Friday, 28 July 2017

Why I think digital currencies will go to zero

In 2011, my girlfriend at the time, who knew next to nothing about finance and investments, asked me out of the blue if she should buy some gold. She produced a bouchure she had procured from somewhere offering for sale small ounce-sized gold bricks. I was already bearishly inclined towards the metal at the time, but that comment cemented my bearishness. It called immediately to mind the depression-era saying that "when the shoeshine boys start telling you what stocks to buy, it's time to sell" (paraphrased). Sure enough, gold, which was at about US$1,800/oz at the time, was within a hare's breath of peaking. Gold now trades at closer to US$1,200/oz - a 33% loss over a 6yr period where the S&P500 has continued to surge to record highs.

An interesting dejavu moment occurred recently, when several old friends of whom I am in irregular contact, who are not involved in finance, all messaged me at about the same time earnestly asking for my opinion on Ethereum, the latest digital-currency fad du jour. I had the same instinctive reaction as I had to my girlfriend's inquisitions about gold - run! So far that instinctive judgment has proven correct. Indeed, Ethereum's price peaked within a few days of receiving those messages, and has now already declined by nearly 50%, from a shade under US$400, to nearly US$200. The market capitalization of all Ethereum coins outstanding still remains at about US$20bn, however - a not inconsiderable sum.

For the record, I think Ethereum and all other digital currencies likely eventually to go zero, or something very close to zero. In what way shape or form, however, I don't know. The madness of crowds cannot be predicted in advance via rational analysis, and pricing outcomes are path-dependent in nature. It may take a detour much-much higher. But I believe something approximating zero is the ultimate destination.

Furthermore, I have a hunch (albeit only a hunch) that we may already have seen the highs, for the same reason gold peaked in 2011 at the time my girlfriend expressed buying interest. Speculative booms require fresh oxygen all the time, and that oxygen is supplied by new buyers. When the average non-financial man-on-the-street type is already bulled-up and buying, you know that the point where the supply of new buyers is nearing exhaustion is already close at hand. It is the same reason ponzi schemes all eventually burst: the supply of new buyers is eventually exhausted. And when prices start to fall, the psychology rapidly changes, with greed quickly morphing into fear.

Fundamental fallacies

Aside from the typical psychological fallacies associated with all speculative bubbles, every bubble has at its core some fundamental misperceptions. In the case of digital currencies, there are several in my opinion, five of which I discuss below. These fallacies have provided sufficient rationalization for many participants to engage in what would otherwise transparently amount to little more than a speculative orgy

The first fallacy, at least as far as Bitcoin is concerned, is the idea that because the number of coins is finite (capped at 21m), that this somehow imbues the coins with enormous value. The finite number of coins, it is argued, represents a vast improvement on fiat currencies, where the supply is subject to the whims of central bankers, and is typically always on the increase. Ergo, Bitcoin should represent a vastly superior store of value over the long term than fiat currencies.

The problem is this: while the supply of bitcoins might be finite, the aggregate supply of digital currency as a whole, including Ethereum, Litecoin, and all the other variants, is potentially infinite. We have already seen the emergence not just of Ethereum, but a seemingly limitless number of new Bitcoin immitation currencies alongside a proliferation of so-called 'initial coin offerings'. It is therefore a clear fallacy that one is buying into a finite supply of the world's next global currency to be.

And why should we not have expected supply to mushroom in this way? Ethereum was created by a 21yo college dropout in his basemen at zero cost. If you can code a currency in your basement that subsequently ends up trading at an aggregate value of $40bn, then why on earth would you not do so? But this sort of alchemy can't last. One of the best measures of something's value is its replacement cost, and if a 21 year old can create a digital currency in his basement, it can't be all that hard. It is therefore reasonable to expect thousands and thousands of new coin offerings to emerge until the supply overwhelms demand and the prices of all of them crash.

This is the same dynamic that eventually contributed to the crash in 2000-02. The booming share prices of worthless dot-com start-ups incentivised investment bankers to bring as many new IPOs to market as possible as fast as possible. As they did, the supply of worthless scrip continued to grow and grow until it eventually overwhelmed what previously appeared to have been an insatiable degree of speculative demand. At that point prices started to fall, and then the psychology rapidly changed, with everyone simultaneously rushing for the exits. Prices crashed and most market participants were wiped out.

In the case of Ethereum, not even the supply of Ethereum coins is fixed. Instead, new coins are constantly issued to network participants that host the currency and process transactions. The platform is therefore ponzi in nature and relies on a continuing increase in coin supply (hardly something that speaks to the long term store-of-value utility of the currency). In Bitcoin's case, it is also unclear who is going to supply the computing power to host and process transactions once the entire 21m of bitcoins are 'mined out' - a potentially fatal ponzi element of the currency.

Central banks can indeed be faulted for willingly increasing the money supply to foster their inflation targeting goals (typically around 2% pa), not to mention having engaged in an irresponsible (in my opinion) degree of quantitive easing in recent years. However, the potential supply of digital currencies is infinite, and is growing faster than even the Venezuelan money supply. And anything whose supply is increasing exponentially will eventually see its price trend towards zero - particularly something where what you are buying is literally nothing more than ones and zeros on someone's server.

The second and related fallacy is the idea that if blockchain technology is indeed revolutionary and is eventually widely adopted as a means of processing payments, then existing digital currencies will end up having a lot of value. There is no reason to think that they inevitably will in my opinion, because as discussed, new currencies and blockchain platforms can be conjured at will. There is no reason existing financial institutions could not get together and launch and host their own blockchain platform, for instance. Blockchain might prove revolutionary for payments, and digital currencies might still end up being worth zero or something close to zero.

Thirdly, there is a fallacy that a digital currency can act as a reliable 'store of value'. It cannot, because all you are buying are ones and zeros on someone's computer, that have zero intrinsic value, and only have exchange value so long as somebody else is willing to buy them off you. A tulip in the midst of the 16th century tulip bubble had exchange value, but almost no intrinsic value, and buying a $10k tulip for its 'store of value' merits would have proved a very bad idea.

Because the only value digital coins have is their potentially ephemeral exchange value, they are therefore at constant risk of being rendered worthless if people are no longer desirous of holding them. This could happen for any reason at any time. In addition, prices are so volatile that they cannot reasonably function as even a reliable means of exchange for anything other than immediate transactions of trivial size. If you sold you house, would you agree to take settlement in six weeks time in Bitcoin or Ethereum? If you had done so with the latter several weeks ago, a house sold for say $1m would now yield only $500k. The degree of uncertainty as to the coins' future value over timeframes as short as even one to two months is too large for these coins to function as practical means of exchange.

It is true, of course, that fiat currencies also have no intrinsic value. However, that does not mean they are equivalent to digital currencies in any meaningful way, because (1) fiat currency is generally not held in large quantities as a store of value - it is held primarily for its transactional value; real wealth is usually held in stocks, bonds, real estate, etc; (2) cash deposits have the capacity to pay interest, so if inflation picks up, interest income can offset the inflation to some extent, preserving its real value; and most importantly (3) existing fiat currencies are in entrenched use (due to both  legislative monopolies, and network effects), and their medium term transactional value and widespread acceptance is therefore highly predictable. This cannot be said of digital currencies.

Fourthly, there is a fallacy in the idea that new currencies are needed to provide new payment systems/solutionsCurrencies and payment systems are not the same thing. The world does not need new currencies - what it needs is improved payments systems that are lower cost and more frictionless. They are already coming down the pike. Digital wallets and new and improved electronic payment systems are proliferating everywhere, from Apple Pay and Samsung Pay, to Alibaba's Ant Financial, which is growing like a weed. Even AirAsia is looking into launching a 10-currency digital wallet. This is the way of the future - cheap, frictionless, and widely adopted digital payment systems that utilize existing currencies, not new faddish digital currencies.

Getting a new payment system widely adopted is already extremely difficult, and getting a new currency adopted is even harder. It almost never happens. There is a good reason for that: our existing currencies and payments systems already do a reasonably good job. Physical cash works well for small payments - it is relatively frictionless and completely costless for users. Debit cards and credit cards also function pretty well, although the latter is more expensive than it needs to be and will probably remain longer term (interchange fees seem destined to be competed down in my view). Inflation rates are also low throughout most of the world at present, so existing fiat currencies are function very well as a store of value (and USD and other 'hard' currencies can be used as a substitute for official local currency in mismanaged developing countries with hyperinflation). Bitcoin is a solution looking for a problem that doesn't really exist, or certainly which can't be solved with the use of existing payment systems and currencies.

Lastly, the final fallacy is the idea that governments will allow a new global distributed-ledger currency to exist and enter into widespread usage without stringent regulatory oversight. This is extremely unlikely. Banks and the financial system are heavily regulated. Digital currencies are not yet similarly regulated because their use for anything other than speculation remains trivial, but if usage of digital currencies rises, they will likely be similarly regulated. Unfortunately, this would neuter a key part of digital currencies' value proposition - their distributed, decentralised nature.

The above fallacies have all been used to justify buying and holding digital currencies as an investment, or to rationalize what is really little more than thinly-veiled speculation. Unfortunately, none of these rationalizations bears scrutiny in my opinion, and I believe digital currencies to be nothing more than a faddish bubble.

That doesn't mean the currencies go to zero any time soon, or that speculation is irrational

The above, however, does not mean that the coins will inevitably go down from here, or indeed, will not rise significantly further before they go to zero. The market capitalization of Apple is about US$800bn. Bitcoin is 'only' about US$50bn (Apple of course produces US$50bn of free cash flow a year, whereas bitcoin is just worthless ones and zeros). There are trillions of dollars of bank deposits sitting idle that could flow into a speculative asset like Bitcoin, and history has shown that speculative extremes can reach levels that surprise most rational pessimists.

It is also not the case that speculation is necessarily irrational, contrary to what many believe. George Soros was the ultimate rational speculator, and said that the first thing he did when he saw a bubble developing was rush to buy. It is not irrational to speculate because you can only lose 100c in a dollar, but you potentially stand to make 5x, 10x, or 100x your money - at least temporarily - if you get in early enough and the bubble inflates significantly enough. There only needs to be a reasonable probability that a huge bubble develops for it to be a rational speculation. To some extent, this is the dynamic that drives bubbles - at least initially.

The smart speculator, however, knows what is going on, gets in relatively early, and knows that the boom will eventually turn to bust, and is therefore prepared for it (Soros liked to switch from long to short when he felt the market was rolling over, profiting from both the boom and the subsequent bust). Few people who speculate do this successfully; most get caught up in the hype, buy in late, end up averaging down as prices decline rather than selling/shorting, and end up selling at or near the bottom and losing almost everything.

I would counsel caution. But don't blame me if the coins double or triple on their way to zero.


(Have never owned any digital coins, and never will for investment/speculative purposes)


  1. Thanks 3K, great post, and very timely as the hardfork event scheduled for 1 August is risky for any holder of bitcoin and should hiccups occur the price may well head in the direction of your target price of zero.

    Despite that, your post is crying out for someone to play devil’s would be remiss of me not to oblige.

    I feel that the risk/reward case to owning bitcoin is as compelling now as it was earlier at significantly lower levels. That may sound counterintuitive, given the order of magnitude increase in the price in the past 2 years; more on that below.

    I’ve outlined some of my counter arguments to your analysis below.

    1. Thanks for taking the time Jimmy, and always appreciate a contrary perspective. Is a lot to address below but have responded to a few of your points. Cheers

  2. #bubble
    You argue that bitcoin (and other cryptos) are in a “bubble” or “speculative boom” and that the “man-on-the-street is bulled-up and buying” and that the “supply of new buyers is near exhaustion”.

    This is not an accurate assessment, in my opinion. Instead, there is clear evidence that ownership of bitcoin (or other cryptos) is NOT widespread and therefore, it is highly unlikely that we are in a ‘bubble’.

    Here’s a list of the people that DON’T own bitcoin (or other cryptos) to any great extent.

    * The Man-on-the-Street
    You and I have been having this discussion for a while now, yet we each know only one person personally that we are sure owns cryptocurrency. What’s more, the person you know and the person I know is the same person. So despite our interest in the space, collectively we personally know ONE PERSON who owns any cryptocurrency.

    There are a few reasons for this. Setting up an account is awkward, storing crypto safely is confusing and perhaps most importantly, getting one’s head around cryto-currencies/distributed ledgers/cryptographic proofs etc is challenging to say the least.

    What’s more, it’s not for lack of trying on my part. I’ve had proper conversations with scores of investors, bankers, high net worth individuals, gold bugs, software engineers, professional gamblers in the past couple of years. As far as I’m aware, none have taken the bitcoin bait.

    Not bubble material.

    * Institutions
    Almost no institution owns bitcoin (or other cryptos); As yet, there is no exchange-listed ETF or comparable vehicle by which an institutional investor can gain exposure (although some institutions have said they will invest as soon as there is an exchange-listed ETF).

    Not bubble material.

    * Very-high-net-worth individuals
    I was listening to a podcast interview this morning with the chairperson of Tiger21, an investment club of 500 members who between them account for $50 billion of investable assets. (Yes, there really is an investment club where the average member has $100 million to invest, collectively representing $50 billion, somewhat more than the entire bitcoin market cap). It’s members are typically people that have sold their businesses and have a) lots of money to invest, b) a high risk tolerance and c) time on their hands to research ideas.

    In the interview, the chairperson explained that they regularly survey their members about their holdings (e.g. real estate, hedge funds and public markets etc). He was asked about their bitcoin and cryptocurrency exposure. His answer:

    “(Bitcoin and cryptos) are still on the fringe, by which I mean if we have 500 members, my guess is that there are 10 or 20 who have really dug into the subject and are making select investments either in assets themselves or companies that are specialising in them.”

    On other words, even amongst that very select group of risk-hungry high-net-worth investors, only 2-4% have considered cryptocurrency exposure.

    Not bubble material.

    So who does own all the bitcoin out there? Because the Blockchain is transparent, we know how many wallets there are and how much each holds. Here are a couple of stats, courtesy of

    * 131,078 wallets own 10-100 bitcoin (equivalent to $25,000 to $250,000)
    * 18,243 wallets own more than 100 coins (equivalent to $250,000)

    Note that an individual can own more than one wallet, so we can summarise that there are less than 150,000 individuals globally that own bitcoin in any sizeable amount.

    For comparison, I read recently that French listed oil company TOTAL has 450,000 shareholders.

    Not bubble material.

    In conclusion, there is without doubt plenty of media hype, but due to limited broadscale exposure, little evidence to support an argument that we are in a ‘bubble’. It’s more likely that we remain in the ‘early adopter’ phase of a new technology’s life cycle.

    1. Fair criticism. It is possible that the bubble has a long way to inflate yet before it turns to pumpkins and mice. I did mention that there are trillions of bank deposits on the sideline & the market caps are still small relative to other assets like Apple.

      However, I think you're setting the bar quite high here. Many financial asset bubbles peak well short of 'everyone' owning something. But your point it taken.

      Use of bitcoin to evade exchange controls in places like China etc could be another source of unexpected demand.

      Again, if you want to speculate, go ahead. Like I said in the post, its not irrational to do so. But it's a speculation and nothing more in my view - not an 'investment'.

  3. #bitcoin v. altcoins/ICOs
    You argue that “while the supply of bitcoin might be finite, the aggregate supply of digital currency as a potentially infinite” and that it is “clearly a fallacy that one is buying into a finite supply of the world’s next global currency to be.”

    The weakness in that argument is that fiat currencies suffer the same potential ‘weakness’. You and I can create “Lyall dollars” and “Jimmy dollars” and issue as many of them as we like. However, our issue of our own funny money doesn’t detract from the value of USD/EUR/GBP/NZD/IDR or other fiat currencies, as there are various network effects at play: Those established currencies have a proven track record and it is more convenient and safer for consumers to transact in one of the widely-accepted and officially backed fiat currencies rather than our funny money.

    For this reason, I’m hopeful that bitcoin might succeed as a store of value due to first-mover-advantage and network effects, while I’m less optimistic on other altcoins, which I agree may be in a ‘bubble’. First, bitcoin is of finite supply, in stark contrast to fiat money and the altcoins. Second, it has an 8 year history as a #storeofvalue (see below), which may give it longevity.

    1. If I created "Lyall bucks" physical notes they would be worthless. But if I created digital Lyall-Coins today and undertook a initial coin offering, someone might buy them. That makes no sense. They are both equally worthless.

      Yes, fiat currencies have potentially unlimited supply as well. And look what happens to their value when the supply goes up. Weimer Republic? You're destroying your own argument for owning digital coins here by analogizing fiat currencies. Fiat currencies have always been terrible investments and will probably remain so.

      On your last part, the problem again is that Bitcoin today as a means of exchange is zero or very close to zero, and the barriers to entry to creating a new currency in widespread acceptance are extraordinarily high. By far the most likely outcome is therefore that Bitcoins go to zero. There is a small (vanishingly small in my view, but small nonetheless) chance that Bitcoin does eventually achieve widespread acceptance, I agree. You may make some money if this happens. But this makes it a moonshot speculation, not a 'store of value' (to address one of your other arguments here as well).

  4. #fiat v. bitcoin
    You argue that “a digital currency cannot act as a store of value because all you are buying are ones and zeros on someone’s computer, that have zero intrinsic value.”

    That’s an exact description of your bank balance! You deposit/transfer your hard-earned funds to Citibank, which then updates a ledger to reflect your deposit, and displays your balance back to you as ones and zeros on a computer screen.

    Just like bitcoin and other cryptos, your bank balance doesn’t exist other than as an entry in a ledger and as ones and zeros on a screen. It has no intrinsic value. Citibank does not store a pile of banknotes in a vault, held together with a rubber band and a Postit note marked ‘Lyall’s money’.

    To summarise, your bank balance and your bitcoin have more in common than you realise.

    Bank balance at Citibank:
    * Doesn’t exist, other than as a ledger entry and as ones and zeros on a screen.
    * Recorded on a ledger maintained by Citibank.
    * Backed by government guarantees and the good reputation (?) and long trading history of Citibank.
    * At risk should Citibank go bust, at risk from confiscation by Citibank through arbitrary fees, at risk from government confiscation.
    * Real value at risk from unlimited central bank money printing and reckless government policy making (e.g. British savers have seen their European purchasing power decline by over 20% following recent government policy recklessness).
    * Can be used to buy real goods (e.g. through using credit card linked to bank account).

    Bitcoin holding:
    * Doesn’t exist, other than as a ledger entry and as ones and zeros on a screen.
    * Recorded on a distributed ledger (the Blockchain).
    * Backed by a cryptographic proof and track record of security (8 years, zero hacks).
    * At risk should bitcoin be hacked, should governments regulate and/or ban, or if should fade from use.
    * Real value protected through finite supply of 21 million coins.
    * Can be used to buy real goods (e.g. through selling for fiat on exchange, transferring fiat to bank account and using credit card linked to bank account, although there are now prepaid debit cards available that take the bank out of that loop).

    1. Hi Jimmy,

      Thanks for your detailed thoughts.

      There was a full paragraph in the post addressing this point - see below:

      "It is true, of course, that fiat currencies also have no intrinsic value. However, that does not mean they are equivalent to digital currencies in any meaningful way, because (1) fiat currency is generally not held in large quantities as a store of value - it is held primarily for its transactional value; real wealth is usually held in stocks, bonds, real estate, etc; (2) cash deposits have the capacity to pay interest, so if inflation picks up, interest income can offset the inflation to some extent, preserving its real value; and most importantly (3) existing fiat currencies are in entrenched use (due to both legislative monopolies, and network effects), and their medium term transactional value and widespread acceptance is therefore highly predictable. This cannot be said of digital currencies."

      I'm of course aware that fiat currency also has no intrinsic value and is also for the most part purely digitally rendered. But that does not make Bitcoin et al equivalent to existing fiat currency, because the latter is already in widespread entrenched use and the former is not.

      It's a bit like saying one company is exactly the same as another company in legal form and so they are both worth a lot. But one company might be Apple and there other might be a worthless shell.

  5. #storeofvalue
    You make the argument that bitcoin has had limited utility as a payment tool. I agree entirely; someone who bought a TV using bitcoin 12 months ago will be reluctant to repeat the experience, given opportunity cost of spending rather than hoarding bitcoin.

    However, as a store of value, bitcoin has had very high utility in the recent past.

    Yes, the price of bitcoin has gone up against fiat currencies. But that’s not the full story. The bottom line is that bitcoin has proved a remarkable SECURE form of saving. Eight years have now passed without a single hack of the software (exchanges have been hacked, but not the underlying software).

    For every day that passes without a hack, government regulation or some other disaster, the utility of bitcoin as a store of value increases. Why is this? There is a derisking process taking place:
    If bitcoin was hackable, it would probably have been hacked by now.
    If governments were to regulate/ban, they probably would have done so by now.
    If bitcoin were to fade from public consciousness, it probably would have done so by now.

    Think of it this way: Two years ago, the sun would go up every morning and a $4 billion honeypot would be waiting for any hacker who is able to break the bitcoin code. Now, the honeypot is still there, but it is $40 billion. 8 years and counting, still no hacks. Bitcoin’s security reputation is growing.

    Similarly, more and more governments are clarifying bitcoin’s legal status, Japan, India and Australia most recently. Regulatory risks are on the decline.

    Moreover, bitcoin has not faded from public attention over that period. In 2015, bitcoin was absent from the mass media and people would ask “is that still a thing?”. Now, it’s all over the media and while few people own cryptos or other currencies, the masses definitely know that “it’s still a thing”.

    So price aside, bitcoin in 2017 is significantly less risky from the perspective of security, regulation and public relevancy than it was in 2015. For this reason, I feel that the risk/reward case at $2,500 in 2017 is more or less equivalent to what it was at $250 in 2015, but that’s purely an opinion based on my gut instinct.

    1. Using the past tense & the fact that Bitcoin to date has proved to be a good 'investment'/'store of value' is fallacious. The same can be said of anything that has gone up in the past. was a great store of value for a while on this basis.

      To be a good store of value, you have to be confident that if you went away to a dessert island and came back in 20-30 years, that the asset in question is likely to have maintained its real purchasing power.

      It is possible that will happen with Bitcoin, but unlikely in my view, and it is probable that you will come back and it will be worthless.

      Something that could be so easily rendered worthless cannot sensibly be considered a good store of value. A good speculation perhaps, but not a good store of value.

  6. #skepticism
    In the case of bitcoin, there is deep skepticism in abundance. I’m not keeping a list, but I’ve noticed almost all the ‘experts’ that I follow have dismissed bitcoin as a bubble:

    Lyall Taylor ‘going to zero’
    Warren Buffett ‘it’s a mirage, stay away’
    Martin Katusa ‘worthless, buy gold instead’
    Frank Curzio ‘bubble’
    Morgan Stanley ‘monopoly money’
    Howard Marks ‘unfounded fad, all the fault of millennials’
    Andrew Horowitz
    Med Faber
    Peter Schiff

    In fact, none of the market ‘experts’ in my universe are on board on when it comes to bitcoin.

    Why is this a cause for celebration? Because abnormal returns requires a starting position of deep skepticism from the so-called experts.

    Case in point: Amazon AMZN. Following the dotcom bust, the share price of AMZN collapsed by 90-odd percent. What were the ‘experts’ saying when the share price was around $5? Were they telling investors that this was a once-in-a-lifetime opportunity to buy a great company at a bargain basement price? No....they were downgrading recommendations en masse, telling investors to SELL, that AMZN was facing a liquidity squeeze and was on the verge of going to go out of business, that it had a negative net worth, that the convertible bonds were a SELL at 45 cents on the dollar.

    Look to this CNN article for a selection of downgrades and bearish comments following positive numbers (!) from AMZN from Goldman Sachs, Salomon, Credit Suisse and others:

    Ironically, it was Lehman Brothers that was at the forefront in predicting AMZN’s imminent demise.

    So what’s happened since then? AMZN’s share price has increased 200-fold (a life-changing result for anyone prepared to look through the skepticism of market experts) and Bezos as emerged (for a brief period this week) as the world’s richest man.

    1. Just because a lot of 'experts' hold an opinion doesn't necessarily make it wrong. The counterintuitive outcome of the consensus expert opinion often being wrong in financial markets comes from well understood phenomena being overly rendered in prices and the capacity for change under-estimated, not from basic facts being misunderstood.

      Furthermore, a lot of the people you list there are a small subset of investors known for their contrarianism.

      Any comparisons with Amazon are a straw man. There is absolutely no relationship or analogy that can be drawn between a company providing goods and services in the real world and digital currencies. None.

  7. #dotcom
    You raise the dotcom bust as evidence that bitcoin (and other cryptos) are heading to zero. I see it differently: The boom was a reflection of a new paradigm and the subsequent meltdown provided the opportunity to sift through the ashes to find the pearls. Witness the parallels between AMZN and bitcoin: Each suffered a 90% fall and subsequent recovery.

  8. #Dunning-Kruger
    Is it feasible that all the experts can be wrong? Yes, and it has a name. It’s called the Dunning-Kruger effect, defined (according to a paper published in the Journal of Personality and Social Psychology in 1999) as:

    “cognitive bias where persons of low ability suffer from illusory superiority, mistakenly assessing their cognitive ability as greater than it is.”

    Are these ‘experts’ dismissing bitcoin as a bubble of ‘low ability’? No, not generally...they are probably all of well-above-average intelligence and as experienced market professionals they think that they can recognise a bubble when they see one.

    However, when they make their arguments that bitcoin is a bubble, I marvel at their lazy analysis of a complex issue. I get the distinct impression that as a group, the people on the list I outlined above have not read a single book on the subject, have never owned bitcoin (or any other crypto), nor read the Satoshi whitepaper. While ‘expert’ in the world of conventional finance, they are of ‘low ability’ (in the Dunning-Kruger sense) when it comes to the world of cryptocurrencies.

    Dunning-Kruger involves a number of phases to be negotiated:
    1. I once was blind but now I see.
    2. Hmmmm there’s more to this than I thought.
    3. Oh man, I’m never going to understand this.
    4. Oh, it’s starting to make sense.
    5. Trust me, it’s complicated.

    I suspect that most so-called ‘experts’ are still in Dunning-Kruger phase 1-2 as it relates to crypto-currencies.

  9. Finally, I realise that I’ve rambled extensively in responding to your various points, without clearly outlining why I’m enthusiastic about the ‘reward’ side of the risk/reward case. That will have to wait for another day, but here it is in a nutshell:

    **I think that bitcoin has potential as a store of value that may prove to be highly secure, is protected against inflation due to its finite-supply-by-design and allows for transactions to be conducted on a near costless basis.**

    Yes, it’s risky! But still, who wants to risk missing the next AMZN? Own a little bitcoin in your portfolio, just in case!

    1. On your last para, it is this type of thinking that results in most people being terrible investors in my view. People are always chasing the next big thing; the massive home run; stalking the dragon so to speak. They swing for the fences and usually get struck out.

      At base, it is just another manifestation of people wanting to get rich quick without doing a lot of hard work.

      A better approach is to invest with consistency and discipline over time, and make unremarkable but consistent profits. I've talked about a handful of such stocks on my blog already - Beijing Airport for instance was trading at a 9% FCF yield earlier this year. It's since up more than 50%. You don't need to be a hero. You need to invest sensibly with consistency and discipline.

      I wish you luck. You'll need it in my view, but you might make some money. I'm happy to leave the moonshots to others.

  10. Great post Lyall, thank you! I know a lot of millenials investing in these currencies at the moment. It suits their believe of "making profit now" or "being successful now" perfectly. Millenials believe in hype, not hope. They want things now! Ordinary stocks or commodities is not exciting. It almost convinced me to do the same thing (i am also a millenial :P). The reason i didn't was for the simple fact that you can only buy other currencies by use of bitcoins. In opinion, this explains the risen prises of bitcoins since everyone needed them for their other "fast profitable" cryptos. That's what pushed the price of the bitcoin. Finally, one big argument for cryptos is an overall lower transaction cost. For this reason it never can happen that cryptos will climb up much as selling/buying them is always accompanied with a small change of the current price. In my eyes this small change can never beat current costs or frictions.. I don't have much knowledge about investing but i believe everyone should invest. I wonder if you agree with my views. All the best buddy! greetings from Bali.

    1. Thanks Koen,

      The get-rich-quick instinct is powerful in people. It gets rationalized away, but really what people want to do is find the 'next big thing' that will make them rich without a bunch of work. Digital coins are the latest shiny new thing promising effortless riches. It will end badly for most market participants in my view.

      The transaction costs with cash are already zero and for debit-card transactions and online banking already at or very close to zero. Digital wallets are coming that will be close to zero cost. New currencies will not be needed for new payment solutions.

      Hope you're well.


  11. Heyy, Awesome Post .. Keep It Up!

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  15. I like your term "rational pessimist". Reminds me of George Bernard Shaw's quote: "The power of accurate observation is called 'cynicism' by those who do not have it."

    Revisiting Bitcoin in light of its recent run-up. I agree with just about everything you write but also believe that one thing that is different now than at prior moments in history is a widespread distrust of governments, and whether rational or not, bitcoin represents a to many people a trustworthy currency and therefore a life raft that will get a lift during bumpy times, like what is happening today with the stock market drop due to the China tariff squabble. Ironically, of course, hardly anyone understands blockchain (including myself) or why it should be trusted, but are willing to accept that people smarter than them (and myself) have vetted it. It seems to me that it might make sense to hold some bitcoin as a hedge against the possibility that there is a crisis of confidence in a major fiat currency(its), because it would seem that these days this is to where a lot of money might flee. Indeed, I was thinking about that a few weeks ago when bitcoin was in the $3K range, and now after the China tariff market selloff, it has doubled. Whether that's due to large number of people buying, or some manipulation, who knows. With such dysfunction in Washington, a narcissistic moron for a president, and a national debt that seems to keep going up and up, it is hard for me to discount what seems like the real possibility of a crisis in the dollar, and I'm not sure what to do about it.

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