## Friday, July 28, 2017 ... /////

### Cryptocurrencies, a speculative mania

Those who have invested a lot of money into the Bitcoin or the Ethereum, a new competitor, at least half a year ago have become wealthy. The Bitcoin's price doubled in less than a year. It added an order of magnitude in some 5 years and several orders of magnitude in just slighter longer intervals. The Ethereum's price added some two orders of magnitude in a year.

The Bitcoin price juxtaposed with the usual graph of stages of a bubble.

The current prices of the Bitcoin and the Ethereum are some $2,700 and$200, respectively. There will be a 5% decrease of ETH to $190 today and another 5% decrease to$180 on Saturday: The Ethereum dropped by more than 50% from a peak in June (when Peter F. was encouraging me to buy LOL), the Bitcoin is close to its peak around $3,000. Should you buy these things? Given the fact that their value may drop 50% in weeks – and I think that it can also easily fall by 99% in weeks – you should only reserve the money for similar cryptocurrencies that you don't need at all, that you may afford to completely sacrifice. A point that you should notice is that due to the absence of any intrinsic value, there is nothing special about the "order-of-magnitude estimate" of the Bitcoin price around$3,000. The price isn't attached to anything else beyond the current psychology of the masses that deal with it. So the future price may be $500,000 as someone said (a man has vowed to cut his penis on TV if this level won't be reached soon) but it may be$3, too.

If you believe that there is more than 50% probability that the price of one Bitcoin will double once again in the near future, there is an easy strategy to make a profit whose expectation value is positive. Buy the Bitcoin and sell it if and when the price doubles relatively to the price at which you bought it.

Again, the point is that even the order-of-magnitude estimate of the cryptocurrencies' price is basically a random number. In a sufficiently distant (several years?) future moment, the price of one Bitcoin will be either substantially smaller than $2,700, or substantially larger. At some moment, the Bitcoin will reach the peak price (oil may have reached this peak price, as Gene reported, a funny new interpretation of "peak oil") and the subsequent evolution may be described as a rather cataclysmic fall. Prices are affected by the experience with the cryptocurrencies "exchange markets" that are being constantly robbed and hacked, by regulators in various countries that sometimes outlaw the cryptocurrencies or seriously change their status (they generally should because tax evasion and organized crime seem to be the main applications of the cryptocurrencies), and other things. But on top of that, the collective mania is still the most important factor. Howard Stanley Marks is an old-fashioned investor whose net worth is some$2 billion. He's been doing things along the similar conservative rules of investment as Warren Buffett and he's a favorite investor of Warren Buffett's, indeed. He's also written numerous memos warning against bubbles. You could view him as a constant fearmonger. I, for one, am mostly annoyed by the persistent financial fearmongers. Certain servers have been spamming my mailbox with the information about the "imminent collapse of the financial markets" in every week since 2010. Junk.

However, he also wrote Bubble.com at the very beginning of the year 2000. That identification of the Dotcom bubble was precious because the bubble began to collapse months after his text. And he wrote some comparable, although less accurately specified, warning in 2007. So maybe his successful predictions weren't just a coincidence. His wealth could be viewed as another reason to consider this hypothesis.

Days ago, he wrote this memo to Oaktree clients,

He generally recommends to be cautious in the markets because prices seem rather overvalued to him. A big part of this 23-page-long document is dedicated to the digital currencies; this section starts on page 15/23. He uses phrases such as "barter", "not real", "product of financial naivite [mainly of the Millennials], willful risk-taking, and wishful thinking", "speculative mania", "unfounded fad", and "pyramid scheme" for the assignment of nonzero values to the digital currencies. I agree with his interpretation of the cryptocurrencies completely. He uses his father's joke to describe the logic of the traders with the digital currencies:
Two guys meet in the street. Joe tells Bob about the hamster he has for sale: pedigreed and highly intelligent. Bob says he’d like to buy a hamster for his kid: “How much is it?” Joe answers, “half a million,” and Bob tells him he’s crazy.

They meet again the next day. “How’d you do with that hamster?” Bob asks. “Sold it,” says Joe. “Did you get $500,000?” Bob asks. “Sure,” says Joe. “Cash?” “No,” Joe answers, “I took two$250,000 canaries.”
LOL, exactly. The hamster and canaries were assigned an astronomical price just because he and some other nuts were willing to do so. But the people assigning these prices are effectively disconnected from the real world. So they may only sell these overpriced things to each other. (Marks point out that much of the Bitcoin "capital" is being used to fund the development of new cryptocurrencies and similar things.) In this perspective, the Bitcoin capitalization measures the total amount of this kind of insanity in the world. A risk for the Bitcoin owners is that many Bitcoin owners may suddenly regain their common sense. It's mainly the Millennials who believe that the bulk of the wealth is in the Bitcoins, hamsters, cannaries, CO2 indulgences – while food, cars, houses are basically for free. But what if too many of them suddenly grow up and realize that they were wrong and the Bitcoins and CO2 indulgences are actually worthless and can't feed them?

And the total price of the Bitcoins and the Ethereum is equal to the capitalization of the PayPal and approaches that of the Goldman Sachs. It's also more than 1/2 of the Forex reserves of the Czech National Bank, the 18th largest in the world. Not bad for pieces of code or a virtual money in a computer game that some people began to identify with the real money but that can never become real money because a risk that the value drops by 20% in a day will never go away. So the mainstream people just won't use these non-currencies as the funds prepared to buy houses or other big things. It would be far too uncertain whether they may afford to buy the house next week. That's also why no one accepts the Bitcoin as the collateral – another reason to say that it isn't a real currency.

Here is his key paragraph by Mr Marks explaining why the purchase of the cryptocurrencies shouldn't be considered investment but rather a pyramid scheme:
Serious investing consists of buying things because the price is attractive relative to intrinsic value. Speculation, on the other hand, occurs when people buy something without any consideration of its underlying value or the appropriateness of its price, solely because they think others will pay more for it in the future.
Amen to that. Sure, it has so far worked beautifully for most of those who bought the cryptocurrencies. But because the dynamics ultimately is one of the pyramid scheme, there will ultimately be the "first generation of buyers" of the cryptocurrencies and for whom the purchase will turn out to be a huge mistake. We don't know when it will take place. We just know that it will take place at some moment. The history of the Bitcoin is a zero-sum game so in total, these unlucky people will lose exactly as much as the profit of the lucky ones. A funny fact is that lots of the people have already made a profit – most of the traders so far were lucky – so most of the traders in the future will make a loss as the price goes back to zero at some point.

The even faster rise of the Ethereum – whose total capitalization is comparable to the Bitcoin's now – also shows another point I've been making for quite some time. Another reason why the Bitcoin's and other current cryptocurrencies' price may collapse in the future is that competitors – and perhaps many competitors – will emerge. The Ethereum proves this point perfectly. When additional currencies like that, perhaps more attractive in some respects, will emerge, the attractiveness of the old ones may go to zero quickly.

It's just an unfounded fad, a pyramid scheme.

Someone may have lots of money that he may really sacrifice. I think that the purchase of super-speculative things such as the cryptocurrencies may be OK for him. But I still think that it's not the best thing to buy.

The volatility of the Bitcoin is comparable to the leverage-50-to-1 EURCZK "sell" contract. If you magnify the changes of the Czech-to-European currency ratio by a factor of fifty, you get the daily oscillations of the Bitcoin's price.

It's unlikely for the Czech crown to weaken by 2% from a local peak – it hasn't done so for years. And the Czech crown is continuing to strengthen because it seems undervalued and the Czech economy seems severely overheated now. The Euro went from 27 to 26 crowns since April so far – the U.S. dollar basically went from 26 to 22.2 from January. But the crown will strengthen further. Next Thursday, the Czech National Bank is "more likely than not", I believe, going to hike the interest rates. This probability of such a move is wildly underestimated by the markets.

It seems much more sensible to short EURCZK now (it was even better in Spring!) than to buy the cryptocurrencies because there's an underlying asymmetry that says that CZK is more likely to strengthen than weaken. On the other hand, the directions are balanced for the cryptocurrencies.

If you've made some profit on the cryptocurrencies, I recommend you to lock the profit and leave this ultra-volatile "market".