reason #9
bitcoin has lots of haters
This may sound like a strange reason to invest in Bitcoin but some of the rules of investing are a little counterintuitive. Normal common sense would dictate you invest in something that everyone loves. That is normally too late. To understand this you need only look at stock market cycles. The stock market is a cauldron of human emotion. Fear and greed are amplified and give us interesting insight into the behavioral nuances of investing. Over the past 100 years, we have seen numerous stock market crashes - in 1929 (the Great Crash), 1987 (Black Monday), 2000 (the Dot.com bubble), and 2008 (the collapse of Lehman Brothers and the Great Recession). All four of these crashes were preceded by widespread investment in stocks. Everyone was in the market. Many people who had no place investing suddenly had an opinion. Your taxi driver would be giving you stock tips, as would your hairdresser, the girl at the checkout of the grocery store, and your doorman.
In the world of investing, there is smart money and there is dumb money. The smart money gets in early. These tend to be professional money managers, hedge funds, and sophisticated individuals. These people don't drive taxis and don't bag your groceries. Their job is to find smart investors. These professionals get in early and they are discreet in their strategy at first. Their buying moves the market discreetly higher. They don't buy all at once - they tend to space their buying over a length of time so the market does not move away from them. Because they operate with large amounts of money, they know that the execution of one large buy order will push the price higher. So they break down the order into small chunks and buy in a way that the price does not rise quickly. They may buy over days or weeks. Once the smart money is in, the dumb money would have noticed how the market is moving up at a gentle and discreet pace. The smart money will now come out and cry from the rooftops about the great investment. They will be on Twitter, YouTube, and the financial press talking up the investment. This is called talking your book. The dumb money starts to dip its toes in the water and this causes the price to increase its upward momentum. The volume of positive news on social media increases exponentially and this is when FOMO sets in. Dumb money now starts pouring into the market indiscriminately and the price increase becomes parabolic. Smart money is now starting to take the other side of the trade - they are quietly bleeding stock into the market and banking profits. As the market approaches the top, the smart selling starts to equal the dumb buying and the market starts to roll over. Most of the smart money is out and as they offload their last investments, the market starts to crash. The actual crash could be triggered by any event and this is where panic selling begins. The dumb money senses the problem and stops buying and starts to sell, but there is no one left to buy, so the market gaps down 10, 20, 30 percent, or more.
This is the anatomy of a stock market crash. The two strongest emotions in investing are fear and greed. On the one end of the spectrum is the greed of making money. Humans love to get something for "free". Few of us can resist that free cheese sample at the local deli. When I was a kid, cereal companies used to throw a free toy into the box. I used to relish the thought of ripping open that box and seeing the treasure inside. On the other end of the spectrum, we have a fear of losing money. This goes back to our caveman ancestors and the inherent need for self-preservation. No one likes to lose money - not even gamblers. If you stand outside a Las Vegas casino at 7 am and watch the hardened gamblers leave, you will not find a phalanx of smiling faces - even the professionals are stung by their losses. So which emotion is stronger? This is an important question to answer because it will explain the anatomy of a stock market crash. It turns out that the fear of losing money is greater than the greed of making money. Stock markets are said to go up the stairs but down the elevator. They go up at 45 degrees but they go down at 90 degrees. More thought is expended in the execution of greed. There is a little more calculation and rational thought. Fear, on the other hand, quickly morphs into panic, and in the boiling soup of panic, rational thought is not an ingredient.
So where are we in the Bitcoin cycle? A bunch of smart nerds has developed a fear and greed index for Bitcoin. It boasts six inputs. The first is volatility in the price. High volatility represents greater uncertainty and therefore more fear. The second is momentum and volumes. This is where it gets a little technical because, in addition to market volume, it also looks at put-call ratios in the derivative market. Puts and calls are derivative instruments used by sophisticated investors to speculate and hedge on Bitcoin. Think of this ratio as expressing the sentiment of smart traders. The third is social media sentiment. The index scrapes data off social sites like Twitter with Bitcoin hashtags looking for positive and negative language. The fourth is simply old-school surveys. The fifth is the calculation of Bitcoin dominance - its share of the total crypto market capitalization. The rationale is that if Bitcoins market share increases, it is a sign of fear in the space - people are selling riskier altcoins and buying the most established coin. The final input is trends in Google data. Again, there is a splash of machine learning in this variable. An increase in negative searches like "is Bitcoin price manipulated" will indicate fear while positive searches like "the best ways to buy Bitcoin" will pump the greed side of the equation.
Does this index work? The index has a range from 0 to 100 and is divided into four categories
0-24: Extreme fear
25-49: Fear
50-74: Greed
75-100: Extreme greed
Let's see how accurate the index has been in predicting price moves in Bitcoin. The index has been around since the beginning of 2018 and since then we have had two major crashes. The first was in March 2021 when the price halved from around $61k to $31k. In the middle of February 2021, the index was at 95 at the higher end of extreme greed. The next big crash was in November 2021 when the price lost 70 percent from $68k. In November the index was at 85 - again in Extreme greed. So the index was accurate in predicting these two crashes. How about massive price gains? Between March 2020 and March 2021, Bitcoin rallied from $5k to $61k. In March 2020, the index was below 10 indicating extreme fear. Another strong rally happened between July 2021 and November 2021. Again in July 2021, the index was below 10. So the index correctly predicted the four major moves since the index was established.
Bitcoin specifically and cryptocurrencies in general are polarizing. There are three kinds of crypto people - lovers, haters, and the clueless. Let's start with the haters. There are two kinds of haters. The first are those that are threatened by it, the second is people who are die-hard traditionalists and do not want to change.
1) Threatened
The most vocal opponents of Bitcoin are the banks. Bitcoin was designed with the specific purpose of providing an alternative to traditional banking after the international banking system almost collapsed in 2008. We know this by the secret message that Satoshi Nakamoto included on the genesis block: "The Times 03/Jan/2009 Chancellor on brink of the second bailout of banks". Although I have mentioned this before, it is worth repeating. Satoshi famously hated the idea that many banks were too big to fail. "Too big to fail" was a term coined by US Congressman Stewart McKinney in a 1984 Congressional hearing and is a theory that some financial institutions are so large and so interconnected that if they fail, they pose a threat to the economy in general. At what point did the financial sector become so powerful that it could bring the world to its knees? You need to have a brief understanding of the monumental rise of the power and influence of the banker.
Think about the anatomy of a dog. Imagine a beautiful golden retriever with friendly eyes and a fluffy tail. I did not take biology in school, but looking at that amazing dog I can see that the dog wags the tail - the tail does not wag the dog. Banking and finance are the tail of the dog and the dog is the general economy. The function of banking is to serve the economy - and not for the economy to serve it. It is there to provide transactional, lending, depositing, and custodial services. They identify productive opportunities and offer a bridge between savers and investors. When I deposit my cash into the bank, I want the bank to put that money to work and lend it to a small business that wants to build a new factory. This means that banking and finance should be a small fraction of the size of the total economy. In reality, the sector has grown dramatically since the end of the Second World War. Its percentage of total GDP has quadrupled. It is the third largest sector in the world behind e-commerce and construction, and bigger than real estate, IT, telecommunications, auto manufacturing, oil and gas, and the food industry.
The total assets managed by the world's largest banks are gobsmacking. The five largest banks in the world control assets the size of the United States economy. BlackRock, which is not a bank but manages financial assets, has $10 trillion under management. BlackRock is the biggest company you have never heard of.
So how did financial companies become so powerful? The answer is simple - the growth of credit. Credit, also known as debt, has always been around. What is interesting is how debt has grown in the last 40 years. We need to go back to the 1970s when Margaret (Maggie) Thatcher, soon to be prime minister of the United Kingdom, set her sights on 10 Downing Street. The majority of low-income families in the UK lived for free in council homes. This was one of the benefits that came after World War 2. In the United Kingdom, there are two dominant political parties - the Conservatives (aka the Tories) and the Labour Party. The former were more educated and wealthier and they tended to own their own houses. Maggie came to the conclusion that this home ownership tended to tie people more to the economy, and also believed that if she was able to facilitate more workers to become homeowners, they would be more likely to vote for the Tories at the elections. She, therefore, (t)hatched a plan to sell these council homes for rock-bottom prices to the inhabitants of these houses. Council homes are not exactly Instagrammable dwellings. They tend to be old, small, and damp but they were still a house and there is a certain pride associated with home ownership. Workers for the first time owned an asset and this open them to the wonderful world of credit in the form of personal loans, credit cards, and auto loans.
Before becoming homeowners, they had no debt because banks were not prepared to lend to them. Now they had assets, banks started to throw money at them. Ronald Reagan saw this and replicated it in the United States. He went about deregulating the credit markets and in so doing, the foundation was laid for the golden age of Wall Street, and by Wall Street, I am not exclusively referring to the US financial system, but the global system. This is the first democratization of finance. Credit was spread to a wider net of people. They would use this credit to invest in the stock market, buy cars and houses and they could participate in the riches of capitalism.
In the 1980s, total household debt was about $18 trillion. By 2021, it had tripled. But Wall Street not only threw money at consumers, but it also facilitated the raising of debt capital for countries and corporations. Total global debt rocketed from a little over $1 trillion in the 80s to $226 trillion in 2021. It was this massive expansion that helped the financial coal sector grow into the beast it is today. We have created a monster and this monster poses a real and present danger to the stability of the world. The tail truly is wagging the dog.
One of the biggest banks in the world is JP Morgan Chase. This bank generates one-third of a billion dollars in revenue every day - including weekends. It has $3.7 trillion in assets and is run by one of the most powerful bankers in the world - Jamie Dimon. He is the most vocal critic of Bitcoin and crypto in the banking space. In 2014 he said, "Bitcoin is a terrible store of value". In 2015 he said, "Bitcoin will not survive". In 2016 he said, "Bitcoin is going nowhere". In 2017 he said, "Bitcoin is a fraud and that he was not going to talk about Bitcoin anymore". In January 2018, he broke his three-month silence on Bitcoin saying he regretted making that fraud comment". Nine months later, his frustration became obvious when he said "I don't really give a shit about Bitcoin". His most recent comment was in September 2022 when he referred to crypto as "decentralized Ponzi schemes" and is quoted in saying that he is a major skeptic on crypto tokens like Bitcoin. He adds that the "notion that it is good for anybody is unbelievable". The reason Jamie Dimon is so anti-Bitcoin is that he knows it can potentially eat his lunch. He understands the disruptive force that cryptocurrencies present especially in the area of cross-border money transactions.
What would you say to the fact that banks in 2022 used exactly the same method to send international payments as was invented in 1973 by SWIFT. SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. SWIFT is a cooperative society and is owned by the bank of the world that use it which means almost every bank in the world. It is slow, expensive, and unreliable, especially when the transfer takes place between countries that speak different languages because the transaction is done through messages that make Morse Code look advanced. SWIFT has such a monopoly on international transfers that it has been used as an instrument in sanctions. In fact, it banned some Russian banks after the invasion of Ukraine. International banks do not only share the profits in SWIFT as shareholders, but they also charge fees directly to the wires and in the exchange rates. This is a highly profitable business for the banks. Crypto does cross-border transfers in real-time and at a fraction of the cost. There is no wonder the world's most powerful and influential banker is anti-crypto!
Governments are also rabidly against crypto because it is not good for their core business which is printing and controlling money. In addition, the tax treatment is complex. This means that it is unlikely you will hear a positive word on crypto from a government official or a central banker because crypto competes directly with their currencies, and governments are not that fond of competition.
The other group of haters is financial traditionalists, and in this space, there is no one more powerful, influential, and rich than Warren Buffett - arguably the greatest investor this world has ever seen. I, personally, am a big fan but am a little disappointed in their short-sightedness on this topic, but not entirely surprised. Let me walk you through my thinking on this. He says that Bitcoin is rat poison and an unproductive asset that has no unique value at all. It is not surprising that Buffett has taken such a violently negative view of Bitcoin. He is a value investor and he values investments as the present value of their cash flows. This strategy means that he is unable to value new technology companies and he has missed completely or invested late in the cycle. Investment rule number 5 for Buffett is to buy simple businesses. He acknowledges that he does not understand tech stocks. He never invested in Facebook, Netflix, or Telsa, and was late into Apple and Amazon. He did not even buy stock in Microsoft, notwithstanding Bill Gates being a close friend of his and the fact Buffett has donated the majority of his multi-billion dollar fortune to the Bill and Melinda Gates Foundation, but he may have avoided Microsoft to avoid a potential conflict of interest. The bottom line is that Buffett's old-school investment playbook has kept him far away from new technology stocks and it is therefore not surprising he does not speak out in favour of crypto. His negative words however shape the views of millions of investors around the world and help to swell the numbers on the crypto haters camp.
Not all the old-school gurus are so toxic in their comments on Bitcoin. Ray Dalio, the 72-year-old hedge fund billionaire, holds some Bitcoin although he does say he does not hold much. He at least is open to the possibility of being wrong. I wouldn't be surprised if there is a large divergence between what Buffett says and what he does. I think he is also a smallholder but prefers not to publish it because if he did, the media would descend on him and flood him with the need to comment on a technology he does not understand which would be a betrayal of his investment thesis.
Bitcoin has been characterized as a speculative bubble by eight winners of the Nobel Memorial Prize in Economic Sciences: Paul Krugman, Robert J. Shiller, Joseph Stiglitz, Richard Thaler, James Heckman, Thomas Sargent, Angus Deaton, and Oliver Hart; and by central bank officials including Alan Greenspan and Agustín Carstens, Other notable skeptics are Bill Gates, Microsoft co-founder, and philanthropist,
Another group of haters is the gold bulls - those die-hard faithfuls that are always positive about gold. Gold bulls are almost as passionate as religious zealots and they are firmly against Bitcoin because it has been called digital gold on account of its scarcity and the difficulty of mining it - two things that are not mutually exclusive.
Crypto is also its worst enemy. It has attracted its fair share of arrogant and greedy actors that have done a fantastic job of fuelling the hatred. Enter now Sam Bankman Fried and FTX. If you are scratching your head wondering what happened with FTX, I will try and explain with different levels of complexity.
Let's start off with the most basic explanation. A magician with big hair and bad dress sense who lived on a paradise island in the Bahamas sold magic beans. For a long time, people loved these beans and praised the magician. Then one day a rumour started saying the magician was a bad man so the people demand their money back only to find the magician had already spent all the money.
Now, the slightly more detailed explanation. A clever guy, also with big hair and bad dress sense, owned a bank. He used made-up money to buy his way into a high-stakes poker game and he lost. In order to pay his debts, he stole money from his own bank. When the bank customers heard about the gambling debt, they panicked and demanded that the clever man pay back their deposits. Many people got their money back but soon there was no more money in the vault and the people who were slower in demanding their money back did not get anything back.
Now for an even more complicated explanation. Let's call the magician/clever young man by his real name Sam Bankman-Fried - aka Scam Bankman-Fraud aka SBF. He started two companies and claimed they were separate companies. One was a hedge fund called Alameda Research and the other was a cryptocurrency exchange called FTX. A crypto exchange is a website where people can buy and sell digital currencies. Another thing that these exchanges can do is create their own cryptocurrencies, which is like printing money out of thin air. FTX currency was known as FTT. These currencies are not mined liked Bitcoin - they are printed like money and apparently, SBF printed a lot of FTT, and a lot of it was sent to Alameda which turned out to be not so separate. This gave the impression to most people that Alameda had a lot of assets. When FTX clients discovered what was going on, they panicked and tried to withdraw their money. They then discovered that over the course of some time, SBF had actually transferred $10 billion of their funds from FTX to Alameda.
Now for the most complex explanation. Alameda was a hedge fund that specialized in making big on crypto companies ie companies that were doing business in the crypto space. In order to make those bets, SBF courted investors promising them high returns and low risk - who in their right mind would turn down something so attractive? This helped catapult FTX to become one of the biggest crypto exchanges. It had issued its own token known as FTT which worked like a loyalty program for customers, giving them perks like discounted trading fees. But FTT was also bought and sold like a normal term, reaching a maximum price of $80 per token. In order to cash in on this demand, FTX minted tons of this highly valuable yet highly speculative token, and the supply reached 300 million. It is alleged that SBF used these tokens to allow Alameda to take out loans. This was dangerous because if the value of the tokens fell, so too would the value of the loan collateral and it would make it more difficult for Alameda to repay its lenders. When the crypto market slumped this year, people were puzzled to see FTX bailing out several companies that were failing. It is speculated that SBF was helping these companies in an effort to prevent them from selling their FTT tokens for a discount.
In early November, CoinDesk reported that 40 percent of Alameda's $14.6 billion balance sheet was held in FTT. This caused panic amongst FTX customers while we're aware that problems at Alameda could well spill over into FTX given the fact they were not at all separate. We now see Binance entering the fray. Changpeng Zhao, aka CZ. When SBF started FTX, CZ took an equity stake.in the new exchange. When SBF got pissed off with big brother looking over his shoulder all the time, CZ sold his stake and was paid in part with FTT tokens. When the CoinDesk story broke, CZ sold his FTT tokens (for an amount rumored to be around $500 million), which sent the FTT token's price into free fall. This is the event that caused the run on FTX. CZ then signed a letter of intent to bail out FTX subject to due diligence being conducted, but he quickly abandoned this plan upon discovering the company had more holes than a slice of Swiss cheese. One of the reasons for the holes, according to Reuters, was that SBF had created a secret backdoor in FTXs bookkeeping that allowed him to move depositor's money off the exchange to Alameda without alerting customers or most of its own employees. In addition to all this, it was revealed that SBF had given himself a personal loan of $1 billion out of the coffers of Alameda.
On November 10, the Bahamas securities regulator froze the assets of FTX Digital Markets following news that SBF was seeking up to $8 billion in capital in order to bail out the exchange. On the same day, the Californian Department of Financial Protection and Innovation announced that it had initiated an investigation of FTX.
Within hours of filing for bankruptcy, the FTX exchange was allegedly hacked. It turns out that it was actually a government asset seizure. It was actually SBF himself who did the hack under the instruction of the Securities Commission of the Bahamas. This makes the Bahamian government one of the world's biggest Ethereum holders as the government quickly converted the assets into ETH. Whether the Commission responded appropriately or not is a matter for the court to decide.
So where do we go from here? There are several big issues in play. Firstly, this is going to hurt the credibility of the crypto industry in general, which has been strained by the year-long collapse in the price of Bitcoin. It has been a rough year for Bitcoin. It took a hit in May with the collapse of the UST stablecoin and its partner Luna, which destroyed $48 billion in investments in the space of a week following a run on the organization. This also lead to the collapse of an important crypto hedge fund, Three Arrows Capital, which in turn led to a slew of bankruptcies among crypto lenders.
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Talking about the collapse of FTX, CZ from Binance said that this was not good for anyone in the industry.....confidence is seriously shaken. Regulators will scrutinize exchanges even more and licenses around the world will be harder to get. Another fallout if the FTX collapse is that at least 11 major exchanges including Binance, Crypto.com, Gate.io, Kraken, KuCoin, Poloniex, Bitget, Huobi, OKX, Derinit, and Bybit have all announced plans to publish proof of reserve statements regularly or have pointed out that they already do.
Secondly, there is the impact it will have on regulators, who have been growing increasingly aggressive with the industry. The SEC and state securities regulators have been getting increasingly aggressive about their contention that virtually all cryptocurrencies are securities. This would require exchanges to register as securities brokers. The industry has strongly challenged that as can be seen in Ripple's ongoing legal battle with the SEC which sued it for illegal securities sales of XRP.
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Finally, there is the issue of political power. The crypto industry has been relatively successful in pushing its agenda in Washington. The most visible lobbyist has been SBF himself who had pledged to spend more than $100 million on the 2024 election cycle. With the implosion of FTX added to the Terra/Luna stablecoin collapse and the crypto lender bankruptcies, the industry's aim to get a more hands-off regulatory regime has been dealt a serious blow.
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In summary, the fact there are many haters of crypto is a good thing. It maintains tension in the market. You can think of Bitcoin as a balloon being held underwater by the force of negative sentiment. It wants to emerge, but it cannot under the negative weight of the haters. As more haters come around to Bitcoin's virtues, so too will the balloon start to rise. It is believed that Gandhi said: "First they ignore you, then they laugh at you, then they fight you, then you win". The balance is now shifting to the third and fourth phases of this evolution.
