Newcomers to Heisenberg may not be aware of this, but when I call something “absurd” or “insane” or “ridiculous”, it comes from someone (me) who is a recognized authority on the subject.
Anyone who has ever known me personally can tell you at least one (and in most cases at least a half-dozen) stories about things I’ve said or done that would qualify as “absurd”, “ridiculous” or outright “insane.” One former friend who only knew me for a very short time described me as “disturbed”. He was right. But really, he didn’t know the half of it. If he had talked to anyone who knew me for longer than 12 months, he would have quickly understood that his assessment was easily a candidate for “understatement of the year.”
One day, I’ll regale readers with tales of Heisenberg’s adventures beyond the ones you already know about the sake bars and the Albanian women and the drinking myself into the ICU. Unfortunately today is not that day and I can’t say for sure when that day will come, but take it from me, Heisenberg is a guy who knows “absurdity” and “ridiculousness” and abject “insanity” when he sees it, and that’s in part why I spent the better part of the last year telling you that short vol. doomsday vehicles like XIV were bound to collapse.
But here’s the thing. I’ve got to tell you that I don’t think I have ever witnessed anything that is as absurd/insane as the cryptocurrency mania. And when I say that, I am including in that assessment situations I’ve been in that were literally life and death. In one sense, risking one’s actual life in the service of something other than maybe rescuing a family member from extreme peril or saving the life of your dog is the most absurd thing one can do. That said, when you’re evaluating the relative insanity of a behavior or a situation, you also have to consider the risk-reward tradeoff and also whether what you’re doing makes any sense whatsoever.
On the former point (i.e. the risk-reward tradeoff), I would argue that some of the crypto riches stories I’ve read make some measure of sense. Take for instance the story of Eddy Zillan, profiled on Wednesday in a piece for Business Insider. Here’s Eddy with his i8:
Long story short (and actually the story isn’t really that long in the first place), Eddy started buying cryptocurrencies when he was 15 and ultimately he became a millionaire. Now he’s running an advisory service that features a picture of a private jet next to three BMW 6s on the homepage. Here’s how Eddy got rich (via the BI article linked above):
When Eddy Zillan started trading in cryptocurrencies three years ago, he was 15 — too young to open an account on the trading platform Coinbase, which requires its users to be at least 18 years old.
But Zillan glossed over the site’s terms of agreement and opened an account on Coinbase and another trading platform called Kraken, cautiously purchasing $100 worth of the cryptocurrency ether.
Before long, Zillan had invested a total of just over $12,000, the entirety of his savings from teaching tennis lessons, along with a tidy nest egg he’d received from gifts and his bar mitzvah a few years earlier.
“I risked everything,” he said.
Ok, I mean sure, Eddy risked “everything”, but when “everything” is $12,000, I would argue that the risk-reward there makes that a decision that doesn’t really qualify as “insane” – especially when you’re still living with your parents which, according to the article, Eddy was. Additionally, BI says both his parents are “wealthy business people.” So I mean, what’s the worst that could have happened? He loses $12,000. So what?
On the other hand, other crypto investment stories I’ve read make no sense whatsoever. Buying Bitcoin on a credit card when it’s trading near $20,000 (which some people apparently did) and has just surpassed the tulip mania to become the largest bubble in recorded history is absurd. In fact, it’s beyond absurd. It’s flat out insane.
But while there is a spectrum when it comes to the evaluating whether the risk-reward calculus that goes into a decision to trade cryptocurrencies can be characterized as nuts, there is no such ambiguity with regard to whether this whole movement makes any sense. It doesn’t. Just think about what it is that people are doing. They are betting (figuratively and literally) that digital tokens backed by absolutely nothing, guaranteed by absolutely no one, and regulated by that same no one, are going to supplant fiat money on the way to effectively forcing governments to cede their monopoly on money to a decentralized network populated by anonymous netizens.
It is so wildly far-fetched that it eludes attempts to properly lampoon it. It is its own joke. And the people who try and make of it anything other than it is (a vehicle for speculation that, if you’re lucky and got in early, might buy you an i8), end up doing things that are objectively insane.
Indeed, the rush to capitalize off the digital gold rush has spawned some of the most ridiculous ideas I have frankly ever heard, including Mike Novogratz’s plan to start a crypto merchant bank and list it on the TSX via a convoluted plot to buy a crypto startup, conduct a reverse merger with a Canadian pharmaceutical shell company, rename the combined entity “Galaxy Digital Holdings”, and raise $200 million in a private placement. And then there’s the group of crypto entrepreneurs who are right now, this second, getting drunk on the roof of an abandoned monastery in Puerto Rico where they intend to build what they’re calling a crypto “utopia”.
(From the New York Times “Making a Crypto Utopia in Puerto Rico“)
That kind of shit right there is stone-cold crazy. It’s absurd, ridiculous, insane, and the people involved in it need to take a step back and try to kind of reevaluate their mental state because clearly, they have gotten so caught up in this mania that they’ve become detached from anything that even remotely approximates reality.
Of course reality has a way of reasserting itself and over the past two months, that’s what’s happened. A relentless stream of bad news has helped drive Bitcoin from the peak at $20,000 in December all the way down to below $6,000 in Coinbase pricing on Tuesday.
It’s against this rather surreal backdrop that Goldman is out with an expansive piece called “Is Bitcoin A (Bursting) Bubble?” (it’s the latest installment of their “Top Of Mind” series). It would be impossible to do the piece justice in a blog post (even a long one), so what I’ll do instead is simply excerpt a few passages from an interview the bank’s Allison Nathan conducts with Goldman’s head of Global Investment Research Steve Strongin. To wit:
Allison Nathan: Do cryptocurrencies have intrinsic value?
Steve Strongin: Like all fiat currencies, cryptocurrencies really don’t have intrinsic value. But that doesn’t mean that people won’t treat them as if they do, and sometimes for sustained periods of time. In fact, people have throughout history accepted things that have no value in exchange for things that do. Examples of non-government-issued currencies being used for periods of time include playing cards in the French colonies in the 18th century and limestone discs on the island of Yap centuries ago. What this means in practice is that even if a currency doesn’t have intrinsic value, it could still be used for some period of time.
Allison Nathan: Will cryptocurrencies survive?
Steve Strongin: Whether any of today’s cryptocurrencies will survive over the long run seems unlikely to me, although parts of them may evolve and survive. They really are the first “modern” experiments in blockchain technology and in cryptocurrencies. To my eye, they still seem too primitive to be the long-term answer. Aside from the fact that many cryptocurrencies have slow transaction times today, there are also challenges in safely storing the associated data, and maintenance requirements can be significant. Given the innovation that would be required to address these problems, it would be surprising—though not impossible—to see existing cryptocurrencies have real staying power in their current form. Ultimately, I think new cryptocurrencies will emerge but of course time will tell. As it relates to the underlying technology—blockchain or some successor to it—there is a great deal of hope that it will prove useful in a variety of ways. That may be true, but if the technology does survive, it may eventually look quite different than it does today.
Allison Nathan:What about the argument that first mover advantage makes the earliest cryptocurrencies—like bitcoin—more likely to survive?
Steve Strongin: The idea of a “first mover advantage” in any industry seems a bit archaic today. In fact, examples of modern day first mover advantages are actually hard to find. The very first web browser and search engine, for example, are no longer in existence. So if being the first mover is an advantage at all today, it doesn’t seem to be a deep or sustainable one. In the case of cryptocurrencies, the strong price movements in dozens of them—not just the first one—suggest that even the broader market hasn’t chosen a clear “winner.”
Allison Nathan: Is the market accurately pricing the likelihood that several—if not most—of the current cryptocurrencies will ultimately fail?
Steve Strongin: I don’t believe it is. People seem to be trading cryptocurrencies as though they’re all going to survive, or at least maintain their value. The high correlation between the different cryptocurrencies worries me. Contrary to what one would expect in a rational market, new currencies don’t seem to reduce the value of old currencies; they all seem to move as a single asset class. But if you believe this is a “few-winners- take-most” situation, then the potential for retirement depreciation should be taken into account. And because of the lack of intrinsic value, the currencies that don’t survive will most likely trade to zero. This is actually an important distinction between cryptocurrencies and fiat currencies; if a government decides to phase out a currency, it will typically determine a residual value for that currency and exchange that currency for a replacement one. But here the ability to merge older cryptocurrencies with newer, better ones—and the incentives for the eventual winners to offer a residual value for the retiring currencies—appears very limited. The market does not seem to be taking this risk into account.
Allison Nathan: Has recent price action in cryptocurrencies been indicative of a bubble?
Steve Strongin: I think so. At least at the moment, cryptocurrencies are not tied to the creation of economic value in the way that equities, for example, are tied to earnings growth over time. Rather, the way cryptocurrencies seem to be valued today is based on what people might pay for them tomorrow, which is almost the definition of a bubble. Even if someone were to believe that blockchain technology will one day change the world, they would be hard-pressed to come up with a fundamental reason to explain why the price of cryptocurrencies increased many times over and then halved in a very short period of time; this volatility is indicative of speculative behavior.
In hindsight, this period will probably end up looking like the internet bubble of the late 1990s. Very few companies that existed then went on to become even more valuable. Amazon did—but in a completely different form. Google—a big winner today—had only just been formed at the time. And numerous other search companies existed but they were unable to create value and ended up disappearing.
Full disclosure, Goldman’s tone is generally measured and professional throughout the note. Again, those excerpts are from an expansive piece that’s 26 pages long and they are by no means attempting to deep-six the market by effectively writing it out of existence.
And yes, Goldman has explored the possibility of getting into cryptocurrency market making, a tacit admission that while they may not generally think the market is viable, they aren’t simply going to sit by and not try to capitalize.
All of that said, I can say explicitly what Goldman can’t. These things are going to zero. Period. If government intervention doesn’t get them, any of the myriad considerations mentioned above and variously discussed in these pages (see our archive here) will.
For those interested, Goldman includes the following useful annotated visual history of the Bitcoin bubble:
One last thing we would say here is that recently, Deutsche Bank compared cryptocurrencies to the short vol. trade, even noting that increasingly, Bitcoin is correlated with the VIX. Cryptocurrencies, Deutsche says, have effectively supplanted short vol. as the “new frontier in risk taking.”
Well, in case you didn’t notice, the short vol. trade blew up on Monday. And with that, we’ll leave you with one final chart to ponder…