In a moment of weakness this weekend, the urge to divert savings into paying off debt rather than buying more crypto almost took control. The debate was whether paying off credit card debt is better than buying crypto. In the existing circumstances, buying crypto won the debate. Let's review the circumstances.
Michael Saylor, CEO of Microstrategy often points out that with the Federal Reserve's money printing, we are looking at a cost of capital between 15% and 20%. That means that money is dropping in value between 15-20%. Therefore, any returns you get from an investment or business needs to be higher than that rate.
Let's think about that. Grocery stores will often operate on thin profit margins of 1% to 3%. Therefore, they are realistically seeing a negative return on their capital between 14% and 17%. On the books, they are still making the profit margin. However, the value of the money they are making has decreased more than what they are generating.
If you have the often touted 8% return on your portfolio, you are actually getting a negative 7% to 12% real return.
It works the other way too. If your credit card is charging you 15-20% interest, the bank is barely breaking even. They may possibly be charging up to 29%, which yields them a 9% return, if you drag out your payments as long as possible. If you can pay off the credit card at a slightly quicker pace, that 9% return shrinks. Again, we are talking about a real return rather than a nominal return. As far as the accounting goes, it's a 29% interest rate.
Compare these rates of return to the rate of return of crypto. Bitcoin, for example, is expected to reach between $150,000 to $250,000 this bull cycle. By today's price of about $57,000, that's between 200% and 400% return. In this circumstance, a bull run, it makes more sense to let your money grow than to pay off debt. Your gains will far outstrip your interest cost. You are better off letting your capital grow and even increasing your position.
The whole debate came about while trying to figure out the budget for the next four pay periods. It is exciting to pay off a debt when it leaves you with extra money that can be used elsewhere. You can take that cash to pay off another debt faster. Or, you can use that extra cash to boost your savings. Then, a pernicious thought crept in saying, "what if you cash out a portion of your crypto to pay off a large chunk of debt? Then you have extra cash every paycheck to put away in more crypto."
This was a seductive thought. However, the circumstances aren't favorable. First, cashing out crypto has a tax consequence. Right away, you're looking at either short-term capital gains tax or long-term gains tax, if you're lucky.
Second, cashing out a large chunk of crypto is not easy to replace. It can take months or years to make it up. In that time, you lose out on any gains you could have made. In that time, you could miss the bull market.
Of course, paying off debt by cashing out crypto does not make sense with a crypto that is performing. If it's just trading sideways during a bear market, or losing value. You might be better off cashing out and paying off the debt.
In this circumstance, what makes the difference is that we are in a bull market, even if it doesn't seem like it some days. We can have a reasonable expectation that we will have higher lows over a long period. The general trend is upwards.
In a bear market or prolonged consolidation period, it would be better to pay off the debt. Freeing yourself of the payments would increase your free cash flow, which can be diverted to buying crypto at bargain prices. The good thing about bear markets is that they give you time to reset your finances so that you can better take advantage of the next bull market.
An alternative for cashing out your crypto during a bull market is to borrow against it. In fact, any extra cash you would have put towards accelerating your debt payoff can be put towards increasing your collateral, thus increasing your credit line. After you have borrowed, it makes sense to keep adding to your position as insurance against a margin call. Yes, you are transferring debt rather than paying it off. But, it is much easier to pay off a 1% loan than a 29% loan.
One perverse trick, for example, is to borrow against your crypto. Then deposit your payments into stablecoin, which pays roughly 10% at this time. You'd be earning more in interest than what you are paying. Once you have the full balance saved up to pay off the loan, you can lump sum it. The lender has paid its own interest while you are using the money. At the end of the loan, you use the stablecoin to pay it off. You can do this today at Celsius using a 25% LTV loan.
I currently have a loan at 1%. The money to pay back the loan is deposited and earning 10%. When the loan comes due, it will deduct the balloon payment, leaving the interest earnings behind. Isn't the crypto world perverse? Meanwhile, the collateral continues to appreciate in value.
Fortunately, reason prevailed. Crypto was not sold.
