- Price Distortions. Usually, when prices go up, demand goes down. When Banana prices increase people buy Apples instead. But in a bubble, prices rising is taken as proof of greatness and demand increases. This is seen in the mania going on right now; many cite past price increases in cryptocurrencies as proof it’s only going to go higher.
- FOMO! The press is full of stories of people who’ve made thousands – or millions – on bitcoin. You should probably react by thinking, “lucky bastard!” but instead the natural reaction is, “wow, I don’t want to miss this – better buy ASAP!”. This Fear of Missing out (FOMO) feeds the sentiment cycle.
- A story where “this time is different”. Many bubbles of the past were spurred by a technological innovation that will “break all the rules”. Tech stocks in 1999 hit insane valuations because the web had supposedly rewritten the rules of investing. Ditto the railroads, PC stocks, etc. Crypto is an entirely new thing invented out of nothing, so valuation is nearly impossible to measure. Enthusiasts argue this time is different. An especially weak argument is that Bitcoin is intrinsically valuable because the blockchain is a revolution. But the blockchain could be a revolution and bitcoin could go to zero. Buying bitcoin isn’t a bet on blockchain technology. It’s a bet that more people will want bitcoin in the future than want it today – the greater fool theory in action.
- Unproductive assets, uncertain valuations. Most productive assets – ones that create value – have some metric that establishes value. Stocks have P/E ratios. Bonds have yields. Houses generate rents. Even currencies are backed by assets or the GDP of their country. What’s the right price for a tech stock with no earnings, or a tulip bulb? Ditto cryptocurrencies, where there is no value creation at all. So what’s it worth? It’s 100% determined by sentiment, which is very dangerous. Productivity also helps set a floor on the value of the asset: If sentiment turns against MSFT or AAPL, the stock can’t drop to zero because at some point it’s obviously a screaming value given their cash flow. The floor on Bitcoin is $0 from this perspective.
- Easy money. When credit is cheap, bubbles are enabled. Interest is now exceedingly cheap. So we should be alert in general.
- Insanity. Remember when company stocks went up because they added “.com” to their name? Consider that an iced tea company renamed themselves long bitcoin and spiked. Dozens of companies are launching ICOs that are only vaguely related to their businesses and stock prices bump up. Tren Griffin is lampooning this trend nicely.
Of course money will be made. Lots of lucky folks will ride the bubble up. Frauds will be invented to take advantage of investor misunderstandings around the newest thing. Startups will take real dollars for digital currencies with no actual value. Things are now in full swing.
I have lived through a number of bubbles. I know, you’ve got a buddy who’s made $2M on bitcoin already so he’s a genius and he’s advising you to go big into crypto, and you’re afraid of missing out. But please be careful. I am certain that for a few weeks or months there will be room to debate whether this blog post is right, and Bitcoin may hit $30,000 before the end. But in the end, there will be tears.