Bitcoin’s meteoric skyrocketing this year has been astonishing,
captivating traders across the globe. This once-obscure
cryptocurrency has exploded into the world’s hottest market. With
fortunes being won on paper, everyone is talking about bitcoin. But
with its price shooting parabolic, unfortunately this wild ride has
all the hallmarks of a classic popular speculative mania. And those
all end badly, totally collapsing.
In
the annals of financial-market history, the word “mania” is never
used lightly. These are very-rare events where some market blasts
higher so radically that it captures the popular imagination. The
dictionary definitions of mania include “an excessively intense
enthusiasm, interest, or desire” and “a pathological state
characterized by euphoric mood, excessive activity or talkativeness,
and impaired judgment”.
The
seminal book on popular speculative manias is Charles Mackay’s
“Extraordinary Popular Delusions and the Madness of Crowds”, first
published way back in 1841. Manias are certainly nothing new, they
have been periodically erupting for many centuries if not
millennia. Mackay’s incredible work is one of the few must-read
books for every investor. I’ve read it several times in my
life, starting back in college.
Mackay’s title is brilliant, perfectly summing up manias. They are
truly extraordinary popular delusions, illustrating the
madness of crowds. Objectively, this year’s extreme bitcoin action
definitely fits that bill. I say this as a lifelong student of the
markets. Like the objects of lust in past popular manias, bitcoin
and its underlying blockchain technology have real potential to
change the world. But that doesn’t justify its price.
As a
techie, I started getting interested in bitcoin about 5 years ago,
well after its birth in January 2009. It was intriguing as the
world’s first decentralized digital currency, an Information Age end
run around the established government fiat-money systems
relentlessly being inflated away by central banks. Bitcoin’s
never-unmasked creator going by Satoshi Nakamoto was a marketing
genius, wrapping bitcoin in gold terminology.
The
“coin” suffix implied bitcoin is money, rather than a virtual
fiction with artificial scarcity. And it used a novel
distributed-ledger technology called blockchain. That is a
record of all bitcoin transactions that is broadcast and validated
by the entire bitcoin network. This ensures that bitcoins can be
transferred with no counterparty risk, trust is irrelevant.
Maintaining the blockchain is called “mining”, again bringing gold
to mind.
The
countless computers all over the world participating in
recordkeeping for bitcoin’s blockchain work to simultaneously solve
complex cryptographic problems, or hashes. This mining guarantees
that all new bitcoin transactions are legitimate. While it is
computationally-intensive which requires much electricity, bitcoin
ingeniously awards participating miners with newly-created
bitcoins. That’s a heck of an incentive today!
Somewhat like gold, the bitcoin supply grows at slow and
ever-decreasing fixed rates. Today there are around 16.7m bitcoins
in circulation. 12.5 new ones are created every 10 minutes and
distributed to the miners maintaining the blockchain. That
supply-growth rate will be gradually halved again and again until
the bitcoin supply hits its hard-coded maximum of 21m bitcoins after
2110. So bitcoin’s supply is artificially limited.
Repurposing old computers to mining is what sparked my initial
interest in bitcoin. I run a small financial-research company where
we must periodically replace our high-end computers. So I
investigated putting some of our old put-out-to-pasture ones to work
mining bitcoins, but at the time the electricity cost well exceeded
the resulting bitcoins’ value. Back then bitcoin mining didn’t
require specialized custom-made rigs.
When
bitcoin was younger, normal computers could solve the necessary
cryptographic hashes to keep the blockchain up to date. As this
distributed ledger grew, more-powerful high-end computer-graphics
cards were needed. Today bitcoin mining requires computers with
processors designed from scratch to do nothing but grind on the
blockchain, called application-specific integrated circuits. They
get very expensive.
Truly bitcoin and its brilliant blockchain distributed-ledger system
are amazing technologies. They will ultimately reshape how we buy
and sell goods and services, shifting the balance of power in
currencies back away from centralized governments. It’s hard not to
be a bitcoin enthusiast. That being said, it’s critical for traders
to divorce bitcoin’s extreme mania price action from these
technologies’ future potential.
For
18 years now, I’ve written
an essay like this
nearly every week. Wednesday mornings I decide on a market topic,
research it, and build any charts. So our Zeal charts are always
current to Wednesday’s close. Then on Thursday I write and proof
each essay before publishing it Friday morning. Normally that
day-and-a-half between finalizing the data and releasing an essay
doesn’t matter, but bitcoin’s mania is crazy.
Bitcoin trades nonstop around the world, with transactions always
happening and the blockchain always being updated. Around the
normal US stock-market close this Wednesday, each bitcoin was priced
at $12,968. So all the data, charts, and analysis in this essay is
based on that ancient price. Merely 18 hours later as I pen
this essay, bitcoin has rocketed another 18.6% higher to $15,379!
Its ascent is meteoric.
So
who knows how high bitcoin will be when you read this. But the
higher bitcoin skyrockets, the more it emphasizes the extreme
danger inherent in this popular speculative mania! Bitcoin is
absolutely deep in a monster bubble, defined as “an increase in the
price of a market that is not warranted by economic fundamentals and
is usually caused by ongoing speculation in the expectation that the
price will increase further”.
This
first chart looks at bitcoin prices over the past couple years or
so. Bitcoin has rocketed parabolic in 2017, soaring
vertically in what looks exactly like a popular mania blowoff top.
Vertical parabolic gains are mathematically impossible to sustain
for long, as they would soon suck in all the available money on the
entire planet! If this chart doesn’t terrify you, you should go
read Mackay’s mania book before it’s too late.
Bitcoin was no slouch in 2016, soaring 123.6% higher in what looked
like a late-stage bull market. That is hardly a blip on today’s
chart though, as that morphed into a full-blown popular
speculative mania this year. As of Wednesday’s sub-$13k price,
bitcoin had skyrocketed 1251.9% higher year-to-date and a
mind-boggling 1565.6% higher since its early-January low! These
mania technicals are extreme beyond belief.
Like
gold and many other investments including lots of stocks, bitcoin
produces no cash yields and thus can’t be valued with conventional
valuation analysis. So no one has any idea what it’s worth. The
range of guesses is vast, running from zero to hundreds of thousands
of dollars per bitcoin! But even in the absence of any fundamental
valuation, bitcoin’s price action itself proves it’s exceedingly
expensive today.
Obviously Wednesday wasn’t this bitcoin speculative mania’s peak,
but let’s assume it was to use as a reference point for analysis.
Bitcoin’s “terminal gains” as of the middle of this week were
astounding. In the past month alone it had soared 87%, nearly
doubling! It had skyrocketed 197% in 2 months, 280% in 4 months,
and 459% in 5 months. This left bitcoin radically overbought,
trading at 3.70x its 200-day moving average.
The
problem with such extreme mania price gains is they soon collapse
under their own weight. Over the past week ending Wednesday,
bitcoin was surging an average of 5.9% per day. Two of those days
had 9.7% gains. Literally nothing can rally 5% to 10% per day for
long, as the math is truly impossible. Think of that old
rule of 72, which is used to approximate how long it takes for any
investment to double in price.
It
is normally applied to years, where 72 is divided by the average
annual return to figure out about how many years it will take to
grow 100%. 72 divided by 7% for example works out to about a decade
to see 100% gains. But at 5% or 10% compounded daily as bitcoin is
doing, its total value will double in just under 14.3 and 7.3
trading days respectively! Even to a casual observer that
sounds absurd, wildly unsustainable.
Early Thursday morning, the total market value of all bitcoins in
circulation was already around $250b. If bitcoin doubles
again over the coming weeks and months, that would soar over $500b.
Just one more doubling after that would take it to a staggering
market cap of $1t! While anything is possible, that seems wildly
improbable. For comparison, the Fed’s latest read on its total M1
money supply is running near $3.6t.
When
anything shoots parabolic in a popular speculative mania,
exponentially more capital inflows are required to sustain such
extreme gains. It doesn’t take many doublings in price and market
cap to suck in all available money on the planet! While
bitcoin certainly enjoys a popular niche, there’s zero chance that
global investors will sell sizable fractions of their bond, stock,
gold, and cash holdings to buy bitcoins.
Thus
extreme gains are never sustainable, as the collective buying power
of even populations caught up in manias soon exhausts itself.
Eventually everyone interested in buying bitcoin has already bought,
drying up their pools of available capital. When those massive
bubble-fueling capital inflows peak then taper off, market gravity
reasserts itself and the stratospheric price starts plummeting back
down to terra firma.
Unfortunately naive speculators don’t realize how extreme
doublings and quadruplings within a matter of months truly are.
That makes it easier for them to get sucked into mania psychology.
They read about the blistering gains, everyone is raving about the
bubble market, so they throw caution to the wind and buy in
super-high. Even worse, many traders rushing to buy into parabolic
bubbles borrow money to do it with!
At
that point all rationality is thrown out the window, it’s an
extraordinary popular delusion as Mackay wisely wrote 176 years
ago. The price is totally disconnected from reality, and the sole
reason capital is flooding in is because it is soaring. That
becomes self-reinforcing for a season, buying fueling gains and
greed which leads to even more buying. While exciting, vertical
parabolic blowoffs are exceedingly dangerous.
Every popular speculative mania in history has failed
spectacularly, the bubbles bursting and crashing, since capital
inflows can never grow exponentially for long. That’s going to
happen to bitcoin too, without any doubt. The deluded speculators
who succumb to the temptation to buy in high, especially if they use
leverage, are going to get slaughtered. An infamous past bubble
helps illustrate bitcoin’s extreme dangers today.
This
final chart again assumes Wednesday was this bitcoin bubble’s peak
for the sake of analysis. The past couple years’ bitcoin action is
superimposed over the notorious silver bubble that crested in
January 1980. Both datasets are indexed at 100 at their respective
peaks to render them in perfectly-comparable percentage terms. The
bottom axis shows time elapsing before and after the peaks measured
in months.
The
parallels between bitcoin’s extreme parabolic price action over the
past 6 months or so and silver’s in its bubble’s final 6 months are
uncanny. While very rare, popular speculative manias are nothing
new. The terminal gains of bitcoin and silver are remarkably
similar as the table above shows. If these data series were not
labeled, today’s bitcoin bubble and the 1979 silver bubble would
literally be indistinguishable.
As
of Wednesday bitcoin had rocketed 87% in its latest month compared
to 104% for the silver bubble in its terminal month. At 2 months
out they were identical at 197% and 196% gains. The same was true
at 3 months with 181% and 179% gains. In their final 5 months, they
skyrocketed 459% and 417% higher. Their terminal 6 months saw 366%
and 402% gains. This bitcoin bubble is behaving
just like the silver bubble!
While bubbles are incredibly exciting and fun when they shoot
parabolic, the aftermath is catastrophic for traders who buy
high. Bubbles always burst, leading to full-on crashes that proceed
long busts. Just a month after silver peaked at $48.00 per ounce in
January 1980, it plunged 35%. In the first 2, 3, and 4 months
post-peak, silver plummeted 54%, 73%, and 76%! Bitcoin faces
similar extreme downside risks today.
Once
this mania bitcoin bubble bursts, and it will, the odds are very
high that bitcoin will lose 50% to 75% of its value within a few
months on the outside! Everyone owning bitcoin today must be
prepared for brutal near-term downside proportional to this year’s
bubble upside. When a bubble bursts it rapidly destroys most of the
paper wealth that bubble created, which was really an illusion all
along if not cashed out.
And
once popular speculative manias inevitably fail, prices don’t return
to those extreme bubble-peak levels for an awfully-long time.
That silver bubble peaked 37.9 years ago, and there are still many
silver enthusiasts today. Like the hardcore bitcoin faithful,
plenty of people love silver with a religious-like zeal believing it
is the ultimate investment. In nominal terms, silver didn’t exceed
that bubble peak until April 2011.
After taking a staggering 31.3 years to regain January 1980’s high,
silver held it for a single day and has never returned since. And
in real inflation-adjusted terms based on the US CPI, silver’s
bubble peak in today’s dollars was over $152 per ounce! Obviously
silver has come nowhere close to trading near
those same real
levels again. Prices are so extreme after popular speculative
manias they may never recover.
A
far-milder bubble than both bitcoin and silver arose in the stock
markets in late 1999 and early 2000. Like bitcoin, the technology
of the Internet was amazing and would forever change our world. Yet
stock prices got so extreme then that the NASDAQ didn’t revisit its
March 2000 closing peak for the first time until April 2015,
fully 15.1 years later! And that only happened because NASDAQ’s
components greatly changed.
The
history of popular speculative manias proves that even if bitcoin
and its underlying blockchain are here to stay, it will likely be
many years or decades until bitcoin prices regain their bubble peak
wherever that happens to be. Once this bitcoin bubble inevitably
pops, there’s virtually no chance its traders will be made whole
again. They’ll hold through the burst in hopes bitcoin will
rebound, but bubble poppings are final.
And
it’s not just bitcoin’s extreme price action that reveals it’s in a
bubble fueled by a popular speculative mania. Anecdotal stories
abound showing a huge influx of young and naive “investors” who have
never lived through a bubble. The leading bitcoin broker in the US
is Coinbase. Its accounts are exploding as people rush to pour
money into this bitcoin mania. By late November, Coinbase’s active
accounts had hit 13.3m!
This
is staggering growth, as Coinbase reported just over 5m accounts as
2017 dawned. 13.3m is way bigger than stock broker Charles Schwab’s
10.6m at the end of October, and threatening to rival the 24.9m
accounts stock broker Fidelity had at the end of June! As in all
manias, the vast majority of these new bitcoin “investors” have
drank the Kool-Aid and believe bitcoin’s technology justifies its
extreme price gains.
When
markets soar so high all rationality is thrown out the window, the
only reason to keep buying is the greater-fool theory.
Late-stage traders buy super-high in the hopes they’ll find an even
greater fool to sell even higher to later! Soaring prices can
entice in big new capital inflows for a season, but eventually the
price levels get so high that it’s impossible to sustain exponential
buying. Then the bubble bursts, prices crash.
Even
if bitcoin and blockchain forever change currencies in the future,
nothing justifies doublings and quadruplings in bitcoin prices in
a matter of months. Such extremes are never sustainable, all
popular manias fail spectacularly even though the technology
investors were excited about lives on and indeed changes the world.
I’m really excited to see bitcoin and blockchain applied to digital
gold in coming years.
Gold
has been universally valued across the world for millennia, yet it’s
impractical to use as money for most transactions. But if
bitcoin-and-blockchain technologies were applied to gold, this metal
could easily be subdivided into the tiniest of increments and traded
globally. A gold version of bitcoin would have to be 100%
physically backed by gold held in secure vaults in safe, trusted
countries. It’s already being worked on.
But
the great value of bitcoin-and-blockchain technologies doesn’t make
bitcoin immune from the natural consequences of this year’s bubble.
Bitcoin is far too large now to keep doubling on a monthly basis,
it’s impossible. And there’s never been a past bubble where prices
stop soaring but don’t crash, instead just rallying on from there
quasi-normally. Greedy traders start selling when the parabola
stalls, driving the burst.
One
of the reasons bitcoin has skyrocketed is there are virtually no
sellers relative to the great herds of new buyers flocking in. That
is all going to change soon, which presents big risks of popping
this bubble. Both the CBOE and CME are set to launch actual bitcoin
futures in the next week or so, which will allow professional
speculators to not only buy bitcoin but short sell it at scale.
That alone may very well slay this bubble.
Bitcoin is pretty inefficient too, with transactions taking up to 10
minutes to process as the blockchain gets bigger and bigger.
Transaction costs are also skyrocketing, leading some major
businesses like the Steam online video-gaming service to stop
accepting bitcoin as payment. Its owner Valve says it now costs
about $20 to process a single bitcoin payment, far too expensive
for this company’s massive 67m users.
As
bitcoin grows, the blockchain itself is getting ever-more unwieldy.
That ledger recording every single bitcoin transfer ever is
requiring progressively more computing power to process, making
mining for the network much more expensive. Recent estimates place
bitcoin-mining electricity usage at 0.13% of the world total. A
single bitcoin transaction now requires enough electricity to
power an American house for a week!
As
long as bitcoin prices are sky-high, large-scale mining operations
to process bitcoin’s cryptographic hashes are profitable. But when
bitcoin crashes after this bubble, computers tasked to mining will
likely plunge in parallel. While the hashes are dynamically
adjusted to account for network mining power, this could still
increase transaction times as blockchain grows. That would make
bitcoin less attractive as a currency.
As a
professional speculator over the past two decades or so, I wouldn’t
touch bitcoin with a ten-foot pole today. Buying into a popular
speculative mania that’s already rocketed parabolic is the height
of folly, guaranteeing massive losses in the near-future. If
you were shrewd enough to buy bitcoins before the last 6 months, you
should be scaling out and taking profits. One bitcoin expert calls
it a “consensus hallucination”.
At
Zeal we’ve spent decades studying and trading the markets, building
wealth normally and consistently through profitable real-world
trading with a contrarian bent. This means buying low and selling
high, so bitcoin is off the table. But as of the end of Q3 we’ve
realized 967 stock trades recommended in real-time in our
newsletters since 2001, which averaged stellar annualized realized
gains of +19.9% over that long span!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, not
when they are euphoric like in bitcoin’s mania. An easy way
to keep abreast is through our acclaimed
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Subscribe today, and build lasting wealth instead of getting
obliterated when bitcoin’s bubble bursts.
The
bottom line is this year’s bitcoin popular speculative mania has
gone parabolic. Such extreme gains are never sustainable, as they
require exponentially-growing capital inflows. Once this
greed-drenched bubble stage is reached, it’s only a matter of time
until the burst inevitably follows. The resulting selling from
panicking traders is so violent that most of the mania gains are
fully annihilated in a matter of months.
While bitcoin and its blockchain distributed-ledger technologies are
amazing and will indeed likely change the world, they don’t justify
bitcoin’s extreme vertical gains. Plenty of past bubbles were based
on great new technologies too, but those prices still collapsed once
the supply of greater fools exhausted itself. After skyrocketing so
darned fast, bitcoin is certainly the riskiest major investment in
the world. Caveat emptor! | 
