(the original analysis is authored by Charles Hugh Smith via OfTwoMinds blog)
Just a couple of days ago we caught off a nice graph on Twitter.
It was 2014 when I was first speculating about the price of Bitcoin when the price was close to $700 which had recently risen from $100 in just a couple of months. I was having a beer with a nice lady (who used to work with Indiabulls at that time) and was good with numbers and finance at one of the swanky pub-cum-cafe’s in Mathuradas Mills in Mumbai famously known as Cafe Zoe. Hell how could I have not entrusted her with the projection of a financial instrument while she was dealing with a heap of numbers everyday on the real estate and home loan market of the entire western region of India! I was looking for answers from everyone, potentially from every other person who seemed to me was doing something right in their life (read: was rich and affluent)! Being in top notch advertising firms of the world and having a network of clients who used to work with Fortune 500 brands, I would always ask my peer and work friends’ opinions on Bitcoin. And the answer was unanimous across, STAY AWAY from such a highly speculative market! When I look back now I realise I was looking for external validations from all the tradionalists. Respectfully some are my good friends, good work friends, clients who became beer buddies, etc. but they were all traditional in opting for their personal finance options. It took me two years to realise where was I standing in this crowd.
From a lifecycle perspective we are right now in the zone of “Peak of Inflated Expectations” and we are way beyond the “Mass Media Hype Begins” stage and this is with respect to what’s currently happening in India. I’d still stay that I’m an “Early Adopter” and there is so much to see in this year itself. Markets will explode with more products and services cause you know what, estimated numbers indicate that nearly 10,00,000 Indians have at least bought a part,if not full, of Bitcoin. Holding coins is good to acquire the appreciation in the price but is there an outlet currently for the same? Currently there is a single outlet, you could cash it out in your bank (via Netbanking) in case you are trading with Indian exchanges. Across the world the market has expanded to Bitcoin ATMs, Prepaid Debit Cards wherein you transfer Bitcoins and you can cash out the fiat currency from an ATM or use it at a merchant POS just like a Visa or MasterCard, Bitcoin Lending has started happening in Peer-2-Peer finance,etc. among the most important feature of it as a tool of remittance. 2018 will most likely see India expanding in the similar direction (waiting for a favorable response from the Indian government).
Coming back to the tradionalists. Why most of the people are asking us, you and I to stay away from such a product which is growing at a rate of 20% MoM in the last 6 months itself. You see the primary dynamic is continued skepticism from the mainstream, which owns essentially no cryptocurrency and conventionally views bitcoin and its peers as fads, scams and bubbles that will soon pop as price crashes back to near-zero.
Skepticism is always a wise default position to start one’s inquiry, but if no knowledge is being acquired, skepticism quickly morphs into stubborn ignorance.
Bitcoin et al. are not the equivalent of a freebie which you received from Big Bazaar. Cryptocurrencies have utility value. They facilitate international payments for goods and services.
The primary cryptocurrencies are not a scam. Advertising a flawless Fitbit and shipping a defective Health Tracker from Karol Bagh is a scam. Advertising a mortgage-backed security as low-risk and delivering a guaranteed-to-default stew of toxic mortgages is a scam.
The primary cryptocurrencies (Bitcoin, Ethereum and Dash) have transparent rules for emitting currency. The core characteristic of a scam is the asymmetry between what the seller knows (the product is garbage) and what the buyer knows (garsh, this mortgage-backed security is low-risk–look at the rating). Does this sound familiar to you, how about buying LIC as an investment product from your neighbor?
Both buyers and sellers of primary cryptocurrencies are in a WYSIWYG market: what you see is what you get. While a Virus Attack (recently: Ransomware) might use cryptocurrencies as a means of exchange, this doesn’t make primary cryptocurrencies a scam or a culprit, any more than using rupees to transact a scam makes the rupee itself a scam.
Bubbles occur when everyone and their sister is trading/buying into a “hot” market. Bubbles pop when the pool of greater fools willing and able to pay nose-bleed valuations runs dry. In other words, when everyone with the desire and means to buy in and has already bought in, there’s nobody left to buy in at a higher price (except for central banks, of course).
At that point, normal selling quickly pushes prices off the cliff as there is no longer a bid from buyers, only frantic sellers trying to cash in their winnings at the gambling hall. While a few of our contributors at Bitcoin Wiser own/use the primary cryptocurrencies, and a few speculate in the pool of hundreds of lesser cryptocurrencies, I know of only one friend/ relative /colleague / neighbor who owns cryptocurrency.
When only one of your circle of acquaintances, colleagues, friends, neighbors and extended family own an asset, there is no way that asset can be in a bubble, as the pool of potential buyers is thousands of times larger than the pool of present owners.
If you have reached until this point in the article, now it’s going to get a bit more technical and mathematical in approach. Stay with me for a while to unlock the secret sauce of forecasting the price of cryptocurrency.
To understand the effect of the entire pool of people who would transcend the borders of traditional financial instruments and have a subsequent result on the price of the Bitcoin we need to visit The Network Effect as expressed mathematically in Metcalfe’s Law: the value of a communications network is proportional to the square of the number of connected devices/users of the system.
The Network Effect cannot be fully captured by Metcalfe’s Law, as the value of the network rises with the number of users in communication with others and with the synergies created by networks of users within the larger network, for example, ecosystems of suppliers and customers.
In other words, the Network Effect is not simply the value created by connected users; more importantly, it is the value created by the information and knowledge shared by users in sub-networks and in the entire network.
This is The Smith Corollary to Metcalfe’s Law: the value of the network is created not just by the number of connected devices/users but by the value of the information and knowledge shared by users in sub-networks and in the entire network.
In the context of the primary cryptocurrencies, the network effect (and The Smith Corollary to Metcalfe’s Law) is one core driver of valuation: the more individuals and organizations that start using cryptocurrencies, the higher the utility value and financial value of those networks (cryptocurrencies).
In other words, cryptocurrencies are not just stores of value and means of exchange–they are networks.
The true potential value of cryptocurrencies will not become visible until the global economy experiences a catastrophic collapse of debt and/or a major fiat currency. These events are already baked into the future, in my view (you should probably check out the Youtube channels of Mike Maloney and Andreas M. Antonopolous) ; nothing can possibly alter the eventual collapse of the current debt/credit bubble and the fiat currencies that are being issued to inflate those bubbles.
The skeptics will continue declaring bitcoin a bubble that’s bound to pop at $3,000, $5,000, $10,000 and beyond. When the skeptics fall silent, the potential for a bubble will be in place.
When all the former skeptics start buying in at any price, just to preserve what’s left of their fast-melting purchasing power in other currencies, then we might see the beginning stages of a real bubble.
The wild card in cryptocurrencies is the role of Big Institutional Money. When hedge funds, insurance companies, corporations, investment banks, sovereign wealth funds etc. start adding bitcoin et al. as core institutional holdings, the price may well surprise all but the most giddy prognosticators.
The Network Effect can become geometric/exponential very quickly. It’s something to ponder while researching the subject with a healthy skepticism.