How To Buy Bitcoin At Deep Discounts?
In 2017, Bitcoin price rose from $965 at the end of January, to $13850 at the end of December. The average monthly price was $4300. What if I had a strategy back then that allowed me to buy Bitcoin at an average price of $2184 instead? $2184 vs $4300 — that’s a whopping 49% discount!
What if that strategy works even today, and allows me to repeatedly buy Bitcoin — or any volatile asset — at a discount?
The strategy discussed here is simple — easy to understand, easy to implement. You don’t need to open new accounts, and it won’t require a ton of time or research. If you understand returns, and you understand volatility, that’s all you need.
Volatility Is Your Friend
Volatility is your friend. It is. If you understand its nature, and learn to manage it.
High growth assets like Bitcoin have a large speculative element to them. People have a hard time agreeing on the right price of Bitcoin, and will continue to for the foreseeable future. This disagreement leads to high volatility. High volatility means deeper discounts.
High volatility means deeper discounts for buyers.
Hard to believe? Let’s start simple to illustrate the point.
Imagine an asset with an average price of $1. The price falls to $0.80, moves up to $1, and settles at $1.20. If I invested $100 at each of the three prices, I will have invested $300 and purchased 308.33 shares at an average purchase price of $0.97. Compared to the average price of $1, that’s a 3% discount.
Now let’s take a second asset with the same average price of $1. This asset is more volatile, and the price falls to $0.50, moves up to $1, and settles at $1.50. If I invested $100 at each of the three prices, I still invest the same $300 but purchase 366.67 shares instead, at an average purchase price of $0.82. This time I get an 18% discount to average price!
The only difference between the two hypothetical assets is their volatility. The more volatile asset sells at deeper discounts from time to time. All I need is a disciplined approach to take advantage of the opportunities when they arise.
Higher the volatility, greater the discount.
You’ve probably noticed already that above is an illustration of Dollar-Cost Averaging (or Unit-Cost Averaging for those who are not fans of the Dollar). It’s a simple strategy to buy the same dollar amount of an asset at regular intervals. For example, you buy $100 worth of Bitcoin on the first day of the month, every month.
Most people know Dollar-Cost Averaging — what is less understood is it’s relationship with volatility. In the illustration above, we saw that the Dollar-Cost Averaging purchase price is lower than the average price. We will call this difference the Dollar Cost Averaging Discount — DCAD for short.
Could something so simple really deliver a 49% discount on Bitcoin purchase in 2017? Let’s look at the numbers.
As Bitcoin price rose from $965 at the end of January to $13850 at the end of December, the constant dollar amount invested monthly ensured more quantity was bought earlier in the year, and less later. A total of 0.54954 Bitcoin was bought over the course of the year by investing $100 per month. More than half of the Bitcoin bought was at a price of $1080 or lower (Cumulative Bitcoin Quantity in the table below). The significant price appreciation created a tremendous opportunity for a 49% DCAD.
Now that we understand DCAD for Bitcoin, let’s explore its nature further. Was the discount limited to 2017, or is it always available? Is it always so high?
The chart below shows rolling-12-month DCAD for the last several years. It’s the difference between average price and the average dollar cost purchase price over the previous 12 months. The discount is always positive but varies widely from a high of over 70% in 2013 to a low of 2.5% in 2015.
Interestingly, the highest DCAD readings coincide with the peaks in Bitcoin price in November 2013, and December 2017. Why is that?
The Relationship with Bitcoin Return
Let’s review Bitcoin price action year-by-year to shed some light on the subject. It’s been a wild ride to say the least — Bitcoin gained 4500% in 2013 and lost 77% in 2014.
Comparing Bitcoin returns with DCAD reveals a very strong relationship (table below). It is clear that the discount is proportional to the magnitude of the return.
The more interesting finding is it does not depend on the direction of the return. It didn’t matter whether the returns were positive or negative; if the returns were large, DCAD was large. Bitcoin price rose 4500% in 2013 and the DCAD was 68%. Bitcoin price fell 77% in 2014 and the DCAD was 9%.
The direction of the return didn’t affect the discount, the magnitude did.
That’s the benefit of the constant dollar amount! In up years, the constant dollar amount invested monthly ensured more quantity was bought earlier in the year, and less later. In down years, less quantity was bought earlier in the year, and more later.
The Asymmetric Reward of Harmonic Mean
DCAD is not merely a Bitcoin investing fact — it is a mathematical truth that applies to all assets with positive prices. For practical purposes, that’s all assets. To understand how requires a quick math detour.
The discount we call DCAD is the difference between the arithmetic mean and the harmonic mean. Let’s use the same hypothetical asset we used earlier to illustrate.
The arithmetic mean (or simple average) of the three prices — $0.50, $1, and $1.50 — is 1.
The harmonic mean is the reciprocal of the arithmetic mean.
The average dollar cost purchase price is the harmonic mean of the three prices. For all combinations of positive numbers containing at least two non-equal values, the harmonic mean is always lower than the arithmetic mean. Asset prices are generally positive, and non-equal (prices change over time), so the practical insight for investors is:
Dollar-Cost Averaging always, always, always provides a discount to the average price.
But that’s not all, there’s another property of harmonic mean which an investor benefits from — harmonic mean tends strongly towards the smaller numbers in the list. Harmonic mean is affected more by the smaller numbers than the larger numbers in the list.
In the illustration above, when the price fell 50% to $0.50, the same $100 invested got us twice as many shares — 200 shares at $0.50 compared to 100 shares at $1. On the other hand, when the price rose 50% to $1.50 the reduction in shares purchased was only 33% — 66.67 shares at $1.50 compared to 100 shares at $1.
Price down 50%, purchase quantity up 100%. Price up 50%, purchase quantity down only 33%.
Such is the asymmetric reward of harmonic mean and Dollar-Cost Averaging.
Who Is Dollar-Cost Averaging For?
There’s one universal truth in investing — that there are no universal strategies. Strategies are tools — you use the tool most suitable for the job at hand.
Dollar-Cost Averaging is most suited for individual as well as institutional investors looking to gradually build a position in an asset. For an individual investor, the gradualness could be due to limited capital, so they choose to invest a small fixed amount from their monthly income.
For institutional investors, uncorrelated returns from Bitcoin and crypto can be appealing but the regulatory uncertainty is a valid concern. Such an investor can build up to their target Bitcoin allocation using Dollar-Cost Averaging over a few years rather than investing all at once.
There clearly are individual and institutional use cases that can benefit from this strategy. The key is to establish a target allocation (say 3%), and a timeframe (say 3 years) to build up to that allocation with Dollar-Cost Averaging. If Bitcoin returns in the future are as spectacular as they were in the past, the investor will arrive at their target allocation much sooner. On the other hand, if the returns are poor, or the financial environment becomes unfavorable, the investor has the opportunity to abandon their target allocation at a smaller loss.
This analysis focused on Bitcoin because it provides a relevant case of high returns with high volatility. Dollar-Cost Averaging is remarkable in its simplicity and minimalism, and can be applied to other assets the same way. It is an excellent strategy for buying at a discount, and gradually building a position in a volatile asset with high potential returns.
The insights we gained here are not limited to Bitcoin — they apply to all volatile assets:
- Dollar Cost Averaging Discount (DCAD) is always available for all assets with positive prices.
- Higher the volatility, greater the DCAD.
- Greater the magnitude of return, greater the DCAD — doesn’t matter whether the return is positive or negative.
- The tendency of harmonic mean towards smaller numbers results in an asymmetric reward for investors — you buy a much larger quantity when prices are low, compared to how much you give up when prices are high.
How To Buy Bitcoin At Deep Discounts? – Refer: https://medium.com/huddlofficial