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So I’ve been thinking about this question of when to switch to a crypto income strategy.
Crypto bull markets are great and all but profits in those market conditions are based on capital gains. You buy low and sell high.
That strategy works as long as
The bull market continues and asset prices continue rising, and
You accept that there is a high risk associated with those high rewards
But what’s the risk though?
Like any market, the risk is that the bull market ends and turns into a bear market.
At that point, the market turns against you and the asset values start going in reverse (removing value from your portfolio).
This is true whether you account for your returns in a fiat currency like US dollars or in a crypto asset like Bitcoin.
Many crypto investors operate on a Bitcoin standard where they measure their returns and their net worth in BTC.
Since the supply of BTC is fixed, if your portfolio holds 1% of the Bitcoin supply, it will always hold 1% of the Bitcoin supply.
How you denominate your returns is an individual choice and not really the topic of today’s episode.
I will say one more thing there before moving on though.
If you denominated your portfolio in BTC, the % of your portfolio that is held in Bitcoin would be considered your cash position, since that is your default asset.
OK, back to the point then.
I think right now most investors are going to continue to denominate their portfolios in dollars so I’ll continue to speak in those terms.
So there is this phrase I use quite often which is “Never eat your seed crop” which means you have to leave some of your harvest left over in order to plant for the next season.
If you eat all your crops you will have no yield the following year and you will starve.
I personally thought about this most recently when I wanted to buy a car.
My first thought was to realise some capital gains, pay the tax on the profits and use the remainder to buy the car.
The trouble is that a car is typically a depreciating asset unless it’s a classic, and I wasn’t looking to buy a classic.
So I would have exchanged an asset that was gaining me capital to an asset that would lose me capital.
That’s the difference between an appreciating asset and a depreciating asset.
Let’s say I was holding a position in Ethereum right now that was worth $50,000, and I bought it for $10,000.
I could sell it,
take out the $50,000
Pay the tax on the gain (which in the UK would be about $8,000)
And then be left with $42,000 in cash to buy the car.
That car might then depreciate at say 10% per year, losing me $4,200 per year in capital value.
Not only that, there is an opportunity cost to factor in.
Not only am I losing $4,200 in depreciation, I’m also missing out on any income or capital gains I would enjoy by continuing to hold my Ethereum.
You might say well Chris, you’re making it sound like a no brainer but you’re forgetting what you said earlier that cryptos can experience bear markets as well.
Ethereum isn’t always an appreciating asset.
Between January 2018 and December 2018, Ethereum depreciated by 94%.
You heard that right, it went from $1,400 to $80.
Now the 10% depreciation on the car doesn’t sound so bad does it?
So what to do?
To my mind this all goes back to what I see as the most fundamental question of investing, the balance between how much money you want to make vs how much risk you are willing to take.
There typically comes a point where you’ve accumulated enough capital through investment gains that it makes sense to shift gears, reduce risk and switch to an income strategy.
With crypto specifically, if you had managed to accumulate say $1m worth of crypto and want to de-risk by switching to an income strategy then one approach would be to split it 50/50.
That would mean converting $500,000 of your capital into dollar stablecoins and then leave the other $500,000 in crypto assets.
Then you could place those $500,000 in stablecoins into a lending scheme and earn anywhere from 10-20% annual yield.
At 10% that would produce a monthly income of $4,166 before tax
And at 20% that would produce a monthly income of $8,333, which is $100,000 a year. And you’d still have your $500,000 of capital.
Meanwhile, if the other half of your crypto portfolio were all in Ethereum, while the dollar denominated value will fluctuate, you could also place your Ethereum on deposit with a lending service and earn an interest rate on that too.
This is a 50/50 illustration because that is the perfect hedge straight down the middle, but the splits are obviously totally flexible.
I just like 50/50 because it allows you to straddle both the fiat and the crypto financial systems equally.
It also allows you to do a re-balancing every so often.
▶️ 3Speak