I don’t know about you, but I love a good cryptocurrency note that finds analysts attempting to develop a model to value something that has no value.
Bitcoin and its progeny are worthless. They have no intrinsic value and as Jack Bogle reminded investors last year, “Bitcoin has no underlying rate of return” and as such, “there is nothing to support bitcoin except the hope that you will sell it to someone for more than you paid for it.”
Right. It’s the greater fool theory of investing taken to its logical extreme which, almost by definition, means it’s pure, unadulterated speculation.
Bogle, speaking last November at a Council on Foreign Relations event in New York, added the following piece of advice for good measure:
Avoid bitcoin like the plague. Did I make myself clear?
Crystal, Jack. Crystal.
Well as it turns out, Bogle isn’t the only one who thinks Bitcoin and cryptocurrencies should be likened to “the plague.”
In a highly amusing new note, Barclays’ Joseph Abate asks if it makes sense to think about Bitcoin prices in the context of “compartmental models of the spread of an infectious disease in epidemiology.”
“Like the infection analogy, the population divides into three groups: ‘susceptible’ individuals who are vulnerable but not yet infected; ‘infected’ individuals; and those who are ‘immune’,” Abate writes, adding that “like infection, transmission — especially to those with ‘fear of missing out’ — is by word-of-month, via blogs, news reports and personal anecdotes.”
He begins with an “asset” (and I use that term extremely loosely) with an unknowable long-term fundamental value that’s concentrated initially in the hands of a small number of people – those people are “the infected”.
He then divvies up the rest of the population into those who are ‘susceptible’ and those who are mercifully ‘immune’ to speculating in something that’s worthless. Here’s more from Abate:
The characteristics of our theoretical model are as follows:
- The crypto currency is assumed by all agents to have a long-term fundamental value, but the value is unknown, as is the time until it is reached.
- Initially, only 0.1% of the population holds the asset and is the source of supply. Their willingness to supply (sell) the asset is positively related to past selling (persistence), inversely related to expected future prices (speculative inventory behaviour) and subject to randomly generated shocks.
- New entrants (buyers) are not existing holders and are drawn from the portion of the total population that is susceptible to the ‘fear of missing out’ speculation. We assume this is 25% based on survey evidence. Their decision to buy the asset is a positive function of previous buyers (persistence), expected future prices (speculation), and randomly generated shocks.
- Some portion of the population is immune and will never buy the asset.
- Expected future prices of both holders and new buyers are a weighted average of the extrapolated exponential trend in recent prices and the most recent price. The weight on the former decreases with time and the weight on the latter increases as it is assumed that prices get closer to the long-term fundamental value as time passes.
- Prices are a function of the ratio of new entrants (buyers) to exits (sellers).
He then plots Bitcoin’s actual price trajectory against his model and the bottom line seems to be that like any “good” disease, it will eventually exhaust itself as the population of potential “hosts” decreases. To wit:
Word of mouth spreads and creates more new entrants (or ‘infections’). As more of the population become asset holders, the share of the population available to become new buyers — the potential ‘host’ population — falls, while the share of the population that are potential sellers (‘recoveries’) increases. Eventually, this leads to a plateauing of prices, and progressively, as random shocks to the larger supply population push up the ratio of sellers to buyers (Figure 5), prices begin to fall. That induces speculative selling pressure as price declines are projected forward exponentially. Analogously, this occurs with infectious diseases when the immunity threshold is reached; ie, the point at which a sufficient portion of the population becomes immune such that there are no more secondary infections.
So the implication here (and it’s actually more than an implication – if you read the full note it’s spelled out explicitly) is that once the saturation point is reached in terms of awareness/willingness to infect oneself, the rally will simply stop.
At that point, buyers become sellers and that will, in Abate’s words, “initiate a downward spiral.”
And you know, you’d be forgiven for thinking that maybe we’re already there:
For Abate, this time is indeed different in terms of whether Bitcoin has the capacity to bounce back and make new highs and the reason this time is different is derived from the considerations laid out above – namely, awareness has peaked and the potential for further “infection” is thus limited.
On that note, we’ll leave you with his concluding remarks:
Past peaks in Bitcoin in 2011, early 2013 and late 2013 were followed by collapses in price of 93%, 70% and 86%, respectively, before recovering and advancing to new highs. But in each of those cases, awareness was relatively low and the potential for new entrants consequently was high. The above survey evidence suggests this is no longer the case: 1) most potential ‘hosts’ (Bitcoin investors) in developed economies already are aware of Bitcoin (have been exposed to the ‘virus’); 2) only a small share of developed populations are susceptible to speculation (‘infection’); and 3) the falling ratio of current to prior holders suggests a rising ‘recovered’ share of the population. As a result, we believe the speculative froth phase of crypto currency investment — and perhaps peak prices — may have passed.