The SegWit2x (B2X) Hardfork – Protecting Yourself and Your Coins, Part 2: Investment Strategies

Abstract: The upcoming SegWit2x hardfork is likely to lead to price volatility.  In this piece we look at some potential investment strategies which could allow you to capitalize on the event.

 

Strategy 1: Do nothing

The most popular investment strategy following the split is likely to be to take no action and remain a holder of both BTC and B2X. This is probably the most prudent approach, as your assets may be protected whichever coin becomes more valuable. Most people may pursue this strategy out of laziness rather than choice.  However, even if this is your preferred investment strategy, it may still be sensible to try and split your coins anyway; to increase the flexibility of your investment strategy and protect your funds in case you need to make a transaction.

 

Strategy 2: Invest in your favored coin

Many investors may support either the BTC or B2X coin for ideological reasons or because they feel their chosen coin has the best characteristics.

  • Supporters of BTC typically prefer the consensus rules to be robust, as they feel this results in superior or more unique monetary characteristics. Also they typically value the cautious and meticulous approach of the current development team. BTC supporters may want flexibility and innovation to come from other layers in the system above the consensus rule layer.
  • In contrast to this B2X supporters may value a more flexible consensus ruleset to ensure the system is dynamic and able to cater to user requirements more quickly. B2X supporters typically value the user experience over the monetary characteristics of the system. Typically they draw less distinction between changes in the consensus layer and other types of changes to the system.

If you agree with one of these visions more than the other, it might be a good idea to invest in the coin that matches your vision, this may not only help you obtain larger returns if your vision is correct, but may also help ensure your favoured token is the “winner”, as it may contribute to the value of the coin.

Alternatively you may not care which vision “wins”, but want to back the winner. In this case it’s important not just to gage opinion, but also the level of conviction those on each side of the debate have. Somebody slightly favouring one of the visions but also wanting to hedge their bets may have less of an impact than a die hard supporter of one of the visions, who is willing to sell all their coins on one side of the split no matter what. This factor could favor the BTC side, since many die hard “large blockers” may have already sold some BTC to invest in Bitcoin Cash.

The most common investment strategy after the fork may be to do nothing. However, of the tiny minority of people that do act, many of those people may be sellers of B2X. This is because the section of the minority that took action in favor of the large block chain in August, will not be allocated either BTC or B2X for the coins they sold for Bitcoin Cash. In contrast, the minority that quickly sold Bitcoin Cash in August, will be allocated BTC and B2X this November. Although, obviously this is highly speculative and nobody really knows what will happen.

 

Strategy 3: Invest in whichever coin is the cheapest/the “bad” coin – The Joel Greenblatt strategy

The top investment tip in one of our favorite books on investing, Joel Greenblatt’s “You can be a stock market genius” (bad title but a great read), appears to be that if a stock split occurs, one should buy the less favored company, the spin-off.  In this case B2X is the spin-off token.

Joel Greenblatt’s Gotham Capital achieved annualized investment returns of 50% from 1985 to 1994. One of the core strategies of the fund in this period was to invest in “bad” spin-off companies. As Greenblatt explains:

There are plenty of reasons why a company might choose to unload or otherwise separate itself from the fortunes of the business to be spun off. There is really only one reason to pay attention when they do: you can make a hole of money investing in spin-offs. The facts are overwhelming. Stock of spin-off companies, and even shares of the parent companies that do then spinning off, significantly and consistently outperform the market averages. One study completed at Penn State, covering a twenty five year period ending 1988, found that stocks of spin-off companies outperformed their industry peers and the S&P 500 by about 10% per year in their first three years of independence.

Greenblatt mentions that spin-offs tend to be driven by a “desire to separate out a bad business so that an unfettered good business can show through to investors”. The bad company or spin-off company is typically sold by investors, with the negative narrative around the bad company dominant at the time of the split, causing negative sentiment. As Greenblatt explains:

The spin-off process itself is a fundamentally inefficient method of distributing stock to the wrong people. Generally, the new spin-off stock isn’t sold, its given to shareholders who, for the most part, were investing in the parent company’s business. Therefore, once the spin-off’s shares are distributed to the parent company’s shareholders, they are typically sold immediately without regard to the price of fundamental value. The initial excess supply has a predictable effect on the spin-off stock’s price: it is usually depressed. Supposedly shrewd institutional investors also join in the selling. Most of the time spin-off companies are much smaller than the parent company. A spin-off may be only 10 or 20 percent the size of the parent. Even if a pension or mutual fund took the time the analyze the spin-off’s business, often the size of these companies is too small for an institutional portfolio.

Greenblatt goes on to cite four spin off case studies, Host Marriott/Marriott International, Strategic Security/Briggs & Stratton, American Express/Lehman Brothers and Sears/Dean Witter, where this thesis applied.

In many ways there are some analogies between the opportunities which may arise from Bitcoin spin-offs such as B2X and stock spin-offs. Perhaps B2X is being distributed to the “wrong people”. Bitcoin investors typically value robust rules and the resulting highly resilient monetary properties. Perhaps, some of the Bitcoin investors who value other characteristics such as flexibility and user experience may have already divested into Ethereum or Bitcoin Cash, therefore the remaining investors may “dump” B2X. The risk for B2X proponents is they allocate their new coin to the “wrong people” and the price becomes “depressed”.  However, this could provide contrarian investors an opportunity.

The price of B2X could fall to cheap levels and there could be significant amounts of negative sentiment with some people writing the coin off. This could then be a good time for contrarians to invest in B2X. This investment philosophy seems to go against a common narrative in the Bitcoin space that “network effect is king” or “the most work chain wins”, meaning a minority chain has limited prospects. However, there may be little investment basis for this view.

However, whether the Greenblatt spin-off philosophy really applies to Bitcoin spin-offs such as B2X is not clear. Greenblatt still does fundamental analysis on the bad spin-off company, and whether one can take this type of fundamental approach to Bitcoin or its spin-offs, is not obvious. It’s certainly more risky. Although, in my view, after the hardfork, if B2X is trading at c5% or less of the price of Bitcoin and the prevailing narrative is that B2X is dead, then the “bad” coin may be worth a small punt.

 

Strategy 4: Take advantage of different policies on different exchanges

During the Bitcoin Cash hardfork, different financial platforms had different policies. For example BitMEX essentially ignored Bitcoin Cash, and the futures price just followed Bitcoin. However, Kraken for example, supported Bitcoin Cash, in such a way that those with long margin positions on Bitcoin were also given Bitcoin Cash. Critically on Kraken if you were short Bitcoin at the time of the fork, you were then automatically short Bitcoin Cash. These different policies between exchanges provide asymmetry, which in theory can be used to earn free money.

For example going into the Bitcoin Cash hardfork, an interesting strategy was to open a margin long position of 1 BTC on Kraken and then hedge the position by taking a margin short position of 1 BTC on BitMEX. Thereby after the hardfork, you receive one Bitcoin Cash token on Kraken, essentially for free, since there was no corresponding Bitcoin Cash liability on BitMEX associated with the short.

When it comes to the upcoming fork, there are four relevant potential exchange policies one needs to consider, when trying to engage in this type of arbitrage.

 

Potential financial platform policies regarding the B2X spin-off token

Policy A Policy B Policy C Policy D
Split user Bitcoin deposit balances into BTC & B2X    
Split user Bitcoin margin long positions into BTC & B2X long positions        
Split user Bitcoin margin short positions into BTC & B2X short positions      
Bitcoin lenders are due back BTC & B2X    
Bitcoin borrowers owe BTC & B2X    

Note: It is also possible to have a different policy with respect to Bitcoin lending and Bitcoin margin positions, which is not illustrated in the above chart.

An interesting investment strategy to engage in before the B2X fork could be to open long Bitcoin positions with exchanges with policy C and D, and potentially open short Bitcoin positions on exchanges with policies A, B and C.  In theory, this should allow you to get B2X tokens for free.

One may think that policy C may seem a slightly inappropriate choice, as it results in an asymmetry. However some exchanges did have a policy similar to this with respect to Bitcoin Cash. The rational for this was that the burden on customers who were short Bitcoin, to go out into the market and buy Bitcoin Cash may have been too high, particularly if the liquidity of Bitcoin Cash was low.

As the B2X fork approaches, we may write a piece summarizing the policies of the main exchanges and how one could engage in this type strategy. Although, if you wait for it to be clearly explained, it could be too late and spreads could have already opened up, reflecting the opportunity. On Bitfinex, B2X is already trading at over $1,000, therefore there could be money to be made by engaging in these types of strategies. Perhaps a good idea, if you really like taking risks, may be to review the policies exchanges took with respect to Bitcoin Cash, to get an idea of what their policies might be with respect to B2X and then open your positions before the policies are officially announced.