The Bitcoin Surge And Madness Of Crowds

Two lasts (one last = 1200 kg) of wheat, four lasts of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads (238 litres) of wine, four tonnes of beer, two tonnes of butter, a thousand pounds of cheese, a complete bed, a suit of clothes and a silver drinking cup. Or a tulip bulb. What would you choose?

At the peak of the infamous Dutch tulipomania in 1636, both cost roughly the same (2500 florins at the time). Most opted for the tulip bulb. Madness? Yes, in a sense.

Countless such examples abound – the Mississippi Mania in France in the 1700s, the South Sea Bubble in the United Kingdom in which none other than Isaac Newton allegedly lost a fortune and closer to our times – the tech boom and bust in 2000, and the stunning collapse of US Real Estate in 2008.

All bubbles more or less follow similar patterns. The arrival of a new ‘paradigm’, early adoption by influential individuals amidst widespread skepticism or information asymmetry, irrational and over exuberant price rises followed by even more unrealistic predictions about the future that fuel further prices rises, the abandoning of rationality, common sense and investment logic, and finally – the thronging retail crowds that create the final, spectacular price surge. And then, the dramatic collapse that leaves thousands tottering in its wake.

Does everybody lose money when crowds go collectively delusional? In fact, no. Many prosper – particularly those who got in early, or those who rode the wave smartly and got out before things went bust. Every bubble will have stories of people of benefitted immensely from it.

What does one make of the recent price surges in Bitcoin, for instance? Is it just the beginning of the Bitcoin rally, or is the 9X price surge in the digital asset over the past year another instance of the collective madness of crowds? One certainly cannot profess to know for sure, but the warning signs are all there. Bitcoin has risen from $648 a year ago to nearly $6,000 as on date. And guess what? Retail investors who have never looked beyond fixed deposits or mutual fund SIP’s, are asking questions on how they can join the party now.

The nature of bubbles is deceptive indeed. In 2014, none other than Warren Buffet said this about Bitcoin – “Stay away from it. It’s a mirage, basically.”

Currency Guru James Rickard called Bitcoin a “Ponzi Scheme” just a few days ago. JP Morgan Chase CEO Jamie Dimon recently slammed Bitcoin as a “fraud”, going as far as to say that he would fire any employee who traded Bitcoin, for “being stupid”. But guess what - since Dimon’s remarks, Bitcoin is up nearly $2,400 - or 75 per cent! As of today, the cumulative market cap of the 16.6 Million Bitcoin in circulation is nearly $100 billion.

Ethereum (ETH), another popular cryptocurrency, has surged from $11 a year ago, to $292 as on date, taking its market cap to nearly $30 billion!

What’s driving these price surges? Without a doubt, speculative buying frenzies. Is a $6,000 Bitcoin price justified? Is a $292 Ethereum Price warranted? That’s really hard to say. After all, what’s a valid valuation indicator for a cryptocurrency? Unlike stocks and real estate, there’s no precedent to actually indicate whether a cryptocurrency is valued fairly or not.

Here’s what we do know for sure – no country is going to relinquish official control of its money supply in a hurry. After all, so much governance and economic control hinges upon the green stuff. China’s recent ban on ICO’s and cryptocurrency platforms may set the tone for other countries adopting similar stances, in the interest of control over its money supply. Only time will tell.

Closer home, RBI Executive Director Sudershan Sen had said in a recent event that “as regards non-fiat crypto currencies, I think we are not comfortable...non-fiat cryptocurrencies like bitcoins, for example"

Amidst the meteoric rise in cryptocurrency prices, deep concerns related to black money, the dark web, terror financing, theft and fraud remain unaddressed.

As an investor, what should you approach towards cryptocurrencies such as Bitcoin be right now? If you’d like to indulge in a bit of healthy speculation (within strict self-imposed limits), go ahead. The charts suggest there’s still some steam left. When a crowd goes berserk, there’s no saying when the party will end. Even $10,000 or $15,000 may be within bounds.

That said, it would be premature to consider cryptocurrencies as part of a defined asset allocation from a wealth management perspective. The next two to three quarters could witness significant paradigm shifts within the space, as governments grapple with the new reality. Once the dust settles and more clarity emerges, long-term investors should revisit the idea. Interesting times lie ahead for cryptocurrencies, and it’s a wait and watch game for smart investors right now.