Opinion: Why the most recent bitcoin decline is different

It’s possible that the mania phase ended last week, and the blow-off phase has started

The emergence of new cryptocurrencies following bitcoin is similar to the numerous dot-com IPOs at the height of the Nasdaq mania in 1999-2000.

On Nov. 21, a client asked me how to invest in bitcoin and whether Navellier & Associates offered a crypto-managed account. I will omit the client’s name, but below is my response with the links I included, as readers of this column need to hear this:

“In my professional opinion, since you are a client and we owe you fiduciary guidelines, bitcoin is a scam. It is designed to cram a rising amount of people into a limited number of bitcoins (will top out at 21 million or so), that’s why the price is rising. This is a bigger scam than Madoff in plain sight. I think it ends like Madoff, but it is not over yet. (Bloomberg, Nov. 21: “Wealth Managers are Being Inundated with Calls About Bitcoin” and “Cryptocurrency Market Capitalizations.”)”

The Bloomberg article described how clients call advisers to ask how to invest in bitcoin. It is right on the money, as I have experienced it more than once. But given the action in bitcoin over the past week, I have to say that it is possible we have reached the top, as the trendy electronic crypto-currency collapsed from $19,363 on Sunday, Dec. 17, to a low of $12,148 (down 37% in five days) before recovering a bit (see chart).

The interesting part is that bitcoin closed at $8,095 on Nov. 21, when that email exchange happened, so this “electronic tulip bulb,” as I like to call this crypto absurdity, saw its price more than double before it crashed last week. If one had bought bitcoin on Nov. 21, one would still be up more than 50% as of this past Sunday, although I am not sure for how long, given how fast the market for bitcoin is moving. Also, bitcoin trading is 24/7, including weekends.

Map of past bubbles

Here is the typical map of investor sentiment for past bubbles (see chart).I think it is entirely possible that the mania phase ended last week, and we have started the blow-off phase. When Bloomberg ran a story to describe the wild trading in bitcoin last week, it included the following chart (Dec. 21, from Bloomberg: “Bitcoin Lost Almost 20% of Its Value This Week”).

The implication in the above chart is that we have seen similar crashes before in bitcoin, which I take to suggest that this may not be a top. The reason why I think it may be a top is that, previously when those crashes happened, we were not in a full-blown mania phase and bitcoin had not yet hit the mainstream. Given that the phone had started to ring with questions on how to capitalize on this electronic tulip bulb absurdity is a good indication that we just completed the mania phase, which to me suggests that last week’s decline may be different.

Other cryptos enter the fray

The popping up of other cryptocurrencies is similar to the numerous dot-com IPOs at the height of the Nasdaq mania in 1999-2000. In addition to bitcoin, we have “bitcoin cash,” a different crypto absurdity named to only associate itself closer with its namesake electronic tulip bulb. Most other cryptos also had really bad sell-offs last week, but the drama is obviously concentrated on bitcoin because it is the only one with futures trading and it is also the biggest. The “value” of this electronic nothingness reached over $300 billion last week and, as of this writing, is still near $220 billion so there is a lot more pain to come.

It is also notable to point out that a crypto called litecoin had its founder dump his entire stake last week after he got wind of the vicious popping of the crypto bubble. The litecoin founder gave the official reason for his cashing out to be to avoid conflicts of interest when he comments on the crypto market, which I personally do not buy as a valid reason (see chart).

The action last week appears to be a meaningful break in the bitcoin madness. I would only add that the major stages in a bubble (as seen in the second chart above) are likely to develop a lot faster than in the case of the Nasdaq in 2000, due to the fact that bitcoin is not an operating company but a line of code.

How not to trade bitcoin in the stock market

In looking up details for this column, I came upon a publicly traded trust in the OTC market whose business is to hold bitcoin! The electronic tulip bulb absurdity is multiplied in this case as the trust typically trades at better than 50% premium to the “value” of the electronic tulip bulbs it holds (see Dec. 21 Benzinga article, “How the Bitcoin Investment Trust Actually Works”).

The bitcoin trust was changing hands near $100 in early 2017 but last week it reached $3,523 before correcting to under $1,200. While I would advise sane investors to stay away, obviously the goal of the creators of this trust was to make it easier to capitalize on the bitcoin mania in the stock market.

While this bitcoin stock market vehicle is unshortable due to the heavy borrowing fees as well as the difficulty with which one can borrow the shares, the GBTC, -6.51% ticker will serve a valuable illustration tool for our purposes as it would allow me to show how the theoretical 10-year gold/bitcoin trade described in last week’s MarketWatch column would work. (Note: Neither Ivan Martchev nor Navellier & Associates hold a position in bitcoin.)

I mentioned on Dec. 19 that if the choice were given to me to hold one bitcoin or the equivalent in gold bullion for 10 years and only be able to sell one of those two items at the end of the decade, I would take the gold bullion because in the case of bitcoin there was unlikely to be any “thing” to sell.

This type of trade can be tracked with a GBTC, -6.51% : GLD, +0.53% ratio where the bitcoin trust and the gold ETF can be seen with GBTC outperforming when the chart is going up and gold outperforming when the chart is going down. Last week that ratio moved from over 29 to under 10 before settling at 16.45 (see chart).

If this was the climactic top in the electronic tulip bulb market, we should not exceed the 29.40 reading seen on the GBTC : GLD ratio seen last week. Also, I think the large net asset value (NAV) premium of the GBTC trust would eventually disappear and that the GBTC : GLD ratio would eventually decline below 1 (where it was earlier in 2017), if not ultimately zero.

By IVAN MARTCHEV
https://www.marketwatch.com/story/why-the-most-recent-bitcoin-decline-is-different-2017-12-28