Some hundred years ago, Russian political economist Nikolay Kondratiev proposed a technological supercycle of 45-60 years, roughly corresponding to a human lifetime. Kondratiev’s core idea is that technology born in the ashes of the prior period drives the growth and investment in the subsequent supercycle. Each “Kondratiev wave” ends with a long “winter” crisis, distinguished by contracting investment and collapsing birthrates.
Kondratiev waves are easily observable in modern history. The steam-power wave ended with the depressions of the 1870s, which lasted through the mid-1890s. The electricity wave ended with the depression of the 1930s, which lasted through the 1940s. The semiconductor wave likely ended with the housing bust of the late 2000s.
This is winter.
To combat the deflation and unemployment of the winter depression, global central banks have unleashed unprecedented credit creation and desperate asset purchases to keep prices rising. The inevitable result has been record-low, even negative interest rates. Risk premia across asset classes have been crushed. Volatility has been pancaked.
The low interest rates have clobbered active management and the hedge-fund industry in particular. This is especially true in fixed income, where compressed yields mean you need massive defaults to make money. Some of the best fund managers (who, as a rule, don’t just look to sell-sell-sell and skin their clients) have returned money or completely shut down services for the public.
As a result, the industry has downsized and bifurcated. On one hand are the large “passive” funds, which can only survive by strong asset-allocation (esp. macro) research. On the other are boutique firms, which can only survive by offering a unique product. Whales of the investment world such as public pension funds can’t enter those narrows because they would wreck the investment strategy with sheer size. This is the barbell writ large. And everywhere survival is tough because ever more freshly created money chases ever more elusive yields. Volatility is record low while tail risk scales ever greater highs.
The technology sector is probably where the thick blanket of free money over Kondratiev’s winter has fallen heaviest. From bloated VC portfolios to unicorn IPOs we can only guess what the scale of the damage is and how much of the tech “industry” will be swept into oblivion by the end of the supercycle. Bitcoin was born into this strange winter of excess.
Let’s get something out of the way right now: anyone who purports to know why bitcoin has exploded in price is an idiot.
However, we do know that much of the recent price action has been driven by retail investors (famous in the industry as “the dumb money”). Some may be buying $BTC in hopes of solving their financial problems, much like they’d buy a lottery ticket. Others may be trying to escape central banks’ redistribution of wealth to the superrich. Yet others have undertaken to promote and own “digital currency” in hopes that it will “democratize” money and financial transactions, taking governments out of the picture.
Hodl is the operative word here. You may hodl bitcoin as a matter of faith, speculation or diversification, but you may not hold it as an investment, let alone one that can be valued.
To bootstrap a new money, create a religion around it. The core teaching is to hodl at all costs, no matter the temptation, until all unbelievers capitulate.
— Naval (@naval) 2017-12-07
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One reason I have been ignoring $BTC is that it's technologically dead on arrival. It simply does not do most of the things its evangelists claim it does (more on that in another post). A big part of this is about the transparency and complexity of market structure. More recently, it has also surfaced that a relatively small group of people own about 40% of all bitcoin. This makes the bitcoin “market” ripe for manipulation worthy of the robber barons of the Gilded Age.
Bitcoin: my answer to the repeated questions.
No, there is NO way to properly short the bitcoin "bubble". Any strategy that doesn't entail options is nonergodic (subjected to blowup). Just as one couldn't rule out 5K, then 10K, one can't rule out 100K.
Gabish?— NassimNicholasTaleb (@nntaleb) 2017-12-09
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A huge misconceptions about bitcoin is that its supply is limited. That belief is founded on the fact that most Coin Fiends have no practical knowledge of how the financial industry works. No domain of human activity can be considered immune to financialization. Not even traditional “money” like gold and silver, which many gold bugs considered the ultimate antidote to financialization. With the tacit support of regulators, the financial industry wrecked the gold market by issuing virtually unlimited (another pun) amounts of paper gold.
1) People who believe that bitcoin has a limited supply don’t understand how the financial system creates money.
— sᴛᴀʀᴛᴜᴘ ᴅᴀᴇᴍᴏɴ (@startupdaemon) 2017-12-07
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Tomorrow, the CBOE launches the first bitcoin futures. And a number of other traditional exchanges have plans to make bitcoin futures available soon. Yes, traders will be subject to draconian margin requirements. But this won’t prevent any large institution from flooding the market with supply. Some less naïve Coin Fiends even expect full-out war with the financial industry from day one. This is possible but unlikely. Bitcoin volume is too small to be a real threat yet, especially to an industry which has government regulators in its back pocket.
A lot of the early demand for BTC futures will likely be from 17-year-old hedge-fund managers downsized from the fixed-income desk of a global major. Experienced mom-and-pop traders, who sometimes get sharky, will probably be some of the early adopters as well. Large institutions starved for yield will wade in over time, but probably much more cautiously and not at scale. The biggest impact, at least initially, will likely be from removing the barriers to speculative demand imposed by the high transaction costs and latency of crypto exchanges. Retail buyers too unsophisticated to set up a coindesk account (the dumbest money) will flood in as more $BTC products become available.
These are some reasons why I am willing to be a contrarian and see imminent financialization as short-run bullish for bitcoin. With the CME, CBOE and other traditionals in the game, one has a much higher expectation of getting paid at the end of the day. Transaction bandwidth will increase by orders of magnitude, which can reduce the frequency of extreme price swings. Tail risk will also increase – exponentially – because of the concave scalability of financial markets in size and complexity. Extreme moves will get rarer and extremer. Which is short-term bullish and long-term devastating.
I have to pause here and address the elephant in the room – ludicrous analogies between bitcoin and Tulip Mania. Understand that historical volatility is a very poor measure of real and present danger. Yes, bitcoin is probably just a massive bubble (like most other assets right now). Yes, it could lose all of its value in the matter of minutes. And yes, I won’t be surprised one bit (pun intended) if it reaches $100,000 by yearend 2017. This is what tail risk is all about. Speaking of which, I would like to remind any Tulip Jokers that their retirement money (if they have any) is likely held in a 401k with inane levels of tail risk.
Tulips are the Hitlers of Bitcoin bubble analogies. https://t.co/2m5dwPsEM1
— Scott Adams (@ScottAdamsSays) 2017-12-09
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Tail risk has spread like wildfire because of the financial repression imposed by central banks over the past decade. It’s metastasized everywhere and it’s very hard to measure. So before you go on giggling about Coin Fiends, it may be a good idea to consider how your job, house and the rest of your risk portfolio are hedged. Willingly or not, today we’re all dwellers of Taleb’s Extremistan. We ought to plan accordingly.
The thing about tail risk is that it lurks where you are least likely to see it. Remember that a lot of the run-up in financial markets is always driven by a few momentum names such as the infamous FANG stocks. Each asset class has a limited capacity. Large-cap momos are where the smart money piles in first and the dumb money leaves last. Because momentum is the only remaining game in town for institutions and retail alike, when volatility makes a comeback it will strike first and hit hardest household names like Apple and Amazon.
The impact on such B2C companies will be unexpectedly large because of the immediate effects of market volatility on consumer spending. The more complex a system and the more repressed its volatility, the greater the fragility. The greater the fragility, the higher the vega. Traditionally volatile illiquids such as private equity and venture capital surely have benefited from financial repression. But they may have less vega exposure than expected because their access to free money is not as large and their valuations are less dependent on near-term sales.
Kondratiev’s winter has a purging effect on the economy and cannot be repressed indefinitely. Hedge wisely if you don’t want to be one of the purged.