DataDrivenInvestor
Oct 20
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Raoul Pal, one of the world’s best business analysis experts, was one of the few investors to predict the mortgage crisis of 2008–2009.
Pal, who Retired at 36 and now lives in the Cayman Islands, knows a thing or two about leverage — and when the sh*t’s about to hit the fan.
He’s now calling out our dirty little secret.
Raoul Pal:
“Sex and Leverage are Two Things that Drive Humans”.
We’ve all done it. The sex part too.
In finance, leverage is any technique involving borrowing funds to buy things, hoping that future profits will be many times more than the cost of borrowing.
Borrowing money brings your future expectations of yourself closer, and it feels great. It can all be yours, a new Rolex, a designer suit or a fancy car.
You don’t even have to work for it.
We’ve been borrowing money for 4,000 years, so this idea is not a new phenomenon.
Merchants 4 thousand years ago gave grain loans to farmers and traders who carried goods between cities.
In ancient Greece and during the Roman Empire, lenders based in temples gave loans while accepting deposits and performing the change of money.
Raoul pal believes we’re facing the most significant opportunity: a new asset class is emerging, which hasn’t happened in such a short time in human history.
He believes that the Cryptocurrency space over the next ten years will be 100 times bigger, based on the speed of the adoption curve.
Pal says humans will be humans; we’re all floored and always looking for the fast option, which is getting caught up in leverage.
He believes in not borrowing and having an income stream to give you more investment options, particularly in down markets.
Pal believes you should stick to a simple plan and not overcomplicate things using financial borrowing tools like futures, derivatives, options or straight-up borrowing cash to invest in Cryptocurrency.
He believes you should keep it as simple as Dollar-cost averaging and buying over a long-term time horizon, like 5 to 10 years.
Dollar-cost averaging is a strategy that can make it easier for you to deal with uncertain markets by making automatic purchases at regular intervals.
It also supports your efforts to invest the same amount of money regularly over a certain period, regardless of price.
Using this strategy in a ‘down market’ may lower your average cost price and reduce the impact of volatility on your portfolio.
Raoul Pal:
Just stick to a simple plan. Don’t use leverage; stick to a simple Dollar cost average plan and think of it as a 5 to 10-year investment, and your probability of success will be extremely high.
Pal believes borrowing puts you in a vulnerable position and uses the example of a leverage loan in Cryptocurrency, where you get an automatic margin call if you don’t pay the loan back.
What the heck is a margin call?
It’s a demand from your lender, brokerage or bank to increase your equity position when the value of the asset you’ve borrowed against drops.
You’re then either required to pay money to increase your equity position or sell off assets to pay the loan. In Crypto, Margin calls usually happen automatically and is out of your control.
Raoul Pal:
Let’s say you borrowed money to buy Bitcoin; you put down 50% of the money and borrowed the rest.
During this recent crash, if you had bought the top, you would have been Margin called because Bitcoin has dropped more than 50%.
Your negative equity position would have wiped you out.
To make the scenario worse, you have missed all of the upsides when Bitcoin inevitably goes back up in price.
Raoul Pal goes into detail about his stance on leverage during an interview on Impact Theory:
“People are using leverage for investments in Crypto, thinking, yeah, I’ll make a giant investment now and reap bigger benefits later”.
“You can make a more considerable investment now, but the trade-off is — what happens if that goes wrong?. You then get a margin call or liquidated”.
“The key lesson the markets are teaching us right now is Don’t use leverage”.
“Every time someone uses leverage in a volatile market, you blow up. Then you lose your position and are back to square one”.
Pal is still not convinced that borrowing against your house is a good move, even though he recognises it’s a less volatile asset to leverage.
Pal explains that leverage might be ok against a house because the prices aren’t very volatile. Occasionally, once in a generation, you get 2008, where people were in negative equity, and banks wanted their money back.
Crypto is highly unpredictable in the short term, so using leverage is dangerous.
Raoul Pal: Don’t borrow money to Invest in Crypto.
Slow and steady always wins the race.
We’re going through a period where digital assets are being adopted at the fastest pace in human history, but you still have time.
Raoul Pal:
“I need to get across to you not to use leverage.
If you don’t use leverage, you don’t care how much Cryptocurrency drops, and it just means you can buy more units at a lower price.
And when it’s trading at $500k, you’ll have become extremely wealthy.
It’s as simple as that”.
Pal goes on to say:
“Bezos is wealthy because he was probably one of the only people in the world who had Amazon shares right from the beginning and never sold them.
Amazon shares went down 95% in 2001/2002 and have had several 60% drops, still making him the wealthiest man in the world”.
The only chart that matters to Raoul Pal is the adoption chart. He tries to block out as much media noise as possible.
Raoul Pal:
“I pick out the one chart that matters to me: the adoption chart.
Is anything happening with China and mining and global macroeconomic news changing the adoption curve or not?
No.
The relentless rise of technology continues. So it would be best to block your ears and not listen to the noise”.
Below is a chart of the adoption of new wallet addresses for both Bitcoin and Ethereum wallets with non-zero balances.
As you can see, the adoption continues to increase even in this downtrend market.
There are countless opportunities to get into Cryptocurrency because of the volatility.
Raoul Pal:
“You need to expect a 50% correction in a Bull market and a 70% correction in a bear market, and over five years, you’ll have still made more money than you can imagine.
So you have to accept those things”.
World-renowned investor Warren Buffett has a similar stance to Raoul Pal regarding leverage.
“The quickest way for an intelligent person to fail is by using leverage.
You only have to be wrong once to get wiped out.
It’s like being Cinderella at the ball, you’re enjoying the wine and food, but sometimes you forget you have to leave at midnight.”
This blog leans to one side of the argument.
Partly because I couldn’t find any examples of where leverage has worked as a long-term strategy for individuals who are not institutional investors with access to large amounts of assets to borrow against.
Using collateralised loans in Cryptocurrency takes the enjoyment out of the whole process. Even if you make money, it’s like fast gambling and unpredictable.
Slowly and tediously accumulating over time, and then just holding usually beats the quick hits of significant investments.
It’s also more fun.
So I agree with Raoul Pal’s stance on leverage in Cryptocurrency.
I’ve borrowed money to leverage positions in Crypto, and when it’s worked, the gains were never significant enough to warrant the anxiety of the outcome.
When it’s turned sour, it’s taken months, if not years, to recover.
If you want to read more of my takes on Web3, consider becoming a member. Your membership fee directly supports the writers you read. I’ll earn a small commission if you sign up using my link CLICK HERE.
This article is for informational purposes only; it should not be considered financial, tax or legal advice. Consult a financial professional before making any significant financial decisions.
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