De-crazifying Crypto, Part III: Enjoy the Wild Ride!
Understanding the Psychology of the Cryptocurrency Revolution
Posted January 19, 2018
Cryptocurrency’s nearly 6000% increase during the past three years is truly extraordinary. Historically speaking, this is a faster growth curve than the NASDAQ Composite Index’s gain during the headiest days of the 1990s. It has even outstripped the Mississippi and South Sea bubbles of the 1700s, and is now approaching the scale of the Dutch tulipmania of the 1630s. If you had thrown a dart and randomly picked some crypto hedge fund to invest in on January 1st last year, you would have made an average 1100% return on your money last year, which solidly trounced the 8 percent average return of hedge funds globally.
Now, with the recent dip below $10,000, the $64,000 question to consider: Is the crypto party over?
First, I'd like to point out that Bitcoin has experienced a 30 percent+ drop pretty much every quarter since it's inception, so a 30 percent plunge is the "new normal." It has recovered from 50 percent drops too, but it usually took more time to recover. Right now, at crypto parties and cruises, the faithful are recklessly declaring that "a 50 percent drop won't shake me" and wearing T-shirts that proclaim "Buy the Dip." On the other hand, doom and gloom Wall Street analysts are shaking their heads, saying, "I don't understand it. There's nothing there. It's got to be a bubble!"
To add to this debate, here's my perspective, and please take this with a grain of salt.
You need to understand that about 40 percent of all Bitcoin is held by perhaps 1,000 users. These are the Bitcoin whales, the term for holders of large amounts of bitcoin. A whale might be a Chinese software engineer who scrapped together $1000 to buy Bitcoin when it started, and is now sitting on tens of millions in paper profit. He is likely waiting to emigrate to a tax haven country, probably in the Caribbean, before bringing his holdings out of cold storage and risking detection by Chinese tax authorities. Another might be a venture capitalist who took a flier and bought $250,000 of Bitcoin on a lark, when it was $25 a coin, and s/he's smart enough to know that a run on the market will end the party prematurely.
It is well known that these whales can send prices plummeting by selling even a portion of their holdings. But at the same time, they can fortify prices by holding firm, providing a floor for the "proof of belief" that any currency requires. So these crypto whales wait because they realize that it’s like a vast prisoner's dilemma on a global scale. So they patiently await the development of a technological exit strategy, like atomic swaps, that could allow them to cash in on their winnings in an orderly manner that doesn’t cause a panic. These whales believe in the cryptocurrency vision fervently, and this belief forms an unshakeable core of consensual support for pricing that can help resist market turbulence.
If you do a scan of the blockchain data, you will find that the total amount of bitcoins that have never been spent is roughly 14 percent of the total. These are whales sitting pretty and holding firm, and are not like normal investors. They are true believers, and are going to do whatever it takes to bring Bitcoin to a stable plateau of value.
So will Bitcoin break $20,000? And when will a stable plateau for pricing be achieved?
To answer this, let's delve into the concept I mentioned above: Proof of Belief. It all boils down to how much people believe in an asset or a currency. One example is realizing that a Van Gogh or Degas painting is worth only what someone will pay for it. Another good example of how this works can be found in the country of Cambodia, which is the home of an amazing culture, vibrant people, and beautiful antiquities like Angkor Wat. However, you won’t find much Cambodian currency when you buy stuff because the populace prefers to trade in U.S. dollars. The “dollarized” economy is driven by the flow of single dollar bills, and the local currency, known as the Cambodian riel, is relegated to the status of undesirable spare change. If you pay for a $4 tuktuk ride with a five dollar bill, the driver might plead, “Can I pay you the change in riels?”
Every time someone prefers to pay in a certain currency, it strengthens belief in that currency. Dollars beat riels, because the U.S. beats Cambodia, in terms of proof of belief. In many Third World countries—like Cambodia, Ecuador, Indonesia, Venezuela and Zimbabwe—the US dollar is the bitcoin. However, crypto fans believe that all fiat currencies are a giant confidence game, because even the almighty dollar is actually burdened by $20 trillion in national debt, which is expected to balloon with the Trump presidency and his infrastructure spending plans. In some ways, it's the U.S. dollar that's become "too big to fail."
For a cryptocurrency, every time someone puts an ASIC-powered mining rig on the credit card, it's proof of belief in cryptocurrency. Every time a vendor slaps “Bitcoin accepted” on their website—or a friend jokes, “Hey, can you pay me back in Bitcoin?” —it demonstrates belief in cryptocurrency. Every time your waiter—the 21st century equivalent of a shoeshine boy in the 1920s offering stock tips—explains the vision of cryptocurrency, it increases proof of belief. What's more, this belief is measured by not only the number of people that believe in it but by the capitalization volume, as people put their money where their mouths are.
Beyond proof of belief, there is a deeper purpose served by cryptocurrency, beyond being the latest form of online gambling posing as an investment strategy. The true value of Bitcoin is as a hedge against the dominant paradigm of fiat currency and fractional banking. As a result, anything that the dominant paradigm does to hurt its value, like Chinese officials stepping up measures to limit cryptocurrency trading that kicked off the latest plunge, will be discounted by the faithful. This isn't an indication of a core weakness in crypto, it's a direct attack by the powers that be. The whales know that this is a financial revolution, and that there will be casualties and martyrs. They believe that, "There is one thing stronger than all the banks and monetary authorities in the world, and that is an idea whose time has come."
Therefore, Bitcoin will likely reach a stable plateau of value only after it proves its true functionality, by allowing citizens of a failed nation to make graceful financial exits as their country's hyper-inflated currency collapses. Examples of failed currencies include the Argentinian peso, which inflated 100 billion fold or the Zimbabwe dollar, which inflated so badly that a trillion Zimbabwe dollars was worth only a single buck USD. Just as people should be protected against a company that raids its own pension plan, why shouldn't they be protected against incompetent governments as well? This is because people are more important than companies or even countries.
When the next significant fiat currency fails, and hundreds of thousands of people in that country, armed with mobile smartphones, successfully leverage cryptocurrency as a hedge and safe harbor, the world will learn its true value—as a strategy for mitigating the risk of everything falling apart. When this happens, people will finally understand the true utility of cryptocurrency, and this will drive its true price discovery. And hopefully, if these people are rational, they won't be crazy enough to bet the ranch on anything as volatile as Bitcoin. It will likely be some new and innovative next generation cryptocurrency.
Speaking of crazy, let's look at John McAfee's prediction and challenge to, um, eat his own manhood on live television, if Bitcoin doesn't reach $1 million by 2020. With 21 million Bitcoins, this equates to a market cap of 21 trillion dollars, which is roughly equivalent to the market capitalization of the entire New York Stock Exchange. Since NYSE is 27 percent of the total market for global equities, it certainly seems like a crazy claim. But McAfee, who may be eccentric but is definitely not crazy, was careful not to say that a Bitcoin would be worth a million euros or 100 million yen or a million bucks worth of SDRs. He said dollars. From this we can deduce that McAfee is likely expecting the U.S. dollar to hyper-inflate, probably due to the $20 trillion in national debt and America's abdication as the leader of the free world, which reduces belief in America all over the world.
The sad reality is that nations and cryptocurrencies go bankrupt in the same way. In Hemingway’s novel, The Sun Also Rises, there’s a memorable passage:
"How did you go bankrupt?" Bill asked.
"Two ways," Mike said. "Gradually and then suddenly."
Both nations and cryptocurrencies tend to fail gradually… and then very suddenly. People will say that the warning signs were always there all along, even at the very beginning. Over a period of years, sometimes decades, the tiny trickle of warning signs turned into a steady stream, and then eventually a great flood that washed everything away. Returning to the metaphor of Cambodia, don't forget that it was once the most advanced nation in the world, at the time that Angkor Wat was built. But today, all you can see are temple ruins being overtaken by the jungle and crushed by strangler fig trees. All things must pass. And so, some may think of crypto's roller coaster ride as a contest between fiat and digital currency, between the past and the future, between the status quo and the revolution to see which might survive.
However, as an optimist, I can see a world where America remains a shining city on a hill and cryptocurrencies achieve a critical mass of consensus so the party never ends. To see what I see, you need to understand that there are two kinds of bubbles, debt bubbles and growth bubbles. Debt bubbles, like the one that overheated the U.S. housing market in the 2000s and ultimately sparked a global financial crisis, leave behind encumbrances and bailouts for companies that should probably be euthanized. But growth bubbles are different. They fund technological revolutions. The 1990s Internet mania left behind valuable infrastructure. The last tech bubble funded the rollout of fiber-optic cable networks, and fueled the development of smartphones, search engines and e-marketplaces, social media, cloud computing, the app economy. Beneficiaries of growth bubbles, emboldened by early wins, will double down on visionary companies that have the capacity to build the infrastructure for the next revolution. Tech bubbles are a good thing.
So yes, cryptocurrencies are almost certainly in a bubble, but it’s important to see the distinction, that it's the good kind of bubble. But as a bubble, this means there will be some pain ahead, to pay for the gains. You can expect the majority of ICOs and new currencies to fail miserably, and only a few to succeed spectacularly. Perhaps the next Google or Uber isn't going to be a centralized company, but rather, a decentralized cryptotoken? Perhaps it is the rise of a digital reserve currency that heralds the full expression of the Information Revolution—by offering an alternative to "too big to fail" banking and fiat currencies that are frankly, manipulated? Perhaps central bankers should stop casting the evil eye on crypto, and maybe take a look inward, at how the U.S., Europe, Japan, China ,and Great Britain have all significantly devalued their currencies during the past ten years? Perhaps it's time to put your own house in order first before trying to smother the future of money in its crib?
Finally, for this happy shiny future to come to be, these new forms of digital currency need to reflect the meaning and purpose of money as a system that not only simplifies barter and optimizes commerce, but serve as engines for generating prosperity across all of society. This is the core belief that keep Bitcoin whales believing in ICOs, blockchains and cryptocurrency, because they see a better tomorrow. Because they're true believers that change is inevitable. They see that cryptocurrency will likely fund the next technology revolution. They believe that cryptocurrency will enable greater social equality, diversity, and personal liberty. And they theorize and pray that cryptocurrency could even—some how, some day—lead to the end of war, hunger, and fake news. These are achievable visions. Don't give up hope! Viva la revolucion!
P.S. I'm barraged by friends asking what to do about their crypto investments. All I can offer are these two simple rules of thumb: (1) because there are no underlying fundamentals for Bitcoin, we must rely on technical analysis. The only thing we can look at is whether the $10,000 support level and $20,000 resistance level hold or break, and with how much volume/momentum, to guess which way things will go. And (2) you should sell down to the "sleeping level." That is, if your investment in crypto is keeping you awake at night, sell enough so you can get some sleep. And remember, it's a roller coaster, so buckle in and try to enjoy the ride.