Up Because It’s Up
BITCOIN HIT A NEW high last week, topping $112,000. Over the past 12 months, it’s climbed an impressive 55%.
What’s driving this gain, and what should you make of it? I believe there are three key factors. Two are new. One is not.
The first factor was a policy change last year. The federal government approved the launch of new exchange-traded funds (ETFs) that offer easier and more direct access to bitcoin. Following this rule change, 11 new bitcoin ETFs were launched in quick succession. These new funds collected more than $100 billion in assets, which then helped drive up bitcoin’s price—and sparked even more interest among investors.
The second factor was the Trump administration’s friendlier posture toward cryptocurrency. The president declared his intention to become the “crypto president” and issued executive orders loosening restrictions on crypto firms. There is now a “crypto czar” in the White House. The administration also discussed the idea of funding a strategic bitcoin reserve akin to Fort Knox.
A third factor, however, may be the most powerful driver of bitcoin’s gains: The reality—justified or not—that asset prices tend to go up when other people think they’re going to go up. While this might sound circular, it’s a well-understood economic concept, one first articulated by John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest and Money.
Keynes compared the stock market to what he called a “reverse beauty pageant.” Investors, he said, were no longer looking to choose the most attractive investments. Instead, “we devote our intelligences to anticipating what average opinion expects the average opinion to be.” In other words, investors want to buy what they think other people will want to buy, regardless of the investment. Using that yardstick, bitcoin looks eminently appealing. In addition to its most recent runup, bitcoin delivered more than a 1,000% gain over the past five years and is clearly what other people want to buy.
To a degree, investors’ attitude toward bitcoin is rational. There’s a concept known as “rational ignorance” that helps explain some of the enthusiasm. According to this theory, there’s too much going on in the world for any one person to follow. Instead, we rely on the opinions of others to help fill in our knowledge gaps. If someone else has done the research and reached a conclusion on a particular topic, it makes sense for others to piggyback on his or her efforts. While this can be helpful, the fly in the ointment is that this same channel can inflate investment bubbles.
A related concept also helps explain the rise of bitcoin. It’s what author Chimamanda Adichie refers to as a “single story.” Whenever there’s a simple, easy-to-understand story associated with an idea, that story will help spread that idea. Bitcoin has several compelling stories. One is the idea that, unlike traditional currencies, it’s independent of any government’s control. Another is that its total supply is structurally limited to 21 million coins, making it resistant to inflation. There’s also mystery surrounding its creator, who used the pseudonym Satoshi Nakamoto but has never been identified. No one has ever even claimed to know someone who knows him.
I believe these stories help explain much of bitcoin’s popularity. No one really knows where it will go in the future, but because bitcoin seems like it’s going somewhere, more people are likely to get on board.
In fairness, investors have been taught to believe in markets and to trust market prices. This is the cornerstone of the efficient market hypothesis (EMH). This theory—for which economist Eugene Fama won a Nobel Prize—argues that asset prices are always “correct” because they reflect all available information. According to the EMH, if bitcoin is trading at $112,000, then that must be the right price, because it reflects the collective wisdom of millions of investors everywhere.
This notion, that prices are “informationally efficient,” goes back as early as the 1900s when a fellow named Francis Galton conducted an experiment at a livestock exhibition. He set up a lottery, asking contestants to guess the weight of an ox on display. He collected 787 votes, and then compared the average to the actual weight of the animal. The crowd was remarkably accurate: The average guess was 1,207 pounds, while the actual weight of the animal was 1,198 pounds. Galton dubbed this vox populi—the voice of the people.
More recently, author James Surowiecki took a closer look at this phenomenon in a book titled The Wisdom of Crowds. Surowiecki points out that crowds aren’t always accurate. Instead, the following criteria are required for the vox populi to deliver a reliable answer:
Diversity of opinion.
Independence of opinion.
Decentralization of available information.
A mechanism for aggregating opinions.
I believe this is where the bitcoin story is flawed. Markets today are generally not independent. In the age of the internet, opinions are rarely independent. Investors all influence each other, especially when it comes to something like bitcoin. Bitcoin has turned people into millionaires and even billionaires because opinions are shared broadly and publicly. Services such as Google Trends can quantify this. This constant public discussion sits in contrast to the secret ballots cast at the livestock competition, where each contestant made a strictly independent judgment.
Hedge fund manager Clifford Asness argues that this phenomenon reaches beyond cryptocurrency. Because the internet—and especially social media—have made communication so easy, Asness says, the collective investment judgment of crowds has gotten worse, not better. He calls this the “less-efficient market hypothesis.”
Bitcoin’s gains may make it appear that it has a solid foundation. I believe, however, it’s like constructing a building on quicksand. A quick survey of bitcoin’s peers helps illustrate why. For starters, there are now thousands of different coins. One online tutorial describes how easy it is to create a new crypto coin. That’s why creations like the TRUMP coin, launched this January just before Inauguration Day, have achieved market capitalizations in excess of $2 billion.
If coins like this can be created out of thin air and gain millions or billions of dollars in value, there’s no reason to see bitcoin as being less of a mirage than its more obviously comical brethren. I believe the only reason bitcoin carries more legitimacy is because it was first. But as economist Owen Lamont points out, that doesn’t mean it has value that’s more tangible than other crypto creations. “We buy bitcoin because we believe others will buy it in the future,” he says. It’s the “Kardashian of money”—famous only because it’s famous.
In his book Narrative Economics, Robert Shiller puts it this way: “People are interested in bitcoin precisely because so many other people are interested in it.”
It’s for this reason that I recommend standing clear of the frenzy. Unlike real investments such as stocks, bonds and real estate, which carry intrinsic value—that is, the ability to generate income—bitcoin has nothing tangible supporting its value. It is only valuable because it’s popular. But as tulip investors learned the hard way in the spring of 1637, sentiment can shift quickly.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
What’s driving this gain, and what should you make of it? I believe there are three key factors. Two are new. One is not.
The first factor was a policy change last year. The federal government approved the launch of new exchange-traded funds (ETFs) that offer easier and more direct access to bitcoin. Following this rule change, 11 new bitcoin ETFs were launched in quick succession. These new funds collected more than $100 billion in assets, which then helped drive up bitcoin’s price—and sparked even more interest among investors.
The second factor was the Trump administration’s friendlier posture toward cryptocurrency. The president declared his intention to become the “crypto president” and issued executive orders loosening restrictions on crypto firms. There is now a “crypto czar” in the White House. The administration also discussed the idea of funding a strategic bitcoin reserve akin to Fort Knox.
A third factor, however, may be the most powerful driver of bitcoin’s gains: The reality—justified or not—that asset prices tend to go up when other people think they’re going to go up. While this might sound circular, it’s a well-understood economic concept, one first articulated by John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest and Money.
Keynes compared the stock market to what he called a “reverse beauty pageant.” Investors, he said, were no longer looking to choose the most attractive investments. Instead, “we devote our intelligences to anticipating what average opinion expects the average opinion to be.” In other words, investors want to buy what they think other people will want to buy, regardless of the investment. Using that yardstick, bitcoin looks eminently appealing. In addition to its most recent runup, bitcoin delivered more than a 1,000% gain over the past five years and is clearly what other people want to buy.
To a degree, investors’ attitude toward bitcoin is rational. There’s a concept known as “rational ignorance” that helps explain some of the enthusiasm. According to this theory, there’s too much going on in the world for any one person to follow. Instead, we rely on the opinions of others to help fill in our knowledge gaps. If someone else has done the research and reached a conclusion on a particular topic, it makes sense for others to piggyback on his or her efforts. While this can be helpful, the fly in the ointment is that this same channel can inflate investment bubbles.
A related concept also helps explain the rise of bitcoin. It’s what author Chimamanda Adichie refers to as a “single story.” Whenever there’s a simple, easy-to-understand story associated with an idea, that story will help spread that idea. Bitcoin has several compelling stories. One is the idea that, unlike traditional currencies, it’s independent of any government’s control. Another is that its total supply is structurally limited to 21 million coins, making it resistant to inflation. There’s also mystery surrounding its creator, who used the pseudonym Satoshi Nakamoto but has never been identified. No one has ever even claimed to know someone who knows him.
I believe these stories help explain much of bitcoin’s popularity. No one really knows where it will go in the future, but because bitcoin seems like it’s going somewhere, more people are likely to get on board.
In fairness, investors have been taught to believe in markets and to trust market prices. This is the cornerstone of the efficient market hypothesis (EMH). This theory—for which economist Eugene Fama won a Nobel Prize—argues that asset prices are always “correct” because they reflect all available information. According to the EMH, if bitcoin is trading at $112,000, then that must be the right price, because it reflects the collective wisdom of millions of investors everywhere.
This notion, that prices are “informationally efficient,” goes back as early as the 1900s when a fellow named Francis Galton conducted an experiment at a livestock exhibition. He set up a lottery, asking contestants to guess the weight of an ox on display. He collected 787 votes, and then compared the average to the actual weight of the animal. The crowd was remarkably accurate: The average guess was 1,207 pounds, while the actual weight of the animal was 1,198 pounds. Galton dubbed this vox populi—the voice of the people.
More recently, author James Surowiecki took a closer look at this phenomenon in a book titled The Wisdom of Crowds. Surowiecki points out that crowds aren’t always accurate. Instead, the following criteria are required for the vox populi to deliver a reliable answer:
Diversity of opinion.
Independence of opinion.
Decentralization of available information.
A mechanism for aggregating opinions.
I believe this is where the bitcoin story is flawed. Markets today are generally not independent. In the age of the internet, opinions are rarely independent. Investors all influence each other, especially when it comes to something like bitcoin. Bitcoin has turned people into millionaires and even billionaires because opinions are shared broadly and publicly. Services such as Google Trends can quantify this. This constant public discussion sits in contrast to the secret ballots cast at the livestock competition, where each contestant made a strictly independent judgment.
Hedge fund manager Clifford Asness argues that this phenomenon reaches beyond cryptocurrency. Because the internet—and especially social media—have made communication so easy, Asness says, the collective investment judgment of crowds has gotten worse, not better. He calls this the “less-efficient market hypothesis.”
Bitcoin’s gains may make it appear that it has a solid foundation. I believe, however, it’s like constructing a building on quicksand. A quick survey of bitcoin’s peers helps illustrate why. For starters, there are now thousands of different coins. One online tutorial describes how easy it is to create a new crypto coin. That’s why creations like the TRUMP coin, launched this January just before Inauguration Day, have achieved market capitalizations in excess of $2 billion.
If coins like this can be created out of thin air and gain millions or billions of dollars in value, there’s no reason to see bitcoin as being less of a mirage than its more obviously comical brethren. I believe the only reason bitcoin carries more legitimacy is because it was first. But as economist Owen Lamont points out, that doesn’t mean it has value that’s more tangible than other crypto creations. “We buy bitcoin because we believe others will buy it in the future,” he says. It’s the “Kardashian of money”—famous only because it’s famous.
In his book Narrative Economics, Robert Shiller puts it this way: “People are interested in bitcoin precisely because so many other people are interested in it.”
It’s for this reason that I recommend standing clear of the frenzy. Unlike real investments such as stocks, bonds and real estate, which carry intrinsic value—that is, the ability to generate income—bitcoin has nothing tangible supporting its value. It is only valuable because it’s popular. But as tulip investors learned the hard way in the spring of 1637, sentiment can shift quickly.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.The post Up Because It’s Up appeared first on HumbleDollar.
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