Monday, November 22, 2021

Crazy Cryptos

Any discussion about economic bubble mania always use the "Tulip Mania" as an example. What is more astonishing is - the mania happened in Netherlands in the period of 1630s and we still use the example very vividly even though it happened almost 400 years ago. I am not sure why THIS mania is remembered fondly compared to thousands of other manias that followed it. But I am sure - the next 400 years, future generations would talk or ponder the crypto mania we are engulfed here in our generation as the worst part of human greed and irrational exuberance to its core.


During bull markets, prices of assets grow to new highs and gradually recede during the recession that follows it. Usually crazy things happen in few specific sectors of the economy. Unlike water, the "new money" does not balance at all the same level. It so happens - some sectors of the economy get very hot - really hot and start operating without logic. Eventually as the recession hits through - the astronomical prices come down crashing. It was the dotcom crash of 2000 that brought the tech stocks to zero and the 2007-08 housing crisis, bought the prices of US homes crashing by more than 50% across most of the US cities.


The current boom we are in is being rightly described as the "mother of all bubbles". Definitely the tech stocks are over-priced and the NASDAQ is more than 3 times what it was in year 2000. Housing prices are now at its peak - well above its 2007 highs just before the crash. It can be easily argued the US bond market is in a bubble as well.


Unlike earlier boom/bust cycles - it appears the boom is in danger zone in multiple sectors of the global economy.


But out of all these, nothing is so screwed up like the entire crypto market.


There are quite a few things that are bad in the crypto market.


An asset has to have an intrinsic value. When you take a home, people live there. It has a utility value. There is a need for housing. It is a place, people can keep themselves warm or cold from weather changes. Its where you keep your belongings safe. It has a use value. Because of its use value, it has a proportional exchange value. Home owners sell their homes for getting cash and use the proceeds to buy another asset . Assets such as home will always have value because it has the fundamental components of productivity - land, labor and capital.


Other assets like stocks - represent a piece of action in a profit making businesses. They have an intrinsic value. The business has assets and employees with skills who can make the shareholder money in the long run.


Every boom period is defined by something new. The newest girl in the block always gets a lot of attention. This bull market that is in place since the 2008 financial crisis has created huge asset price appreciation overall. The causes being the zero percent interest rate policy of the world central banks and endless quantitative easing measures the world hasn't seen. With the covid arriving early in 2020 - Every boom has been re-catapulted with more stimulus. With "free money" everywhere, investors have no choice but to buy risk assets all over the world. That would explain the exponential growth of the crypto market.


Cryptos have all increased in value during this phase of the boom. For example Bitcoin has went from few dollars into its all-time high of $68000. For anyone who made the journey they have profited exponentially.


No asset go up in price for ever. For those investors who missed the bitcoin ride regret not being able to get in to the ride when the price was really in double digits or even triple digits or few thousands. For those investor who got in and burnt themselves in volatility know the high price of losing the money on the way up. But for me - the best investor are the ones who will make the sane decisions and stay normal during crazy times. I have been watching bitcoin when it was as low three figures. When it reached $4000, I thought it was way expensive then. Today its $68000 - of course it's way expensive now. Can it go higher and higher still - Of course yet. Can it go to $100,000 - Yes, it can. Can it go to a $1M - possible but not probably. With each coin costing a million, it would seriously undermine other monetary parameters.


The cryptos are digital meaning you need to go online to view or see it. Its virtual - which is it is not fungible (felt or touched). Peter Lynch in his "Beating the Markets" says - the investments you make on businesses must be explainable with crayons. There are many things that can be explained - but not the cryptos. People who have no idea about cryptos - don't invest in them, and the people who do -> think it's very valuable. Only way out for someone who is holding his bitcoin is to sell it to someone who is willing to give more money than what the seller paid for it.


Crypto currencies by itself are transmissible tokens via the internet. It can be exchanged between the crypto valets of users. That's all it is. Their value is only exchange value. There is no use values. Meaning people will not buy it because there isn't any use to it, they will only buy under the belief that someone else will be willing to pay more for it in the future. It doesn’t solve any problems. It takes a lot of electricity to "mine" the cryptos. The cryptos are end product of the mining operation. If it's not useful by itself - what is the purpose of "mining" them.


One of the big drawbacks of the cryptos is its lack of simplicity. The medium of exchanges is not physical. It is online. With a large population of the world outside the internet, it is not sellable to any larger public.


If you have a checking account in the bank and you are able to digitally transfer funds to your friends and family 24x7 and to any part of the world - That is a reasonable mode of exchange that we know works well. It solves all problems that bitcoin tries to solve. When you are without an internet or a power supply, you will not be able to do a fund transfer in your bank account mobile app. It’s the same there too. If an bank account can facilitate exchange of currencies online - separate channel of mechanism is redundant.


Because they are not useful by itself - when the confidence is lost, the price of the cryptos will go to its minimum of zero. There is a precedent to it for us. The dotcom companies who made spectacular stock market debuts in the 1990s - eventually went to zero when reality caught up with it. The same is true for today's cryptos.


One of the big talking points of bitcoin enthusiast is its scarcity. They say there can be only 22M odd number of bitcoins ever. Even though there may not be enough bitcoins, there are enough crypto currencies, actually 13000 of them that are being traded. Even within bitcoin there is a "bitcoin cash" which operates along with bitcoin. It’s a separate crypto that operates outside the 22M limit. So the whole things is very unconvincing and we hard to explain even by the so called "crypto experts".


Centrals banks printing money has dramatically increased since the great recession of 2008. Bitcoin enthusiasts point to this obvious problem with the fractional reserve banking the world economy follows quite rightly. They advocate cryptos as financial instruments that is outside world governments. They often site it as free from government regulations and its uncontrollable independence from any entity. The individual countries stand behind their currencies. Even though we do agree with the problems world Central banks have created - crypto is not an effective alternative for it as it lacks a lot of other qualities of sound money.


Internet is a life changing invention. Most of its value derives from its experience of being mostly free. It doesn't cost much to be using the internet. Say If popular social media sites like FB are made payable site. The traffic would come down to single digits overnight. For most people, its optional meaning they would want to use it only if free. If its chargeable - they will choose to ignore or choose an alternative site, that is less sophisticated but doesn't cost any. Unlike the internet - the cryptos are not something people cannot live with.


The astronomical valuations of certain cryptos confirm the big asset bubble the world has ever seen. It is very hard to believe - it will gradually smoothen itself to a new normal. There is going to be adjustment and when it happens it will be more painful than before as the monster bubble is massive this time. 


Eventually all cryptos including bitcoin will go to zero as that is where it belongs.