Bitcoin and the Madness of Crowds

The purpose of this article is to provide a clear, reasoned macro thesis on Bitcoin and related assets. I will steer clear of abstract mathematical models, bias and ‘shilling’ in favor of reducing complexity and fundamentalist thinking.

The parabolic rise of Bitcoin and associated alternative cryptocurrencies in 2017 propelled the asset class from a relatively obscure speculative market into one of the hottest ‘watercooler’ conversation topics in recent history. The resulting mania realized a 20x increase in the price of Bitcoin, and over 100x for other tokens such as Ethereum. Market conditions have demonstrated that these instruments are one of the most emotionally driven assets that one can speculate on.

Bitcoin/USD 2017 — The Great Bubble

The Bitcoin market (and associated tokens/currencies) is a unique opportunity to capitalize on the ‘macro-trend’ opportunity that this asset class presents. Many have mistakenly formed the belief that the Bitcoin market is ‘dead’, ‘finished’ and it is history. In fact, the opposite is true. This article will discuss the notion of ‘Incentivised signalling’ and provide a supporting argument in favor of another ‘bubble’.

It is important to understand that our brains are fundamentally wired to follow ‘herd’ mentality and form tribes and niches. It is the psychological engine that empowers brands, politics and the notion of the institution itself. Perceptions of self and a desire to ‘fit in’ also contribute to this.

The notion of a ‘cryptocurrency’ and the associated anarcho-capitalist and revolutionary story attracts a certain brand of individual where a disproportionate amount of mental and social capital is spent participating in echo chamber online communities. It is important to understand that the Bitcoin and Alt-Coin communities are overall highly tribal as a result of their psychographic and demographic profiles.

Exhibit A: Example of ‘HODL’ culture and irrational exuberance in markets; Incentivised signalling by token holders.

Many investors in Bitcoin that thrive in online communities have formed a negative worldview of societal structures and hierarchical systems and see Bitcoin as a way to ‘revolt’ against those systems. They invest as a way to get ‘skin in the game’ against the institutions that they feel hard done by. Individuals that do not feel like they ‘fit in’ in the real world invest in these ‘revolutionary projects’ as a way to feel validated and part of a community. Their ‘heavy bags’ act as social currency and status symbols inside of their communities. The retention rate in these communities is very high: Participants are encouraged to ‘HODL’ (Keep positions open).

These attitudes and beliefs of the ‘core’ cryptocurrency community represent an opportunity to exploit the relatively clear cyclical nature of Bitcoin. It has been established that the intense tribalism of the cryptocurrency community has created an army of shills proliferating the ‘new paradigm’ of Bitcoin and crypto, incentivised by a desire to virtue signal and perhaps more importantly: The notion of ‘tokenomics’ has created one of the worlds biggest decentralized affiliate programs.

Their ‘heavy bags’ act as social currency and status symbols inside of their communities.

As of July 2018, Bitcoin has corrected 60% and many ‘Alt-Coins’ that were invested in during the peak of the bubble are upwards of 95% down from all time highs. What separates this bubble from the traditional notion of a bubble such as the Dot Com bubble is the familial and closely interconnected echo chambers that have formed as a result of Twitter, Reddit, 4chan and other channels. Participants are able to re-enforce each others beliefs and attitudes, and attract and capture new participants into the network. As the friction of acquiring, storing, and disposing of the asset decreases, the ability of these incentivised signallers to convince people inside of their sphere of influence widens. This supports the theory that the ‘Bitcoin bubble’ is not a one trick pony and the likelihood of another, larger market cycle is statistically probable.

Bitcoin is kind of a Ponzi scheme that starts with smart people. So the smartest people understand it first. Then they sell it to the people who need the cryptography explained to them, like me. Then we sell it to the people who need the next level down. — Naval Ravikant

It is basic human nature to want to seek return without putting in the hard work. Inside of cryptocurrency echo chambers, any dissenting opinion that does not align with the herd mentality is instantly dismissed.

To think like a successful trader, emotions must be removed from the investment. For smart traders and investors, the irrationality of the Bitcoin and Alt-Coin markets provides a unique opportunity to capture value from participants. Identifying and assessing fundamental indicators of further parabolic growth and decline will likely provide portfolio returns that far outweigh other asset classes.

Key Macro Indicators of December 2017 Irrational Exuberance:

Google Trends:

Bitcoin is a vehicle that is primarily driven by non commercial retail investment. As part of the ‘discovery’ process, a participant will use networking channels to search for information. By examining the ‘on-ramps’ that participants use to search for this information can be used to determine if an instrument is ‘trending’. Google trends provides a large enough sample size to be used an inferential tool. It is important to note that ‘discovery’ indicators are trailing indicators.

Bitcoin Transaction Fees:

Bitcoin transaction fees are a function of the number of transactions performed across the Bitcoin network. This is because in the network’s current form, past a certain threshold of transactions per second participants have to bid for a limited amount of block space/time. An increase in transactions on the Bitcoin network will therefore increase the transaction fees.

An increase in the number of transactions across the Bitcoin network is positively correlated with price movement. Bitcoin is a speculative vehicle where price is a primarily a function of sentiment and interest. Use of the network is primarily speculative in nature with only a very small percentage of transactions being used as a medium of exchange for other assets outside of the cryptocurrency and blockchain space. Therefore, it is reasonable to assert that an increase in transactions and use of the Bitcoin network is positively correlated with the price of the instrument.

In December, Bitcoin saw over a 600% increase in transaction fees to nearly $60 US per transaction. Bitcoin was being rapidly exchanged between participants, driving the price of the asset up nearly 400%. Bitcoin is also used an on-ramp to purchase Ethereum and Alt-Coins. These two factors led to competitive block time bidding. The willingness to pay for extremely inflated Bitcoin Fees to enter and exit positions is an indicator of irrational exuberance in markets.

News Cycle:

Peak mania

One of the most effective indicators of irrational exuberance is an accelerated news cycle. News outlets are incentivised to amplify mania and serve as effective contrarian signals. During peak mania, Financial news networks