If you do buy into the latest hot investment, one homespun piece of advice is to sell when even the taxi drivers are talking about it. It is funny how people now are ready to trash every single information about the crypto bubble yet they were too consumed to listen to any talks about the stages of a bubble. I happen to undertake my community service in a primary school and fortunately enough I’m given a chance to talk to the students about life (I am pretty young) and about my career in general. In between our conversation, that word pops up.
Bitcoin has been around for a few years but now it is a very popular thing in Kenya. It has been in our day-to-day conversations; right from the investors, regulators, and the fancy bitcoin miners. People understood the investing bit for a moment but never understood the reality of a bubble. Back in 1720, the mania of that time was South Sea Company Stock, one of the largest stock scams of all time. The UK based company saw its shares appreciate purely based on rumour, speculation and false claims before hurtling into a huge loss for investors. One of the investors at that time was the great renowned scientist of all time Sir Isaac Newton. He was a genius and was largely known for his ground-breaking discovery of gravity. However, Newton lost a sum amount of 22,000 (today’s purchasing power is equivalent to 3.1 million). Not even Newton could understand the law of Financial Gravity, yet he is the author of universal gravity.
History repeats itself and investors in Bitcoin are unravelling this truth about bubbles. The price of the crypto peaked last month at somewhere over $19,000 but, at the time of writing, some exchanges now show a price below $10,000 (Economist). Perhaps the best way of understanding bitcoin is a model of how bubbles operate. The classic model, developed by Hyman Minsky and elaborated by Charles Kindleberger, a historian who studied bubbles, has five stages: displacement, boom, euphoria, financial distress and revulsion. The displacement is some technological development that can be used to justify a “new era”—railways, canals, the internet or blockchain. A boom then occurs and drags in more and more investors; at some stage, we reach euphoria, where the boom is widely known to the public and there is talk about those who made millions from the trade. This stage had been reached in November when there were adverts for cryptocurrencies on the train and discussions on popular radio programmes.
In the euphoria stage, people buy because others are buying and because they anticipate being able to sell quickly at a higher price. For a while, this trend is self-reinforcing. At some stage, however, doubts set in; some people decide to take their profits while they can. Bad news occurs; with bitcoin, like South Korea (where trading has been particularly active) banning anonymous cryptocurrency trades according to the BBC.
Once the price starts to fall, the psychology changes. People who bought early and were counting their millions suddenly see a dent in their wealth (and it is worth noting that you are not really rich unless you have got into the asset class and out again). Other people may have bought above the current price and are bitterly regretting their mistake. Bargain hunters jump in and temporarily drive the price higher but it doesn’t last.
We have not yet reached the “distress” stage but we might be near it. Worries about the security of cryptocurrencies could be the trigger for another sell-off. At that point, the price could fall as quickly as it rose—as the saying goes “up like a rocket, down like a stick”. Investors may well reflect that bitcoin has not become a means of exchange for day-to-day transactions, has not proved to be a reliable store of value and thanks to the proliferation of cryptocurrencies, does not really benefited from a limited supply.