Bitcoin’s meteoric skyrocketing this year has been astonishing, captivating traders across the globe.  This once-obscure cryptocurrency has exploded into the world’s hottest market. With fortunes being won on paper, everyone is talking about bitcoin.  But with its price shooting parabolic, unfortunately this wild ride has all the hallmarks of a classic popular speculative mania.  And those all end badly, totally collapsing.

In the annals of financial-market history, the word “mania” is never used lightly.  These are very-rare events where some market blasts higher so radically that it captures the popular imagination.  The dictionary definitions of mania include “an excessively intense enthusiasm, interest, or desire” and “a pathological state characterized by euphoric mood, excessive activity or talkativeness, and impaired judgment”.

The seminal book on popular speculative manias is Charles Mackay’s “Extraordinary Popular Delusions and the Madness of Crowds”, first published way back in 1841.  Manias are certainly nothing new, they have been periodically erupting for many centuries if not millennia.  Mackay’s incredible work is one of the few must-read books for every investor.  I’ve read it several times in my life, starting back in college.

Mackay’s title is brilliant, perfectly summing up manias.  They are truly extraordinary popular delusions, illustrating the madness of crowds.  Objectively, this year’s extreme bitcoin action definitely fits that bill.  I say this as a lifelong student of the markets.  Like the objects of lust in past popular manias, bitcoin and its underlying blockchain technology have real potential to change the world.  But that doesn’t justify its price.

As a techie, I started getting interested in bitcoin about 5 years ago, well after its birth in January 2009.  It was intriguing as the world’s first decentralized digital currency, an Information Age end run around the established government fiat-money systems relentlessly being inflated away by central banks.  Bitcoin’s never-unmasked creator going by Satoshi Nakamoto was a marketing genius, wrapping bitcoin in gold terminology.

The “coin” suffix implied bitcoin is money, rather than a virtual fiction with artificial scarcity.  And it used a novel distributed-ledger technology called blockchain.  That is a record of all bitcoin transactions that is broadcast and validated by the entire bitcoin network.  This ensures that bitcoins can be transferred with no counterparty risk, trust is irrelevant.  Maintaining the blockchain is called “mining”, again bringing gold to mind.

The countless computers all over the world participating in recordkeeping for bitcoin’s blockchain work to simultaneously solve complex cryptographic problems, or hashes.  This mining guarantees that all new bitcoin transactions are legitimate.  While it is computationally-intensive which requires much electricity, bitcoin ingeniously awards participating miners with newly-created bitcoins.  That’s a heck of an incentive today!

Somewhat like gold, the bitcoin supply grows at slow and ever-decreasing fixed rates. Today there are around 16.7m bitcoins in circulation.  12.5 new ones are created every 10 minutes and distributed to the miners maintaining the blockchain.  That supply-growth rate will be gradually halved again and again until the bitcoin supply hits its hard-coded maximum of 21m bitcoins after 2110.  So bitcoin’s supply is artificially limited.

Repurposing old computers to mining is what sparked my initial interest in bitcoin.  I run a small financial-research company where we must periodically replace our high-end computers.  So I investigated putting some of our old put-out-to-pasture ones to work mining bitcoins, but at the time the electricity cost well exceeded the resulting bitcoins’ value.  Back then bitcoin mining didn’t require specialized custom-made rigs.

When bitcoin was younger, normal computers could solve the necessary cryptographic hashes to keep the blockchain up to date.  As this distributed ledger grew, more-powerful high-end computer-graphics cards were needed.  Today bitcoin mining requires computers with processors designed from scratch to do nothing but grind on the blockchain, called application-specific integrated circuits.  They get very expensive.

Truly bitcoin and its brilliant blockchain distributed-ledger system are amazing technologies.  They will ultimately reshape how we buy and sell goods and services, shifting the balance of power in currencies back away from centralized governments.  It’s hard not to be a bitcoin enthusiast.  That being said, it’s critical for traders to divorce bitcoin’s extreme mania price action from these technologies’ future potential.

For 18 years now, I’ve written an essay like this nearly every week.  Wednesday mornings I decide on a market topic, research it, and build any charts.  So our Zeal charts are always current to Wednesday’s close.  Then on Thursday I write and proof each essay before publishing it Friday morning.  Normally that day-and-a-half between finalizing the data and releasing an essay doesn’t matter, but bitcoin’s mania is crazy.

Bitcoin trades nonstop around the world, with transactions always happening and the blockchain always being updated.  Around the normal US stock-market close this Wednesday, each bitcoin was priced at $12,968.  So all the data, charts, and analysis in this essay is based on that ancient price.  Merely 18 hours later as I pen this essay, bitcoin has rocketed another 18.6% higher to $15,379!  Its ascent is meteoric.

So who knows how high bitcoin will be when you read this.  But the higher bitcoin skyrockets, the more it emphasizes the extreme danger inherent in this popular speculative mania!  Bitcoin is absolutely deep in a monster bubble, defined as “an increase in the price of a market that is not warranted by economic fundamentals and is usually caused by ongoing speculation in the expectation that the price will increase further”.

This first chart looks at bitcoin prices over the past couple years or so.  Bitcoin has rocketed parabolic in 2017, soaring vertically in what looks exactly like a popular mania blowoff top.  Vertical parabolic gains are mathematically impossible to sustain for long, as they would soon suck in all the available money on the entire planet!  If this chart doesn’t terrify you, you should go read Mackay’s mania book before it’s too late.

Bitcoin was no slouch in 2016, soaring 123.6% higher in what looked like a late-stage bull market.  That is hardly a blip on today’s chart though, as that morphed into a full-blown popular speculative mania this year.  As of Wednesday’s sub-$13k price, bitcoin had skyrocketed 1251.9% higher year-to-date and a mind-boggling 1565.6% higher since its early-January low!  These mania technicals are extreme beyond belief.

Like gold and many other investments including lots of stocks, bitcoin produces no cash yields and thus can’t be valued with conventional valuation analysis.  So no one has any idea what it’s worth.  The range of guesses is vast, running from zero to hundreds of thousands of dollars per bitcoin!  But even in the absence of any fundamental valuation, bitcoin’s price action itself proves it’s exceedingly expensive today.

Obviously Wednesday wasn’t this bitcoin speculative mania’s peak, but let’s assume it was to use as a reference point for analysis.  Bitcoin’s “terminal gains” as of the middle of this week were astounding.  In the past month alone it had soared 87%, nearly doubling!  It had skyrocketed 197% in 2 months, 280% in 4 months, and 459% in 5 months.  This left bitcoin radically overbought, trading at 3.70x its 200-day moving average.

The problem with such extreme mania price gains is they soon collapse under their own weight.  Over the past week ending Wednesday, bitcoin was surging an average of 5.9% per day.  Two of those days had 9.7% gains.  Literally nothing can rally 5% to 10% per day for long, as the math is truly impossible.  Think of that old rule of 72, which is used to approximate how long it takes for any investment to double in price.

It is normally applied to years, where 72 is divided by the average annual return to figure out about how many years it will take to grow 100%.  72 divided by 7% for example works out to about a decade to see 100% gains.  But at 5% or 10% compounded daily as bitcoin is doing, its total value will double in just under 14.3 and 7.3 trading days respectively! Even to a casual observer that sounds absurd, wildly unsustainable.

Early Thursday morning, the total market value of all bitcoins in circulation was already around $250b.  If bitcoin doubles again over the coming weeks and months, that would soar over $500b.  Just one more doubling after that would take it to a staggering market cap of $1t!  While anything is possible, that seems wildly improbable.  For comparison, the Fed’s latest read on its total M1 money supply is running near $3.6t.

When anything shoots parabolic in a popular speculative mania, exponentially more capital inflows are required to sustain such extreme gains.  It doesn’t take many doublings in price and market cap to suck in all available money on the planet!  While bitcoin certainly enjoys a popular niche, there’s zero chance that global investors will sell sizable fractions of their bond, stock, gold, and cash holdings to buy bitcoins.

Thus extreme gains are never sustainable, as the collective buying power of even populations caught up in manias soon exhausts itself.  Eventually everyone interested in buying bitcoin has already bought, drying up their pools of available capital.  When those massive bubble-fueling capital inflows peak then taper off, market gravity reasserts itself and the stratospheric price starts plummeting back down to terra firma.

Unfortunately naive speculators don’t realize how extreme doublings and quadruplings within a matter of months truly are.  That makes it easier for them to get sucked into mania psychology.  They read about the blistering gains, everyone is raving about the bubble market, so they throw caution to the wind and buy in super-high.  Even worse, many traders rushing to buy into parabolic bubbles borrow money to do it with!

At that point all rationality is thrown out the window, it’s an extraordinary popular delusion as Mackay wisely wrote 176 years ago.  The price is totally disconnected from reality, and the sole reason capital is flooding in is because it is soaring.  That becomes self-reinforcing for a season, buying fueling gains and greed which leads to even more buying.  While exciting, vertical parabolic blowoffs are exceedingly dangerous.

Every popular speculative mania in history has failed spectacularly, the bubbles bursting and crashing, since capital inflows can never grow exponentially for long.  That’s going to happen to bitcoin too, without any doubt.  The deluded speculators who succumb to the temptation to buy in high, especially if they use leverage, are going to get slaughtered.  An infamous past bubble helps illustrate bitcoin’s extreme dangers today.

This final chart again assumes Wednesday was this bitcoin bubble’s peak for the sake of analysis.  The past couple years’ bitcoin action is superimposed over the notorious silver bubble that crested in January 1980.  Both datasets are indexed at 100 at their respective peaks to render them in perfectly-comparable percentage terms.  The bottom axis shows time elapsing before and after the peaks measured in months.

The parallels between bitcoin’s extreme parabolic price action over the past 6 months or so and silver’s in its bubble’s final 6 months are uncanny.  While very rare, popular speculative manias are nothing new.  The terminal gains of bitcoin and silver are remarkably similar as the table above shows.  If these data series were not labeled, today’s bitcoin bubble and the 1979 silver bubble would literally be indistinguishable.

As of Wednesday bitcoin had rocketed 87% in its latest month compared to 104% for the silver bubble in its terminal month.  At 2 months out they were identical at 197% and 196% gains.  The same was true at 3 months with 181% and 179% gains.  In their final 5 months, they skyrocketed 459% and 417% higher.  Their terminal 6 months saw 366% and 402% gains.  This bitcoin bubble is behaving just like the silver bubble!

While bubbles are incredibly exciting and fun when they shoot parabolic, the aftermath is catastrophic for traders who buy high.  Bubbles always burst, leading to full-on crashes that proceed long busts.  Just a month after silver peaked at $48.00 per ounce in January 1980, it plunged 35%.  In the first 2, 3, and 4 months post-peak, silver plummeted 54%, 73%, and 76%!  Bitcoin faces similar extreme downside risks today.

Once this mania bitcoin bubble bursts, and it will, the odds are very high that bitcoin will lose 50% to 75% of its value within a few months on the outside!  Everyone owning bitcoin today must be prepared for brutal near-term downside proportional to this year’s bubble upside.  When a bubble bursts it rapidly destroys most of the paper wealth that bubble created, which was really an illusion all along if not cashed out.

And once popular speculative manias inevitably fail, prices don’t return to those extreme bubble-peak levels for an awfully-long time.  That silver bubble peaked 37.9 years ago, and there are still many silver enthusiasts today.  Like the hardcore bitcoin faithful, plenty of people love silver with a religious-like zeal believing it is the ultimate investment.  In nominal terms, silver didn’t exceed that bubble peak until April 2011.

After taking a staggering 31.3 years to regain January 1980’s high, silver held it for a single day and has never returned since.  And in real inflation-adjusted terms based on the US CPI, silver’s bubble peak in today’s dollars was over $152 per ounce!  Obviously silver has come nowhere close to trading near those same real levels again.  Prices are so extreme after popular speculative manias they may never recover.

A far-milder bubble than both bitcoin and silver arose in the stock markets in late 1999 and early 2000.  Like bitcoin, the technology of the Internet was amazing and would forever change our world.  Yet stock prices got so extreme then that the NASDAQ didn’t revisit its March 2000 closing peak for the first time until April 2015, fully 15.1 years later!  And that only happened because NASDAQ’s components greatly changed.

The history of popular speculative manias proves that even if bitcoin and its underlying blockchain are here to stay, it will likely be many years or decades until bitcoin prices regain their bubble peak wherever that happens to be.  Once this bitcoin bubble inevitably pops, there’s virtually no chance its traders will be made whole again.  They’ll hold through the burst in hopes bitcoin will rebound, but bubble poppings are final.

And it’s not just bitcoin’s extreme price action that reveals it’s in a bubble fueled by a popular speculative mania.  Anecdotal stories abound showing a huge influx of young and naive “investors” who have never lived through a bubble.  The leading bitcoin broker in the US is Coinbase.  Its accounts are exploding as people rush to pour money into this bitcoin mania.  By late November, Coinbase’s active accounts had hit 13.3m!

This is staggering growth, as Coinbase reported just over 5m accounts as 2017 dawned. 13.3m is way bigger than stock broker Charles Schwab’s 10.6m at the end of October, and threatening to rival the 24.9m accounts stock broker Fidelity had at the end of June!  As in all manias, the vast majority of these new bitcoin “investors” have drank the Kool-Aid and believe bitcoin’s technology justifies its extreme price gains.

When markets soar so high all rationality is thrown out the window, the only reason to keep buying is the greater-fool theory.  Late-stage traders buy super-high in the hopes they’ll find an even greater fool to sell even higher to later!  Soaring prices can entice in big new capital inflows for a season, but eventually the price levels get so high that it’s impossible to sustain exponential buying.  Then the bubble bursts, prices crash.

Even if bitcoin and blockchain forever change currencies in the future, nothing justifies doublings and quadruplings in bitcoin prices in a matter of months.  Such extremes are never sustainable, all popular manias fail spectacularly even though the technology investors were excited about lives on and indeed changes the world.  I’m really excited to see bitcoin and blockchain applied to digital gold in coming years.

Gold has been universally valued across the world for millennia, yet it’s impractical to use as money for most transactions.  But if bitcoin-and-blockchain technologies were applied to gold, this metal could easily be subdivided into the tiniest of increments and traded globally.  A gold version of bitcoin would have to be 100% physically backed by gold held in secure vaults in safe, trusted countries.  It’s already being worked on.

But the great value of bitcoin-and-blockchain technologies doesn’t make bitcoin immune from the natural consequences of this year’s bubble.  Bitcoin is far too large now to keep doubling on a monthly basis, it’s impossible.  And there’s never been a past bubble where prices stop soaring but don’t crash, instead just rallying on from there quasi-normally. Greedy traders start selling when the parabola stalls, driving the burst.

One of the reasons bitcoin has skyrocketed is there are virtually no sellers relative to the great herds of new buyers flocking in.  That is all going to change soon, which presents big risks of popping this bubble.  Both the CBOE and CME are set to launch actual bitcoin futures in the next week or so, which will allow professional speculators to not only buy bitcoin but short sell it at scale.  That alone may very well slay this bubble.

Bitcoin is pretty inefficient too, with transactions taking up to 10 minutes to process as the blockchain gets bigger and bigger.  Transaction costs are also skyrocketing, leading some major businesses like the Steam online video-gaming service to stop accepting bitcoin as payment.  Its owner Valve says it now costs about $20 to process a single bitcoin payment, far too expensive for this company’s massive 67m users.

As bitcoin grows, the blockchain itself is getting ever-more unwieldy.  That ledger recording every single bitcoin transfer ever is requiring progressively more computing power to process, making mining for the network much more expensive.  Recent estimates place bitcoin-mining electricity usage at 0.13% of the world total.  A single bitcoin transaction now requires enough electricity to power an American house for a week!

 

As long as bitcoin prices are sky-high, large-scale mining operations to process bitcoin’s cryptographic hashes are profitable.  But when bitcoin crashes after this bubble, computers tasked to mining will likely plunge in parallel.  While the hashes are dynamically adjusted to account for network mining power, this could still increase transaction times as blockchain grows.  That would make bitcoin less attractive as a currency.

As a professional speculator over the past two decades or so, I wouldn’t touch bitcoin with a ten-foot pole today.  Buying into a popular speculative mania that’s already rocketed parabolic is the height of folly, guaranteeing massive losses in the near-future.  If you were shrewd enough to buy bitcoins before the last 6 months, you should be scaling out and taking profits.  One bitcoin expert calls it a “consensus hallucination”.

At Zeal we’ve spent decades studying and trading the markets, building wealth normally and consistently through profitable real-world trading with a contrarian bent.  This means buying low and selling high, so bitcoin is off the table.  But as of the end of Q3 we’ve realized 967 stock trades recommended in real-time in our newsletters since 2001, which averaged stellar annualized realized gains of +19.9% over that long span!

The key to this success is staying informed and being contrarian.  That means buying low when others are scared, not when they are euphoric like in bitcoin’s mania.  An easy way to keep abreast is through our acclaimed weekly and monthly newsletters.  They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks.  Easy to read and affordable, they’ll help you learn to think, trade, and thrive like contrarians.  Subscribe today, and build lasting wealth instead of getting obliterated when bitcoin’s bubble bursts.

The bottom line is this year’s bitcoin popular speculative mania has gone parabolic.  Such extreme gains are never sustainable, as they require exponentially-growing capital inflows.  Once this greed-drenched bubble stage is reached, it’s only a matter of time until the burst inevitably follows.  The resulting selling from panicking traders is so violent that most of the mania gains are fully annihilated in a matter of months.

While bitcoin and its blockchain distributed-ledger technologies are amazing and will indeed likely change the world, they don’t justify bitcoin’s extreme vertical gains.  Plenty of past bubbles were based on great new technologies too, but those prices still collapsed once the supply of greater fools exhausted itself.  After skyrocketing so darned fast, bitcoin is certainly the riskiest major investment in the world.  Caveat emptor!

Adam Hamilton, CPA

December 8, 2017

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