January 27, 2018
Back in November, one of our colleagues at work started talking about Bitcoin and its surging price. Every. Day. Of. The. Week.
At 49, Dean has worked hard his whole life towards a pension, paying off the mortgage, saving up to get the house extension done, and seeing his kids graduate from school. He’s a happy-go-lucky type; curious, clever and educated with the goal of ‘early’ retirement at 55.
True, he’s worked in banking his whole life, but he is by no means a risky investor. On the contrary, Dean is the exact opposite, practising frugality and adopting a conservative philosophy towards investments since the ripe age of 17. While building his career, he’s lived through the Russian crisis, the dot-com bubble and the 2008 crash. His pension is healthy thanks to him religiously contributing to his tax-free ISA since 1989. A few more years and he plans to retire at 55 by taking out 25% of his self-managed pension as a lump sum to live off.
This is the guy at the office whose eyes light up when he talks about the beauty of compound interest, investing in passive funds for the long term, golf, and how he rebalances his portfolio every year. His discipline is second to none but something started nagging him slowly but surely. Something that went up 20% every ‘day’ rather than every ‘year’. Something that defied the logic of investing. This was a long-term player who started questioning his decades-old philosophy on how fortunes were made. It started to bother him that almost any crypto could have given him the same return in one year as what he had achieved with his passive funds in the last twenty.
Dean was the sort of guy that checked his phone to monitor the negligible movements of his portfolio every five minutes. Soon he included reading Bitcoin charts into his routine and he was addicted to those green candles. “It’s got to be a bubble,” he said confidently yet his eyes seemed to search for some validation. He wasn’t the only one saying that. It was a mantra espoused by CNBC that was broadcasting non-stop on the TVs above our heads so that we’d all think that.
Six months on and we’re still talking about the so-called bubble. It was just this week that Goldman issued a warning on Bitcoin and an even bigger warning on Ethereum claiming that Bitcoin’s “meteoric rise in a short time has dwarfed the rise seen during the dot-com bubble” and that “cryptocurrencies have moved beyond bubble levels in financial markets, and even beyond the levels seen during the Dutch ‘tulip mania’ between 1634 and early 1637.” Yet that has not prevented them from serving all their prime brokerage clients with a clearing service allowing Bitcoin futures trading by the end of June. It’s also quite possible that Goldman Sachs Asset Management’s hedge fund arm is one of these clients.
We disagree with Goldman’s premature assessment and comparison to the tulip phenomenon. The overzealous attempts at drawing a parallel between Bitcoin and tulip mania in the 17th century only seemed to increase the desire among purchasers to prove them wrong. Tulip mania peaked within a year of inception but there are fundamental differences that can change the outcome, magnitude and rate at which the event will unfold this time:
- The tulip crisis was an isolated phenomenon geographically whereas Bitcoin is borderless
- Disposable income across the average investor was significantly less compared to what it is now
- Access to credit was non-existent whereas household debt is at its highest in the 21st century
These varying conditions suggest to us that Bitcoin’s bubble is likely not going to burst in the near future. It will take years yet for everyone to jump onto the bandwagon.
Often comments about a crypto bubble stem from a basic misunderstanding of the application of market capitalisations to cryptocurrencies. This week crypto market capitalisations hovered at around $500bn, much of it shaved off from the euphoric highs experienced at the start of the year.
First of all, market cap should not be confused with the amount of money invested in crypto. According to research at JP Morgan, when the market cap was around $300bn for crypto, the net inflow was around $6bn. This means that only $6bn was actually invested, not the $300bn. If you consider where the market cap is sitting right now, this very simplistically means that the entire amount of money actually invested in crypto is only around $10bn at this point. $10bn is hardly anything to wave a stick at so from our perspective, take it as a sign that we aren’t really in a bubble and there’s likely a lot more growth coming our way.
Secondly, market cap for crypto shouldn’t be represented in the same way as market caps for public companies. Valuations of cryptocurrencies are still unclear and speculative in terms of how much of the potential future value of a coin should be priced into the current value, let alone be manipulated by whales.
But none of this matters for the layman and all of this seems to be temporarily forgotten when prices are rising in an unprecedented fashion. Dean cracked in the end and made the bold decision to invest into an Ethereum tracker fund that was tied to his pension. The temptation of crypto was just too strong. Talk about diversification! A few weeks later, he could not contain his excitement at increasing his portfolio by £100,000 in such a short timeframe. However, recently he started not coming into work, conveniently timed when crypto crashed across the board over the past weeks. Having said this, his loss wasn’t of the same magnitude as the loss felt by the Winklevoss twins who lost nearly $1bn. It takes some guts to stomach volatility.
The dip that we all had to face straight on at the start of the year persists to this day. Dean will have to wait a little longer for his pension to recuperate. But one thing great about Dean is that he’s regained his composure and his skills in being patient are certainly coming in handy. It’s natural to break sometimes, and to have occasional feelings of uncertainty and at times frustration when expectations don’t become reality. Stay strong, crypto enthusiasts, the best is yet to come!