The Big Picture

“We have a shiny new penny here…”

I always thought it was “chomping at the bit”, but apparently the original phrase was “champing at the bit.” The phrase refers to a horses’ tendency to chew and chomp, and I suppose champ, while impatient and eager to go!

I will not be discussing horses today. You may already know what I am hinting to discuss. What are we witnessing in this new fascination with cryptocurrency and the different “coins” being minted? (FYI: there are no actual coins, just nice renderings of them). Let’s just say there is nothing surprising in the way many market participants are behaving. While this development may be new, exciting, and full of future potential (a shiny new penny); The manner in which these opportunities present themselves can be quite perilous.

Is Bitcoin (a dominant cryptocurrency) a bubble? How do we identify bubbles? Usually we cannot be sure until after a bubble pops. However, if it looks like a duck, and walks like a duck… what else could it be?

Have a Plan and a Process!

From the Trenches

“Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative. But I am not familiar with the specific product to assert whether it is the best potential setup. And we need a long time to establish confidence.” – Naseem Taleb

Indeed, a long time to establish confidence…

Interesting points in the quote above. Taleb referred to Bitcoin as a product as well as a currency. Why? Did you know there are over 1300 active cryptocurrencies today? (Wiki) Which one will prove to be the one? If one cryptocurrency becomes the dominant, what happens to the others? What happens to technologies that become obsolete?

Tread very carefully…

What are cryptocurrencies exactly? Are they a currency? An investment? A technology? The technology side is based on an electronic ledger system called blockchain. There is considerable debate on exactly what role cryptocurrencies and blockchain will have. As there usually is with any new doodad. I wrote about Money in June of last year. Money has three common definitions: unit of account, medium of exchange, and store of value. One last common descriptor we could add is money is generally issued by a sovereign government which backs the currency.

So do cryptocurrencies meet any of these definitions? I would argue that at present only one condition is met. They are a medium of exchange. And they may prove to be a very efficient one. However that has not quite been proven just yet. Store of value? Way too early to tell. Most crypto-currencies are not yet 10 years old. Unit of account? Way too volatile at present. It is hard to hold Bitcoin as a unit of account when its value rises and falls by tens-of-percent within days or even hours!

As for being issued by a sovereign government, cryptocurrencies are not. That isn’t necessarily a bad thing. Many proponents of cryptocurrencies have claimed this is one of the primary benefits. However this is very new and does bring up many questions. One important question is if the currency is not backed by any authority than are we simply relying on faith that it will hold value? Important to ponder. That said, it is not likely you will be paid in cryptocurrency anytime soon nor will your friendly neighborhood tax man accept them for your tax bill! So let’s not get ahead of ourselves. There is much to still learn, develop, and explore here.

Bottom line: As with many new technologies, cryptocurrencies and the technology behind them likely have a future. We are in the very infant stages of this new innovation. So any conclusions made are incredibly premature.

The Weeds

“Market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” -George Soros

Are Bitcoin, and other cryptocurrencies, in a bubble? The answer to that may depend on your position and opinion of them. If you are a proponent, you will likely argue all of the reasons why it isn’t a bubble and the rise is justified. It’s different! If you missed out or think it is some kind of scam, you are sure to say this is indeed a bubble and all should beware! That is the emotional reaction.

Now that is out of the way; My opinion. And keep in mind it is just one opinion: It is likely a bubble. If it looks like a duck, walks like a duck, it’s probably a duck! Remember bubbles are defined as prices rising well above the intrinsic value of the asset. How do we value Bitcoin? Hmm, problem. One of the many! Another accepted definition is an irrational and rapid rise in prices driven by groupthink or herding behavior. Are we seeing that? I would certainly say so. Does this mean the technology has no future? That is not what I am proposing. Simply the recognition that new and exciting sometimes enters this world with a frenzy. Remember technology stocks in the late 90’s? Case closed.

In looking at that chart; you may have noticed that the “Bit” may be one of the largest bubbles of all time! Human speculation is an incredibly powerful force. Bubbles are no stranger to human behavior. Great fun on the way up, heartbreak on the way down.

In the late 90’s we had companies changing their names from “XYZ Inc.” to “XYZ-Dotcom”. Only to see their stock prices race to the moon in spectacular fashion and crash back down just as quickly. That could never happen again, could it? Hold your tongue. We have already seen a few companies pull this off in the cryptocurrency and blockchain mania. How about an iced tea company becoming a blockchain company. Yep, happened. Unfortunately some market participants have very short-term memories.

Bottom Line: Cryptocurrencies still have much to prove. As well as many hurdles to clear before we can be confident in defining exactly what role they will have in the future.