What Could Finally Stop the Bitcoin Juggernaut

It’s a good thing we’ve never tried to develop an indicator for bitcoin.

Why? Because it’s tough even to imagine what variables would have pointed us to the cryptocurrency’s exponential gains. At this point, probably the only valid comment is that history is on the side of the bears.

It’s hard to find even one example of a stock that has matched the intensity of bitcoin’s rise over the past year and a half. Even when tech stocks went berserk in the late 1990s, I can’t think of any that soared 20-fold or better in an 18-month stretch, as bitcoin has done. Cisco probably came closest. But even that leader in one of the world’s craziest investment manias managed “only” a 16-fold gain, and it needed more than twice the time bitcoin has taken to climb by considerably more.

There also are no clear signposts to when massive gains are overdone. Valuation metrics aren’t a reliable guide. After all, Cisco’s peak P/E was well into triple digits, nearly 150. It would have seemed an obvious great short once the P/E topped 60 or 70, but had you shorted it then, you’d have found yourself covering with big losses. No bells ring at tops and bottoms, which can go to extremes.

I don’t know how much higher bitcoin will go. But I expect the catalyst for the top will be the onset of greater regulation of bitcoin trading. That will come once the Chicago Mercantile Exchange starts trading bitcoin futures, expected before yearend.

Easier to Short

Two things will happen. First, bitcoin will become more akin to being just another asset. And second, the cryptocurrency will become easier to short. In the late 1990s and in 2000, short sellers of the wildly overvalued tech stocks had to hedge their bets.

Bitcoin’s rise shows why indicators, no matter how good, can take you only so far. With the EFTs we follow, we do have tried-and-true measures of when prices become sharply overbought or oversold. These readings always come in the context of how other variables are performing. To give a simple example, if commodities are rising and oil is rising faster, overbought levels for oil would be higher than if commodities were flat.

But trying to fully capture that psychological component is a fool’s errand. That’s one reason we cut our losses if a trade goes against our indicators.

For now we are sticking with our call on bonds. We still have negative signals on oil stocks, but before acting on them we’re waiting to see what OPEC does. The rest of our readings remain neutral.

Stock Talk

Peter G

Peter G

Hi Stephen,

A thoughtful article on Bitcoin in comparison to most of the recent opinions/writings of analysts and financial commentators. Amusing on CNBC this week, whilst discussing the current exponential rise in BTC, they carelessly admitted that they had little clue of what the underlying technology (Blockchain) is and what it represents, yet felt free to make financial predictions based on what little they did know. Perhaps this mirrors many of the current round of BTC investors and perhaps why this iteration of the technology may fail.

What I can add to the discussion is some background on the underlying technology and why it is relevant for the future and why it is receiving a considerable inflow venture capital. Like all “disruptive” advances – i.e. printing presses, electricity, automobiles, computers, networks, cellphones – it is a bumpy road until it achieves widespread adoption. This adoption is often exponential before it settles into a logistical curve when the use of the “technology” reaches saturation.

Perhaps the best comparison for Bitcoin/Blockchain is the Internet itself. In the period 1991 – 1995, the Internet Protocol (TCP/IP) started to become adopted though few even knew or understood what this protocol was or what it meant. The next 5 years was a boom and bust for companies (read “applications”) that ran on top of the TCP/IP protocol, and analysts viewed the “value” of the Internet based on the stock prices – or future value – of these companies/applications.

What is forgotten is that TCP/IP survived the dot.com crash and has allowed all of the new “applications” to prosper e.g. the www, social media, communications, massive shift to online sales, online trading, VOIP (Skype & WhatsApp), Smartphone adoption etc etc. We still value the Internet by these companies that run on top of the protocols but the true value is the foundation protocols that allow all of this to function.

How did this compare to Bitcoin? Blockchain solves a problem known in computer science as the Byzantine General’s Problem, which in layman’s terms defines the issue of trust in a distributed network. It does this without the use of a “trusted middleman” – Pentagon if you will – to control the network and ensure it is functioning correctly, for example governments use a central bank and entities such as credit card companies have a central hub to control its transactions. Blockchain’s “distributed ledger” essentially eliminates the requirement for a trusted middleman, hence governments – and especially banks and financial entities – are rightfully concerned as to how the technology will affect their future.

The Blockchain protocols provide the technology for the applications to run. It provides the technology for the Bitcoin and for all the other currency applications and as such it is the “Internet of Money”. It will also see other applications (companies) prosper including those related to ownership and trust, i.e. real estate, art, medical records etc etc.

How do you value the Blockchain? Good luck with this! What can be said is this iteration of crypto-currency on Blockchain may fail – like the dot.com boom – but the underlying blockchain protocol will prosper (as did TCP/IP) and much money will be made. Bitcoin is speculative but the Blockchain has the venture capital flowing in.

The key for BTC investors is deciding:
1. if it will be successful,
2. where the value curve moves from being exponential to logistical, and
3. in the future will exchanging BTC to fiat currency be necessary i.e. at what point do you really need government issued money anymore.

For question 1, who knows! For question 2, that value is probably somewhere between $0 and approx $400,000 (the value of gold assets) in the next 5+years. For question 3, this is really interesting.

Buyer beware and use proper Risk Management!

Scott Chan

Scott Chan

Dear Peter,

Thank you for your thoughtful post. Indeed, we believe regardless of what happens to bitcoin, blockchain technology will have staying power.

Jeff f

Jeffrey Forman

Was there a suggestion to exit the CLR put that I missed? Today’s statement that “we cut our losses if a trade goes against our indicators” Other than suggesting that we might roll over the trade to a latter expiration…we’ve been riding CLR put down to zero. Now the TLT trade is nosediving…waning confidence in your “signals”

Scott Chan

Scott Chan

Dear Jeffrey,

There was no sell recommendation for the CLR put. It’s likely we will just let it expire worthless since the cost of selling it may be higher than the value of the option at this point, depending on how many contracts one holds and how much one’s broker charges for option trades.

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