonged collateral shortage in the interbank eurodollar system contrasted with inflationary pressures from monetary and fiscal stimulus create an unstable situation where interest rates fall and inflation expectations rise. The over-leveraged debt-laden economy cannot stand either a rise in interest rates or a rising dollar, and we are likely to see one or both as the unsustainable nature of feverishly buying both bonds and equities dawns on investors.

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Coronavirus Specific