Market Musings - December 11, 2017
We continue our blog series: Market Musings, Volume 1, Edition 14, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present Bitcoin and the Obsession With Market Quotations.
If the current Bitcoin craze elucidates anything, it shows how deeply the gambling instinct is ingrained in the human psyche. Here we have something that isn't actually a thing at all (unlike gold or tulip bulbs, you can't hold or touch bitcoin), but rather exists somewhere in the ether. Whether it ultimately has any utility to humankind remains up for debate, however one attribute it does have makes all the difference right now: it has a market quotation, and to borrow a quote a market participant recently commenting on Overstock.com shares (which are also shooting up due to its blockchain investments), bitcoin has been "going way the f--- up" this year.
When an asset like bitcoin has a market quotation, then you can gamble on whether the quotation will increase. (Note here that we use the term "gamble" rather than "invest"; it is popular for people to use the phrase "invest in bitcoin", but one cannot "invest" in a crytocurrency [or any other kind of currency, for that matter], one can only speculate in it). And when people see their friends and co-workers "getting rich on bitcoin" (and, dare we say, bragging about it), envy naturally leads them to question their lack of participation in the craze du jour. Then they look at the bitcoin price chart and see the following (source):
Six years ago, bitcoin was trading at under $10, so a speculator could have purchased 100 bitcoins for under $1,000. Today those same 100 bitcoins trade at a valuation of $1.65 million. This fact certainly catches the eye and warps the mind. The more bitcoin's price rises, the more folks on the sidelines agonize about and regret not participating (and the more those already participating crow about their "investment" prowess--"Honey, we can afford that new car, bitcoin went up 20% today--yay!"). Fear of missing out grows ever stronger, more and more potential speculators block out their lingering doubts, abandon their reserve and plunge in with both feet, pushing the price ever higher. The cycle feeds on itself and the object of the speculative mania inevitably goes parabolic.
In our humble view, however, all other things being equal, the higher an asset's price is, the more dangerous it is to purchase; and conversely, the lower an asset is priced, the safer it is to buy. Bitcoin may have been "safe" to buy in late 2011, but is it today, up 1,650-fold in six years? Market participants take comfort in seeing each further dopamine-releasing price rise ("Whew, I was right to go in at $12,000, look, now it's $16,000!"), but they really should become increasingly nervous. Parabolic price increases should be considering neither normal nor comforting, as bubbles always end in the same fashion.
Take the house bubble of the last decade, for instance. With the magic of leverage, one could buy a $500,000 condo in Manhattan by putting down just $25,000. Sell it for $650,000 about a year and a half latter and, voila, that $25,000 just turned into $150,000, or a 500% profit (if one ignores transaction costs). It was literally free money, all you had to do was participate with the rest of the masses...until the music stopped and all those who bought at the top on margin were left in agony for the next few years as real estate prices fell relentlessly nationwide. The following are some apropos comments from Warren Buffett on the subject of speculation in the wake of the late 1990s tech bubble popping, taken from Berkshire Hathaway's 2000 annual letter:
Finally, we find the fact that speculators cheer on bitcoin's price rise highly ironic. After all, cryptocurrencies were invented by those who detest so-called "fiat currencies" issued by governments. Yet these same people now cheer the fact that you can obtain more dollars (the very asset they hold in contempt) in exchange for bitcoin than previously. Aren't these people thus implicitly admitting the very thing that they claim to oppose, namely that the dollar (a fiat currency) is the "real" currency and will not be replaced (and, as a corollary, that bitcoin itself is the "fake" currency and not a true store of value)? If you want to overthrow the dollar and replace it with bitcoin, logically you shouldn't care at all how many dollars you can exchange a bitcoin for. But nobody wants a buzzkill in the room when there's such a fun party going on, so we'll shut up now.