Thursday, 18 January 2018

We need to talk about cryptomania

Every market crash is sparked by a trigger. Every trigger is preceded by a mania. Every mania began as an overshoot optimism. And every optimism started off by a justifying reason to be positive.

In 1880s the optimism was the invention of US railways. In 1920s the radio and motorcar companies. In 1980s the invention of microcomputers. In 1990s the optimism was the internet. In 2000s a complex invention of derivatives. And in 2010s? It's the blockchain technology and its cryptocurrencies.

People in every era always say that this time is different, and they rightly point out at the new technology being invented. But the market consist of people who collectively decide the direction of the market, and people are fundamentally irrational. Throughout history human behaviour has not changed a bit since the 1st ancient market crash during the Roman Empire era, they’re still overly greedy at the optimism, and overly fearful at the sight of a collapse.

Just as George Soros explained in his book The Alchemy of Finance: "when events have thinking participants, the subject matter is no longer confined to facts but also includes the participants' perceptions. The chain causation does not lead directly from fact to fact but from fact to perception and from perception to fact."

Hence, when a new invention caught the exuberant eyes optimism quickly turns into an offshoot, a bubble.

It took approximately 5 to 7 years for each of the new inventions of 1880s, 1920s, 1980s, 1990s, 2000s to turn into an overall market bubble, which then entered into a mania phase for 1 to 2 years before they respectively crashed in 1893, 1929, 1987, 2000, 2008.

Likewise, at first it took Bitcoin 1789 days from 2008-2017 to increase its price from $0 to $1000. But when the optimism grows, $1000 quickly rise into $5000 in half a year in 2017. And then we enter the overshoot optimism phase, that’s when the exuberant speculators come in: it took 13 days to rise from $6000 to $7000 in October 2017, 14 days from $7000 to $8000, 9 days from $8000 to $9000, 2 days from $9000 to $10,000, less than 1 day from $10,000 to $11000, 6 days from $11,000 to $12,000, a whopping 17 hours from $12,000 to $13,000, 4 hours from $13,000 to $14,000, 10 hours from $14,000 to $15,000, 5 hours from $15,000 to $16,000 and it hover around at nearly $20,000 before it fell down and began to be slightly saturated.

As Bitcoin started to get saturated, other cryptocurrencies began to rise too, everything from the serious like Ethereum and Ripple, to the ridiculous like CryptoKitties, DogeCoin and Okoin, to the bizarre like Venezuela's Petro.

And suddenly everybody everywhere can’t stop talking about Bitcoin and other cryptocurrencies. Every single Initial Coin Offerings (ICO) is greeted in the same manner as every Initial Public Offering (IPO) of any internet company in 1990s, or when people in 1720s all rushing to buy the South Sea Company's stock: the price immediately shoots up no manner what their underlying is. In a true bubble manner Long Island Iced Tea change their name to have the word "blockchain" in it and as a result enjoyed an astronomical rise in share price (+200%), even though they still sells iced tea and has nothing to do with blockchain. Even Kodak is rising from the dead, to be a cryptocurrency company.

Indeed, a lot of companies have began to divert away from their core business to trade cryptocurrencies. This is exactly what happened in Japan 1980s with their Zaitech invention, where at the height of the bubble companies no longer gain their profits from their core work but from the practice of Zaitech and speculating on their Eigyo Tokkin account in the market, just like a steel company named Hanwa who raised over ¥4 trillion from speculating in the market (which is 20 times larger than their gains from their core business).

This, right here, is unmistakably signs of the mania phase of the bubble. This situation is not that different than the height of the 1920s stock market bubble described by Bernard Baruch: “taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929.”

True to any mania phase, in the middle of the hype there's opportunity for scams. Because cryptocurrency is independent and the industry has no proper regulation yet, it is truly a Wild West out there. All the oldest dirty tricks in the book - from the tricks used by John Law and Jesse Livermore, to Heinze and Morse, to Ivan Boesky - are all back.

However, while we’re quite possibly at the peak of the bubble, the fact remains: every crash always have to be sparked by a trigger. And while Tulipomania 1630s finally crashed after a rumor spread about a break of war in Nice, France (which people afraid could spread to the Netherlands), and while the derivatives-fueled subprime mortgage market crash was inevitable once the subprime mortgage borrowers all defaulted in the beginning of 2007, in the crypto world the trigger is far less visible and far less obvious. So this time it really is different.

Of all the possible risks in cryptocurrency, exchange risk come first in mind, with the likes of Mt Gox and Bitconnect, among many others, have famously been spectacularly hacked (or stolen by its owners). But perhaps the biggest thread comes in the form of regulatory risk. China, Japan and South Korea trading ban in this early January 2018 have sent enough danger alert to the crypto market and have caused several crashes.

But still, as we have witnessed several times in 2017, every time a crash comes, another willing buyers quickly jack the price back up, and even rising the price even more towards new record high. Hence the argument by crypto supporters, that this unregulated Wild West always self-sustain itself and will never crash. 

So, are all the bubble riders justified? Maybe. As long as the bubble is still developing there’s no reason not to consciously, and carefully, participating for a neat profit. Just make sure that we don’t become the greater fool.

Nevertheless, just like in every market bubble, a [healthy] correction is eventually needed for the new invention to "return to the mean", the "normal" price, before its true function can perform well in a healthy environment. The Black Friday crash 1929 wiped out the many amateur motorcar companies and left us with the likes of General Motors and Chrysler. Out of the Black Monday 1987 survivors we have Microsoft. The crash wiped out all the frauds and half-baked companies, and left us with Google, Apple and Amazon. Because while the mania was insane, the technology behind it (the internet) had a promising future. The railway, motorcar, microcomputer and even derivatives have also become a vital part of our modern society.

Likewise, while cryptomania is arguably starting to get out of control, the technology behind it (the blockchain) has a very promising future. But before we can reach the "normal" phase, the market will eventually need to wipe out the speculators, the scammers, and the amateur hitchhikers.

So the million dollar question then becomes this, when will the healthy correction going to take place? And what will cause it? It is very interesting to watch, because like a good movie nobody knows where the plot of this story is heading.

Further reading on the enigma of market crash