20/11/18: Bitcoin's Steady Loss of Fundamentals

Base rate fallacy is one of the key behavioral heuristics or biases in economics and finance, defined as a cognitive error whereby too little (or too much) weight is placed on the base (original) rate of possibility (e.g., the probability of A given B). In behavioral finance,

• Base rate neglect is the case of giving not enough weight to the prior/original fundamentals in analyzing a complex phenomena, focusing analyst's attention instead on more proximate/more recent trends. Put differently, analysts tend to assign greater weight to a rare category / outrun when tested with a single symptom whose objective diagnosticity was equal for all possible outruns; and 
• The inverse base rate fallacy is the case when too much weight is given to the complex priors / original fundamentals, downgrading newer information. In other words, people tended to give higher probability to a rare outrun when tested with a combination of conflicting priors or cues.

Some research has shown that the key effect of the base rates on judgement error is that base rate presence distorts our analysis by making more frequent outruns of uncertain events more important in our analysis. Thus, more common realizations of the uncertain gambles are magnified in perceived frequency, overriding either the original priors (neglect) or the changing nature of the priors (inverse neglect).

You really can't avoid stumbling on both of these manifestations of the fallacy in today's Bitcoin markets analysis.

Take for example this:

A 'guru' of Bitcoin investment world has been issuing absurd forecasts like a blind drunk armed with an AK47: fast, furious and vastly inaccurate.

The dude, armed with 'fundamentals' (unknown to anyone in the finance research universe, where predominant consensus is that Bitcoin has no defined price fundamentals), has predicted BTCUSD at $22,000-$25,000 for the end of 2018 some months ago (back in January). He upped the ante around March by 'forecasting' BTCUSD at $91,000 some time before the end of 2019, and scaled this back to $36,000 in May. He then re-iterated his $25,000 target in July, just around the same time another 'Hopium sniffing' 'analyst' - Julian Hosp - put a target of $60,000 for BTC in 2018. Four days ago, Lee scaled back his 'forecast' for the end of 2018 to $15,000. This comes on foot of the guru adding lots of mumbo-jumbo to qualify his optimism, saying in early November 2018 that he was "pleasantly surprised" by Bitcoin's stability around the newly found price floor close within the $6,400-$6,500 range.

Taking decreasing doses of the sell-side drug-of-choice, Mike Novogratz was a bit more 'reserved'. In November 2017, struck by the recency bias (the fallacy of not even bothering considering any information other than hyperbolic BTC price dynamics around the end of 2017), he 'forecast' Bitcoin to reach $45,000 by November 2018. This 'forecast' was trimmed back to $9,000 for the end of 2018, issued by Novogratz on October 2, 2018.

There were madder ravings still on offer this year. Mid-April 2018, Tim Draper and CNBC's Brian Kelly pushed out (separately) 'research' arguing that BTC will be hitting $250,000 by 2022. Lee's prediction for 2022 target was $125,000 per BTC mid-January 2018, and advised investors to follow his alleged strategy: "We expect bitcoin's major low to be $9,000, and we would be aggressive buyers around that level... We view this $9,000 as the biggest buying opportunity in 2018."

Note: this drivel has been reported by the likes of Bloomberg, CNBC, et al - the serious analysis folks, employing a bunch of CFAs. I mean, you wouldn't be conflicted if you employed institutional investors trading in Bitcoin as your analysts, would you? Of course, not! Next up: CNBC to hire Wells Fargo sitting executive to analyse Wells Fargo.

But returning to the behavioral anomalies, both base rate neglect and inverse base rate effect can (and do), of course, take place in the same analysts' decisions and calls. Framing - conditioning on surrounding attributes of the decision making - determines which type of the base rate fallacy holds for which 'analyst'. Hence, this:

Ever since the collapse of the parabolic trend, Bitcoin price dynamics can be seen as a series of down-trending sub-cycles, with only one slight deviation in the pattern since mid-September 2018 (the start of the 6th cycle). I wrote about this back in August, suggesting that we will see new lows for BTCUSD - the lows we are running through this week.

When you look at liquidity (trading volumes), you can see that the 'price floor' period from mid-September through the start of November has been associated with extremely low trading. This runs contrary to the 'fundamentals' stories told by the aforementioned 'analysts': the increasing efficiency of the cryptos networks and mining, the growing rates of cryptos adoption in the real economy, and the rising interest in cryptos from institutional investors.

Put more simply, the period of 'calm' (and it wasn't really a period of low volatility, just a period of lower volatility compared to the internecine levels of volatility that BTCUSD investors have been conditioned to accept in the past) was the period when the Bitcoin Whales (large miners) stuck to their mine-and-hold strategies, so that pump-and-dump scams were running wreckage across smaller investors portfolios. The events of the last two weeks seem to have broken that pattern, removing the supports from one of the only two fundamentals Bitcoin has: the fundamental factor of cross-collaterlization a myriad of junky ICOs with Bitcoin capital.  (see volume dynamics below)

As the ICOs crash, their collateral Bitcoins are being dumped into the markets to recover some sort of liquidity necessary for a shutdown or a run from the creditors and regulators, the only floor that BTCUSD has is the floor of the Whales still sitting on large BTC holdings accumulated from mining. Which is not the good news the BTC 'analysts' can hang onto with their 'forecasts'. Cost of mining is rising (as local energy utilities are jacking up electricity rates on large scale mining operations). Just as profit margins on mining are turning negative (at current prices). This means that in the short run, Whales are going to start dipping into their BTC reserves to sustain operations. In the longer run, two things can happen:

1. If the miners shut down their operations to cut on variable costs of mining, BTC might find a new temporary 'floor' until another regulatory assault on Bitcoin takes place and the downward momentum returns; or
2. If the miners decide to double-down in hope of price stabilization and continue to beef up their fiat cash reserves to pay for loss making mining, there will be a new sell-off coming soon.

Behaviorally, both mean that at some point in the future (no, I am not talking about end-of-2022 outlook, but something much sooner), the Whales will decide to cut losses and sell their holdings. As usual in such circumstances, first off, retail investors will step in to soak up some of the supply avalanche. The first sellers in this game will be the winners. The followers will be the relatively uninjured party. The hold-outs will end up with the proverbial bag in the end of the game. It is how all bubbles end up playing out in the end.

Now, go on, listen to the idiot squad of BTC 'analysts'. Everything will be fine. $15,000 --> $25,000 --> $36,000 --> $91,000 --> $125,000 --> $250,000 --> Takeover of the Universe. The Death Star is powering its lasers...

18/9/18: Extreme Concentration Risk: Bitcoin's VUCA Bomb

I wrote before both, about the general problem of concentration risk and the specific problem of this risk (more accurately, the concentration-implied VUCA environment) in the specific asset classes and the economy. Here is another reminder of how the build up of concentration risks in the financial markets is contaminating all asset classes, including the off-the-wall crypto currencies: https://thenextweb.com/hardfork/2018/09/18/cryptocurrency-bitcoin-blockchain-wallet/.

The added feature of this concentration risk is extreme (87%) illiquidity of major Bitcoin holdings. This means that under the common 'Mine and Hold' strategy, already monopolized, highly concentrated mining pools literally create a massive risk buildup in the Bitcoin trading systems: with 87% of wallets not trading for months, we have a system of asset pricing and transactions that effectively provides zero price discovery and will not be able to handle any spike in supply, should these accounts start selling. Worse, the system is tightly coupled, as Bitcoin holdings are frequently used to capitalize other leveraged crypto currencies undertakings, such as investment funds and ICOs.

The extent of latent instability in the crypto markets is currently equivalent to a Chernobyl reactor on the cusp of the human error.

1/8/18: Dynamic patterns in BTCUSD pricing: is there a new down cycle afoot?

Bitcoin Cycles Analysis in one chart:

As the above suggests, BTCUSD dynamics are signalling continued structural pressures on Bitcoin prices and the start of the new double-top down cycle. The Great Unknown remains with the behaviour of the buy-and-hold investors who dominate longer-term BTC markets. Increase in market breadth with arrival of more active traders from the start of 2018 has not been kind to Bitcoin. More institutional investment flowing into the cryptos market has been, on average, a net negative for the crypto.

15/6/18: "Ripples in the Crypto World" - Our New Article on Systemic Risks in Cryptocurrencies

Our new article on dynamic properties and systemic risks of key cryptocurrencies is available at:

Gurdgiev, Constantin and Corbet, Shaen, Ripples in the Crypto World: Systemic Risks in Crypto-Currency Markets (June 15, 2018). International Banker, June 2018 https://internationalbanker.com/brokerage/ripples-in-the-crypto-world-systemic-risks-in-crypto-currency-markets/ . Ungated version: https://ssrn.com/abstract=3197351.

19/5/18: The Scary Inefficiency & Environmental Costs of Bitcoin

Bitcoin is just one of the cryptocurrencies, albeit the dominant one by market capitalisation and mining assets deployment. The cryptocurrency is best known for volatility of its exchange rate to key fiat currencies and other commodities, but the more interesting aspect of the Bitcoin (and other cryptos) is their hunger for energy. Cryptos are based on blockchain technologies that promise a range of benefits (majority unverified or untested or both), amongst which the high degree of security and peer-to-peer data registry, both of which are supported by the mining processes that effectively require deployment of  a vast amount of hash/algorithmic calculations in order to create data storage units, or blocks. In a sense, energy (electricity) is the main input into creation of blockchain records of transactions.

As the result, it is important to understand Bitcoin (and other cryptos) energy efficiency and utilisation, from three perspectives:
1) Direct efficiency - value added by the use of energy in mining Bitcoin per unit of BTC and unit of information recorded on a blockchain;
2) Economic efficiency or opportunity cost of using the energy expended on mining; and
3) Environmental efficiency - the environmental impact of energy used.

To-date, estimating the total demand for electricity arising from Bitcoin mining (let alone from mining of other cryptos) has been a huge challenge, primarily because Bitcoin miners are too often located in secretive jurisdiction, do not report any data about their operations and, quite often, can be highly atomistic. Although Bitcoin mining is a concentrated activity - with a small number of mega-miners and mining pools dominating the market - there is still a cottage industry of amateur and smaller scale miners sprinkled around the globe.

Thus, to-date, we have only very scant understanding of just how much of the scarce resource (energy) does the new industry of cryptos mining consume.

A new paper, published in a peer-reviewed journal, Joule, which is a reputable academic journal, titled "Bitcoin's Growing Energy Problem" and authored by Alex de Viries (Experience Center of PwC, Amsterdam, the Netherlands) attempts exactly this. The paper is the first in the literature to be peer-reviewed and uses a new methodology to discern trends in Bitcoin's electric energy consumption. The paper does not cover other cryptos, so its conclusions need to be scaled to estimate the entire impact of cryptocurrencies energy use.

The findings of de Viries are striking. He estimates the current Bitcoin usage of energy at 2.55 gigawatts, close to that of Ireland (3.1GW), approaching 7.67GW that "could already be reached in 2018", comparable to Austria (8.2GW). When reached, this will amount to 0.5% of the total world electricity consumption.

Per 'efficiency of blockchain', a single transaction on Bitcoin network uses as much electricity as an average household in the Netherlands uses in a month. Which is, put frankly, mad, wasteful and utterly unrealistic as far as transactions costs go for the network.

Per de Viries: "As per mid-March 2018, about 26 quintillion hashing operations are performed every second and non-stop by the Bitcoin network (Figure 1). At the same time, the Bitcoin network is only processing 2–3 transactions per second (around 200,000 transactions per day). This means that the ratio of hash calculations to processed transactions is 8.7 quintillion to 1 at best. The primary fuel for each of these calculations is electricity."

The key to the above numbers is that they vastly underestimate the true costs of Bitcoin and other cryptos to the global economy. The paper focuses solely on energy used on mining. However, other activities that sustain Bitcoin and blockchains are also energy-intensive, including trading in coins/tokens, storage of information blocks, etc. Worse, mining and processing / servicing of the networks required use of constant electricity supply, which means that the energy mix that goes to sustain cryptocurrencies operations is the worst from environmental quality perspective and must rely on heavy use of fossil fuels in the top up range of electricity demand spectrum. The environmental costs of Bitcoin and cryptos is staggering.

Scaling up Bitcoin figures from de Viries; paper to include other major cryptocurrencies would require factoring in the BTC's share of the total crypto markets by energy use. A proxy (an imperfect one) for this is BTC's total share of the cryptocurrencies publicly traded markets which stood at around 37.3% as of May 16, 2018. Assuming this proxy holds for mining and servicing costs, total demand for electricity from the cryptocurrencies and blockchain use around the world is more than 2.55GW/0.37 or more than 6.9GW, with de Viries' model implying that by year end, the system of cryptocurrencies can be burning through a staggering 1.35% of total electricity supply around the world.

The problem with the key cryptocurrencies proposition is that the system of blockchain-based public networks can deliver lower cost, higher efficiency alternatives to current records creation and storage. This proposition simply does not hold in the current energy demand environment.



The full paper can be read here: de Vries: "Bitcoin's Growing Energy Problem" http://www.cell.com/joule/fulltext/S2542-4351(18)30177-6.

21/2/18: Cryptos Fans Checkmating Themselves on Petro

Venezuela launched the Petro, an oil-backed cryptocurrency that is supposed to augment (strike that: replace) the totally debased fiat currency the country has. And the launch is a pure gas, surrounded by bombastic claims from crypto-fans who can't be bothered to read the script.

Behold the following bits from the priceless writeup by the Bloomberg (https://www.bloomberg.com/news/articles/2018-02-20/venezuela-is-jumping-into-the-crypto-craze):

Apparently, Dubai has an asset-backed or commodity-backed currency. It does not.

Apparently, currency is what makes Dubai Dubai. It does not.

Apparently, all that differentiates Dubai from Venezuela is... err... I am not sure what it might be in the eyes of the cryptos experts, but here is a tangible metric of difference:

One ranks 179th in the world in Economic Freedom Index, another ranks 10th. And similar rankings differences apply across all reputable measures of economic, social, legal and political institutions quality, and country risk measures.

But, not to be outdone by their own ignorance, the crypto-fans brigade soldiers on:

Free markets led by some of the most corrupt, venally politicized Government officials in the world.

Check mating oneself publicly is, apparently, a required condition for being a crypto expert these days.

13/12/17: Why cryptos might not prevail? Because of their supporters...

Why cryptos might not prevail? Because of this:

Or, put differently, because the entire hype around cryptocurrencies, and increasing also blockchain technology, is based on myths.

Let's tackle the above, shall we?

Are cryptos a liquid market? No. In fact, the markets are illiquid (see here: http://trueeconomics.blogspot.com/2017/12/81217-coinbase-to-bitcoin-flippers-you.html) and worse, transactions costs for even basic movement of Bitcoin across accounts are atrocious today (in markets without a direct liquidity squeeze, amounting, sometimes to 15%). See https://www.bloomberg.com/view/articles/2017-11-14/bitcoin-s-high-transaction-fees-show-its-limits and https://www.bloomberg.com/news/articles/2017-09-29/paying-15-to-send-25-has-bitcoin-users-rethinking-practicality. Imagine what these can balloon to in a liquidity squeeze event. And then there is concentration issue: http://www.zerohedge.com/news/2017-12-08/bulgaria-government-shocked-discover-it-owns-3-billion-bitcoin and the 1,000 'whales' problem. Oh, no, these are not liquid markets.

Are cryptos global? Yes, if you consider Venezuela, China, Japan and other places where either hype or regulatory evasion or hyperinflation are driving demand for BTC. Yes, if you consider markets for illicit funds flows to be global. No, if you consider usability of BTC in standard sense of money (as a medium of exchange). See https://www.bloomberg.com/gadfly/articles/2017-12-01/bitcoin-is-hot-until-you-actually-try-to-spend-some. It turns out that as a medium of exchange (one function of money) it is utterly useless. It is also useless as a unit of accounting, which is another function of money (no one accepts 'bitcoin-priced accounts' and its volatility makes any attempt at preparing bitcoin-based accounts futile). And bitcoin is horror who as a store of wealth (third function of money), because so far, it has a combination of sky-high volatility, positive correlation with interest rates and upward trend, while also having sky-high volatility to the downside, which suggests that any trend reversal will be really ugly. Now, you do not store wealth over one month (as arguments in favour of bitcoin go), but you store it over the years. And here, bitcoin is untested at best, recklessly dangerous at worst. Take you 'happy middle' pick.

Are cryptos less susceptible to corruption? You need your head examined to believe in this: cryptos are subject to waves and rounds of pump-and-dump scams, potential insider theft, and insider hacks. Worse, they are clearly being used (at least to some extent) to sustain illicit trade and finance flows, and to launder money. Cryptos 'whales' can collude at any point in time to fix the markets in their favour. If bitcoin is susceptible to corruption, a free-for-all unregulated bazar crossed with the Silk Road would be a 'well functioning exchange'.

Possibility of a fractional ownership is clearly available to bitcoin 'investors'. No doubt. So is possibility of fractional ownership for those buying elephants as pets or condos in Bahamas. Hell, you can even have a fractional ownership of a few acres on the Moon. End of story.

Highly secure networks are not a feature of cryptocurrencies, as we all know. Frequency of hacks and other cyber events involving cryptos exchanges this year exceeds the same for large corporate IT infrastructures, according to our research data. Put differently, cryptos appear to be more frequently targeted by cyber crime and/or are more vulnerable to attacks and theft than larger publicly listed corporations. Now, notice that, for now, vulnerability is in wallets and exchanges, not in blockchain itself. 'For now' is the key bit. We do know that cybercriminals are incentivised by abnormally high returns to crime (see https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033950) and we know that cybercrime is evolving rapidly to acquire ever-expanding capabilities, tools and strategies. It is simply inconceivable that blockchain will remain 'unhackable' into the near future. More importantly, current evidence of the lack of efficient corruption of the blockchain itself rests on the assumption that it is technology that is a barrier to entry for the cyber criminals. This is an untested proposition. In reality, most likely, the reason for lack of efficient penetrations into blockchain system itself is the existence of the low-hanging fruit in the form of exchanges and wallets, as opposed to the impenetrability/security of the blockchain itself.

Blockchain 'changing incentives structure' is the daftest argument in favour of anything, including the blockchain. There is no 'incentives structure' difference between holding/investing in a BTC and holding/investing in any other speculative asset. None. Full stop. Bitcoiners and blockchainers did not change human nature. They did not rewrite our positive and negative incentives systems. To claim otherwise is to impose such a vast range of assumptions on our behavioural incentives and constraints as to make basic economics 101 sound like a reality-hugging discipline of empirical rigour.

'Code wins against theory' is another 'incentives change' mumbo-jumbo. Code, in the case of Bitcoin and cryptos, is theory. Not because it is physically disembodied from the currency. But because it is the basis for the key assumption (axiomatic theory, idiots?) of 'trust'. Bitcoiners are quick to point that there is no 'mistrusted' Central Banker behind the BTC, because there is a 'trusted mathematical algo' behind it. I rest my point, folks. Because you know 'trusted' and 'mistrusted' terms are (1) the defining terms of the bitcoiners' logic, and (2) these terms have nothing to do with logic or mathematics: they are purely subjective. 'Code is theory', morons, because it only matters as long as we believe it matters.

Do bitcoin or cryptos remove 'systems inefficiencies'? Doh! See transactions costs above, lack of exchange medium function, above, lack of storage and exchange security, above. The promise of the blockchain is to reduce systems inefficiencies when it comes to registering and storing information. This has nothing, repeat, nothing to do with BTC or cryptocurrencies. Besides that, there is a host of major problems with market efficiency of bitcoin (see https://www.forbes.com/sites/francescoppola/2017/07/26/the-fundamental-conflict-at-the-heart-of-bitcoin/2/#527d30435aac and https://arxiv.org/abs/1704.01414).  In basic terms, today, Visa and Mastercard are vastly more efficient (in cost, time and security of transactions sense) than BTC is. Worse, as bitcoin rage evolves, efficiencies of the crypto to act as an information clearing platform are further reduced by system congestion. If anything, the boom we are witnessing is 'creating inefficiencies' rather than reducing them.

Finally, there is the last argument that 'enough talented people believe' in cryptocurrencies to warrant their rise to power. Oh, dear. Enough talented people believed in the property bubble, in the dot.com bubble, in every bubble, to drive the respective assets to mad levels of valuations and the eventual crashes. Enough talented people believed that the Sun revolves around the Earth at some point in time too. Talented people beliefs are not exactly a decent test for resilience or sustainability or success of anything. Let alone, cryptos. Why 'let alone'? Because in cryptos case, 'enough talented people' pool of believers is a highly skewed pool of 'talent' defined by affinity for one type of technology. In a way, 'enough talented people' here is equivalent to the Church of Scientology. They define their own breed of 'talented people' by identifying them as believers in the Church. It is a circular argument, folks.

So, no, none of the above arguments are either necessary or sufficient to establish the future of cryptocurrencies or the BTC. Try again. Try harder.

20/11/17: Bitcoin: an Unknowable Bubble?

There is a much-discussed in the crypto-sphere chart making rounds these days, plotting Bitcoin price dynamics against the historical bubbles of the past:

The chart is striking. Albeit simplistic. See Note 1 below for a technical argument on the chart timing.

On price dynamics alone, Bitcoin looks like a sure bubble - a disaster waiting to happen. But Bitcoin dynamics are basically not suited for any empirical analysis of any significant accuracy.

As noted by some commentators, Bitcoin had numerous 80-90% and larger drawdowns in the past (given its immense volatility). It keeps coming back from these. Some claim this to be the evidence that Bitcoin it not a bubble. Which is neither here nor there: bubbles are generated by exuberant expectations of investors, not by actual parameters of price processes. Causality does not flow from dynamics to bubbles, but the other way around. So to identify a bubble, one needs to identify exuberance. See Note 2 below for more on 80% drawdowns.

In the case of Bitcoin fans, there is clearly such.

No investor or serious analyst has been able to provide a fundamentals-based valuation model for Bitcoin.

A disclosure in order here: myself and a graduate student of mine have looked at the fundamental modelling for Bitcoin over the summer. We found no tangible relationship between any economic or financial parameters tested and Bitcoin price dynamics. In another piece of research, myself and two co-authors are currently looking at empirical dynamic and fractal properties of Bitcoin. Again, we finding nothing consistent with a behaviour of an asset with fundamentals-derived valuations.

Absence of evidence is not the same as evidence of absence. But, taken together with the general lack of credible fundamentals-linked modelling of the crypto-currency, this means that, at this point in time, Bitcoin price can be potentially driven solely by… err… expectations held by its enthusiasts, plus the incentives by the predominantly China-based investors to avoid extreme risks of capital controls and expropriations. If so, both drivers would make it a speculative bubble.

The only quasi-fundamentals-linked argument for Bitcoin has been the blockchain one - the promise of Bitcoin serving as a key tool for data aggregation, recording and transmission. This argument, however, no longer holds. Blockchain technology has migrated from public blockchains, like Bitcoin, to either open blockchains, like Ethereum or, increasingly more frequently, private blockchains. It is the latter that currently hold the promise to serve as viable platforms for data economy.

As a libertarian, I should like a private currency system that supports anonymity of transactions. As an economist, I should like the innovative nature of Bitcoin. And, put simply, I do. Both.

But as an investor, I do not have the stomach for Bitcoin’s valuations and volatility, as well as for its higher moments behaviour (in particular worrying are kurtosis, co-skews and co-kurtosis, which severely complicate empirical dynamics analysis, see Note 3 below). And I have even less enthusiasm for the crypto market that is sustained increasingly by undertakings, like BitMEX - a purely speculative platform trading some $35 billion in Bitcoin derivatives with leverage up to x100 to the amateur speculators who, put frankly, have zero idea what they are buying and at what price. The vast majority of Bitcoin investors have no clue what a butterfly option looks like and how it can be valued. And the vast majority of financial markets analysts and professionals won’t be able to price a butterfly strategy for Bitcoin, given its painfully twisted moments. Yet, within a month of starting trading, BitMEX reached 1/3 of the market capitalisation of Bitcoin. This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.

Another worrying issue with Bitcoin is the argumentation of its main supporters.

This ranges from the cognitively biased “you don’t know anything about the Bitcoin” to “Bitcoin is scarce & limited in supply” to “Bitcoin is a promise of liberating the masses from the oppression of the Central Bankers”.

The first sort of argument exhibits not just Jurassic ignorance of logic, but also a gargantuan dose of arrogance. Repeated sufficiently enough, it signifies the absurd degree of exuberance of investors’ expectations.

The second argument is patently false. Bitcoin has undergone splits, and engendered dozens of other cryptos, with unlimited supply of such into the future. Bitcoin itself is divisible ad infinitum and, with forks, its supply is potentially unlimited. Worse, Bitcoin rests on man-made mathematical foundations. Which means it has no physical bound or constraint. Anything man-made (and even more so, anything mathematically derived) is, by definition, fungible and axiomatic. Just because to-date no one cracked the code to alter Bitcoin mid-stream or drain blockchain-held information does not mean that in the future such a code cannot be written. So hold your horses: gold is physically limited in quantity (even though in the Universe, it is not as scarce as it is on Earth, which makes long term supply constraint on gold potentially non-binding). Bitcoin is limited by our capacity to alter the underlying code defining it. Anyone thinking of an algorithm as a 'law' needs to go back to Godel's mathematics.

Finally, there is an argument of ‘liberation’. Bitcoin value is only sustained as long as it remains convertible into goods, services and other currencies. This means that Bitcoin cannot remain a government- regulation-free asset, as long as its popularity as a medium of exchange and a vehicle for store of value grows. Which means that in the medium terms (3 years or so?), Bitcoin will either cease to be, or cease to be anonymous. All protection from the dictate of the Central Bankers will be gone.  Benign tolerance of Bitcoin by some regulators can quickly turn into outright prohibition on trading - as current and past examples of China, Vietnam, Nigeria, Colombia, Taiwan, Ecuador, Bangladesh, Kyrgyzstan and Bolivia, Russia, and Thailand suggest. Evolution of cybersecurity measures and regulatory and supervisory tools, including their spread into cryptocurrencies domain will only increase effectiveness of such measures into the future. So, unless you are planning to live in a libertarian paradise, where legal norms of other states do not apply, good luck committing much of your wealth to Bitcoin as a safe haven for oppressive or coercive actions of the nation states.

Worse, anyone claiming that Bitcoin is a hedge against inflation fails to understand how modern markets work. Again, to increase in value, Bitcoin requires higher rates of adoption. Higher rates of adoption bring about higher rates of asset instrumentation (see above for BitMIX). Higher rates of instrumentation and adoption, taken together, imply higher holdings of Bitcoin by institutional and diversified portfolio investors. So far so good? Right, now the kicker: these holdings imply greater, not lower, positive correlations between Bitcoin and other asset classes in shock-experiencing markets. That's right, dodos: Goldman holdings of Bitcoin are correlated to liquidity supply in general markets, because if such liquidity starts evaporating, Goldman will sell Bitcoin to plug holes in other instruments. Sell-off in the markets can trigger sell-off in Bitcoin. Now, another kicker: Bitcoin is currently less liquid than any major asset class (see extreme volatility of pricing across various Bitcoin exchanges). Which means that smart folks at Goldman will be dumping Bitcoin before they dump gold and other assets. Hipsters hugging their laptops will be the last to wake up to this momentum (behavioural evidence suggests, they might actually buy into falling Bitcoin in hope of speculatively gaining on a bounce, which, incidentally, can explain why large drawdowns in Bitcoin can turn so fast into upward trends).

The tricky bit about Bitcoin is that its enthusiasts need to learn to live in the real world first. Until they do, Bitcoin will continue its upward path, and this process can go one for quite a while, depending on the supply of cash in the markets for Bitcoin. Once they are taught a sufficient lesson, however, the rest of us will be learning the long term fundamentals valuations of Bitcoin. I, for now, have no idea what these valuations might be.

So Bitcoin, then. A bubble or not? If you ignore the arguments that attempt to justify its valuations, it looks like one, albeit with dynamics that are very hard to interpret. If you listen to them, it looks that way even more, with more confidence in the arguments bogus nature. Draw your own final conclusions.



Note 1: In defence of the chart above, without validating its implied conclusions: the chart plots Bitcoin evolution from 3 years ago through today. This starting point makes sense. Until mid-2014, Bitcoin was extremely obscure, hype-only investor vehicle, with volatility so off the charts, any analysis of its dynamics was futile (I know, I did such analysis and presented the results in my talk at Bloomberg two years ago). Those us who do research in finance generally and routinely disregard the first 3-4 years of existence of Bitcoin for exactly that reason.

Note 2:  A note due here: Bitcoin's returns from 80-90% drawdowns is not a solid evidence of the crypto-currency not being a bubble, because they are in line with Bitcoins' overall massive volatility. In other words, a valid comparative for these drawdowns relative to other asset classes is not "an 80% drawdown in  Bitcoin ~ an 80% drawdown in stocks", but "an 80% drawdown in Bitcoin ~ an 8% drawdown in stocks". Apples to apples. Dust to dust.

Note 3:  Interesting Elliott Wave analysis of Bitcoin dynamics here: https://atozforex.com/news/29-september-bitcoin-elliott-wave-analysis/ and here https://www.cnbc.com/2017/07/20/bitcoin-bubble-dwarfs-tulip-mania-from-400-years-ago-elliott-wave.html, although I am not convinced Bitcoin price trends are established enough for this technique to work.

22/5/17: The Economist Calling a Bubble in Cryptos? Why not...

A very interesting chart from The Economist from last week providing evidence on rapid evolution of cryptocurrencies:

Source here

In basic terms, the value of cryptocurrencies market has risen to over USD60 billion, tripling within less than 6 months of 2017, while trading across cryptocurrencies markets has increased tenfold to ca USD 2 billion per day (average) and 38 initial coin offers have been launched in 2017 so far.

What is also notable is that Ripple is now on par with Ethereum and their combined valuation is now a challenger to Bitcoin.

Uncharacteristically for The Economist,  the publication that never sees a bubble until it pops is calling a bubble in the cryptos. Perhaps due to a freshly acquired consciousness of empiricism or due to the publication's innate distaste for anything not-state-centric. Still, given the exponential growth so far this year, cryptos are overdue a major correction. When and how will it be triggered is anyone's guess.