Bitcoin and a bubble.

Revisiting the Bitcoin investment I made in August, I now find that my investment has grown by %200.

That is nothing short of ridiculous. From mid August to early November Bitcoin has tripled.

There is no legitimate reason for something without intrinsic value to triple in under three months. Investors collectively realizing the higher actual value that I believe it has would be accompanied by a corresponding higher volume of actual transactions. And without that kind of reasoned collective realization, the kind of price movement I’m looking at for the last few months is driven strictly by the interplay of fear and greed. This is what it looks like as the speculators settle in and declare themselves immune to reality. So yes, we’re looking at the dynamics of a bubble.

It’s hard to know how to respond.

On the one hand, I am one of those speculators and I can’t deny that. The impulse to declare that I’ve been right about things is very strong, especially before the world presents me with stark evidence to the contrary. So I can’t trust my own judgment to be impartial here. On the other hand, I still believe that Bitcoin is undervalued. It all comes back to the simple fact that nothing else solves the problem of transferring value electronically as simply, securely, effectively, and frictionlessly as Bitcoin, and that the world at large still isn’t using it for that. And on the third hand, there is never a reason to trust something that has tripled in under three months without game-changing transformations in actual use.

People are buying it because the price is going up, and the price is going up because people are buying it. That’s pretty much the textbook description of an unsustainable bubble. This cannot last. But, I believe that it’s still undervalued. Furthermore, I don’t believe this bubble will take it to its fairly valued price, because we’re not yet close enough to the fairly valued price for the bubble mentality to last that long. It’s going to pump up and pump up and pump up, and then it’s going to pop and crash, and then it will start climbing again, and eventually rise past the point where it popped. And if I could say exactly when those things will happen, then I would be a better and wealthier man than I am. The optimal strategy would be to sell right before the current bubble hits its top, ride out the crash in another investment vehicle, then reinvest right before it starts its recovery. The problem with that is that there’s no way to tell when the current bubble is about to hit its top or when the recovery is about to start.

This isn’t the first time this has happened with Bitcoin. It may not be the last. Looking at historical Bitcoin bubbles, we have a couple of analogous situations. The first is when the price dropped from $29 per coin in early June 2011 down to under $3 in December of that year. That’s a 90% drop. The bubble at that time was burst by a “double whammy” – first, the federal government moved in on Silk Road which was arguably the main source of transactions at that time, and second, a week or so later, Mt.Gox got itself hacked and black hats got their hands on a bunch of coins. Anyway, the whole deal with a bubble collapsing is that it doesn’t really matter what sets it off. Sooner or later, confidence is blown and then the market swings. Bitcoin recovered to its previous high by Feb 18 2013 and continued until it hit April 8 2013 and a price of $266 per coin. And that my friends was the tip of another bubble collapsing. This time it crashed down to $50 – a loss of 80% – and started recovering again. It recovered to about 100, and then had a long plateau, which is where I bought in, and now it’s spiking upward again. It passed that $266 dollar mark a couple of days ago, and appears to be picking up steam in a major speculation bubble.

Now, it’s important to realize that there’s no widely accepted math for this. This is an unsecured currency without so much as a tax base to back it up, that goes up mainly on the distrust of standard or “fiat” national currencies and on the distrust of financial decisions made by governments. It’s easy to see why it’s been picking up steam lately, but where does it go from here? There’s no generally accepted way to tell. And of course, if there were then speculators like me would be using that method to “get ahead of the crowd” and therefore it would be wrong. But here is what I think. I think that this bubble carries it to about $1000, and then it bursts and drops down to $500 or thereabouts. And after that, there’s a recovery, and some kind of plateau, and if the plateau isn’t at least a couple years long, then another, higher bubble that STILL won’t take it to its correct value. This is what I think because I’m looking at the graph of historical prices on a logarithmic scale, and drawing a top line across the tips of the last few bubbles and a bottom line across the pits of the last few troughs, and I’m guessing on a purely unscientific basis that it’s likely to stay within these lines for the next little while. This methodology is, of course, complete horseshit. This is about as scientific as a caveman looking at the sky and saying “It looks to me like the stars are painted on the inside of a hollow sphere and it’s spinning around us.”

But that’s what I think. So, shall I sell at $990 and then wait for the price to crash to, say, $550 before buying back in? If I were absolutely confident that I were right, I would do that. But my method for arriving at the above figures is complete horseshit and I know it, and everybody who thinks they can time the market exactly, is exactly wrong. So I’m probably better advised to just hold it, ride out the crash, and ride out the recovery.

And this is kind of what the interplay of fear and greed look like from the inside. There are thousands of people out there with itchy trigger fingers and different horseshit theories on when and how bubbles collapse, and sooner or later one or two or three of them will randomly do something that causes the price to twitch in a way that scares five or six or seven of the others, and those five or six or seven will sell, notching the price down in a way destroys the confidence of twenty or thirty or fifty…. and this is how bubbles actually collapse. And there’s no way to sum over all the different kinds of horseshit theories people are using and predict how all these irrational people are going to react, so there’s really no way to fully predict it.

The bottom line is this: I believe that Bitcoin has a genuine value as the best and eventually dominant means of transferring value online. Considering the magnitude of that value, I believe that it will remain undervalued at any price that it is capable of reaching before this bubble bursts. And therefore, even if I’m relatively sure that the next collapse is imminent, I’m going to just hold it. I will not fear enough to sell off and I will not allow greed to cause me to sell thinking I can buy again cheaper. The hand that does nothing, I conclude, is the wisest hand to guide the course through the current price collapse. Am I painting a great big bullseye on the back of my coat, or do I make faint clanging noises when I walk? Hindsight’s twenty-twenty, but I ain’t got no hindsight on this situation yet. We shall see what we shall see.

The investment in Bitcoin has been worth it in entertainment value at this point. Others may be sweating bullets; I’m just reaching for the popcorn.

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