Category Archives: Cryptocurrency

Bitcoin, A Game Theoretic Perspective

Recently Charlie Bilello put together a nice collection of charts with the common theme of markets humbling the prognosticators. The one on bitcoin particularly has been making the rounds. However, I doubt that it will stop the top-calling. With the latest correction precipitated by China’s banning ICO and exchanges, there’s no shortage of “I told you so” going round, even from sources I respect. In this post, I discuss why I believe bitcoin prices will recover from this latest episode and go on to even greater heights. I’ll also address some of the common misconceptions.

The starting point is two facts: 1) Bitcoin is a survivor, from its obscure origin in 2009, it survived no less than five 70-90+% declines, the Mt. Gox hack, the Silver Road case, and most recently the BCC hard fork. It not only survived but flourished with price briefly exceeding $5000. 2) Bitcoin is now an international phenomenon with participation in every major economy. The map below came from a recent Cambridge study “Global Cryptocurrency Benchmarking Study”. It shows where key components of the cryptocurrency ecosystem are located.

Bitcoin and Government Crack Down

One of the greatest fears for a “would-be” bitcoin investor is the likelihood of government crack-down. I want to counter by taking a look at the most well-known example in game theory: the Prisoner’s dilemma. I’ll assume it’s somewhat a common knowledge. A full description can be found at the the Wikipedia Link. A quick synopsis of the conclusion is that although the best outcome collectively is for both prisoners not to talk, the rational decision for each is to talk irrespective of what the other prisoner does. An analogy to bitcoin and government crack down can be drawn:

  • A crime has been committed → the distributed ledger/blockchain is a true innovation that will have profound disruptions in finance and beyond. The bar is not high: it only needs to be believed to have a reasonable probability of coming true.
  • The best collective outcome is for both not to talk → the best collective outcome for all governments is to maintain the status quo by collectively crack down on bitcoin/all crypto.
  • The rational decision for each is to talk → the rational decision is for each country to foster bitcoin/crypto development within so as to get a leg-up/not fall behind in a future where the promises of the distributed ledger come true.
  • The worst outcome for each prisoner is when he does not talk but his partner does → the worst outcome for each country is to crack down on bitcoin/cryto only to find itself fallen behind. Here’s why the multi-player version of the Prisoner’s dilemma is stronger since the probability is higher that at least one other will talk/decide to develop blockchain technology.

So that’s the basic game theory consideration as far as whether governments will or can ban bitcoin/crypto altogether. My conclusion is no country at this point can afford to given the disruptive potential that the blockchain technology has already demonstrated. It’s telling that China’s ban was focusing on the exchange between fiat and crypto which had everything to do with capital controls. They actually made a point to distinguish the blockchain technology itself. Note also that cryptos are both the platform and the funding mechanism so can’t be separated from the development.

Bitcoin and Criminal Activity

It’s undeniable that historically bitcoin has been used by criminals to bypass financial controls, e.g. Silk Road and ransomware; however, there are serious misconceptions as well. I’ll offer some of my own thoughts.

  • All bitcoin transactions are part of the ledger and traceable. There are other coins or services on top of the bitcoin network that make transactions anonymous but bitcoin is open and fully transparent by design. The anonymity comes from the fact that addresses can be obtained easily and without any reporting mechanism.
  • I fully expect that US based exchanges and wallets to be required eventually to identify real persons behind the accounts ala the FINRA “know your customer” regulation. There will be efforts to register individual accounts and addresses. Coinbase will issue 1099’s & that’s probably a prerequisite for its IPO.
  • I have the mental picture of a large “gray goo” that represents all the bitcoin addresses. As legitimate businesses and individual addresses are certified, they become probing needles into this gray goo. Of course the gray goo is growing in size too, so it’s not so easy to limit nefarious activities. But the flip side is that it’ll be trivial to verify the legitimacy of funds and transactions which can be made into a requirement.

The last bullet point is why some believe “Satoshi Nakamoto” to be the evil incarnate (or a CIA agent, which is the same thing) bent on subverting individual freedoms. Now contrast that with those who believe bitcoin is invented for criminals, the dissonance is almost comical. I offer no personal opinion on this matter but thinking individuals should be aware of all sides of this issue.

Miners and Hedge Funds

Of the members of the bitcoin/crypto ecosystem, the miners have probably made the largest capital investment. They are also likely the largest beneficiary of the advancement in prices. There are staircase-like advancement in most cryptos, usually one after another. I have always thought it was the miners engaging in pump-and-dump to unload the results of their mining operations. I have no evidence of course. I simply put myself in their shoes and ask “what would I do?”, with the assumption that everything I can think of, plus plenty more, other people can think of. Anyway, as long as miners are in it for the dough, and the going is good, there is no reason to stop. In that vain, we must watch out for the next halving for an inflection point.

As I write this we’re still in the middle of a decline from early September where the spike low below $3000 represents a correction of over 40% in BTC. From Charlie Bilello’s table that could be the extent of this correction using the other two in 2017 as a guide. We know hedge funds are getting into this game. The new entrants are probably looking to load up since there are no easy way to short. We know the miners can’t leave the correction running too long or too deep, lest it gets “cold” and people lose interest. We also know the potential hard fork on Nov 1 could be a catalyst. So let’s see how things will play out.

Is Bitcoin a Bubble?

Well, fuck yeah! What else can you call it?! Now before you go sell off all your bitcoins make sure you read my views on bubbles. A statement like that has no meaning outside of the context of price targets and time frames (but it absolutely won’t stop people from issuing them). My own view as always been there is still one more leg of this bubble with mass participation to come, especially as the two main concerns mentioned above gets addressed. While we’re at it, here are some other thoughts related to bitcoin that may or may not be commonly accepted:

  • All currencies are based on confidence (hat tip to Martin Armstrong). Bitcoin is the opposite of fiat. It costs way more to mine a bitcoin than to print a federal reserve note.
  • Bitcoin is limited in number by design. Those who say there are be other cryptos so the supply is unlimited should look up the words “network effect”.
  • Crypto is an asset class. Claims of being currency are at best half-truth, just like every bubble needs some element of truth to get started. Bubbles are not about truth or falsehoods but the magnitude of expectations.
  • Hedge funds are rushing into cryptos like it’s a modern day gold rush. Except the gold is not the cryptos themselves but the masses that will loose their shirts.
  • In cryptos we may well be witnessing the repricing of a trillion-dollar asset classes, eventually. Just as the promises about the internet pretty much all came true, but the road was littered with carcasses like Webvan and, and so will most altcoins.
  • Bitcoin will not be ALLOWED to reach 1 million (short of hyper inflation), at that point the whole lot will be worth 16-21 trillion. That’s simply too big a fraction of the world economy and such wealth transfer cannot be allowed.
  • That said I believe a price of $10-50K is totally possible or even likely.
  • The mass phase of the bubble will be signaled by something like a bitcoin ETF and/or Coinbase IPO. I would expect the price to double in several months to a year.

One thing for sure, crypto is a once in a life time opportunity. At times I find it a greater fascination to observe my own emotional reaction to the price movements. This self-awareness is at the root of my conviction that the mass bubble phase still lies ahead. Timing, as always, is everything.

Cryptocurrency Correction

Cryptocurrencies have been correcting since June 12 when Bitcoin price reached $3000. The bounce out of the May 25-27 correction produced a new high but had a lot of internal weakness. Bitcoin is leading the entire crypto universe down, with Ethereum correcting even further than BTC.

Left for its own devices, the correction may last a few months at least. The big unknown is the UASF on Aug 1, meant to address the scaling issue but may leave Bitcoin irreversibly split. That would be a nightmare scenario.

I sold a chunk of coins on June 24 and a quick summary of my crypto experiences so far is as follows: Mar’17, deposited 0.1X; withdrawn so far, 0.068X (68%); coins left, ~0.28X. When I first started, I saw the outcome as bi-modal: it will either take-off or crash to zero. The realization justified a small allocation (~1% of the active accounts). The table below shows the peak and correction so far in BTC, ETH and LTC. Also shown is what I consider as the likely correction targets, as well as my cost basis. It’s amazing that Mar’17 can be considered early here and disaster will have to strike for me to lose money.

Longer term, if one considers Bitcoin to be a competitor to gold and that current monetary gold total about $3-4 trn, it wouldn’t surprise me to see BTC increase 100X. That would bring BTC to about parity with today’s monetary gold marketcap which will surely increase by that time. Of course, I don’t know for sure and I don’t know if another crypto will supplant BTC. There is plenty of evidence that institutions are getting involved, which makes it either 4th or 5th inning using everybody’s favorite baseball analogy.

Cryptocurrency Update

Crytocurrencies were a sea of red on Saturday (above screen shot from Bitcoin peaked at close $2800 (prices differ on different exchanges so the number is for US exchanges and not exact) on Thursday and was below $2000 at one point before bouncing back. According to this technical analysis (note the source), the first correction target is in the $1700’s. This kind of price movement is par-for-the-course for cryptocurrencies. Indeed, the movement in some of the altcoins are multiples larger.

My earlier blog post was in the middle of this vertiginous move up, amongst media exposure in many main stream outlets such as CNBC and Bloomberg. Coupled with buying pressure out of both Japan and Korea where both BTC and ETH prices were about 30-40% above US exchanges, the FOMO fueled rally was all but inevitable. It remains to be seen whether there will be a month-long consolidation as predicted in the CNBC piece or whether it will snap back to $4000+ based on my primitive similarity reading to the 2013 rally. Either way, longer term bitcoin is likely to be higher as I believe a substantial amount of “anti-establishment” capital will be drawn to this “digital gold” rather than the physical one. That said, I remain skeptical about most of the altcoins.

Here’s a quick summary of my activities so far:

  • Mar 2017: Deposited 0.1X into Coinbase/GDAX (X is my estimated annual retirement spend as usual)
  • Apr 2017: Traded LTC along side the SegWit development
  • May 2017: Took some profit and withdrew 0.028X (28% of initial deposit)
  • Value of coins remaining: >0.2X with positions in BTC, ETH, and LTC
  • I have placed several limit sell orders far above the market. Hitting all of them will mean I have sold 30% of the peak coin holdings and have withdrawn the entire initial deposit.

Obviously, I have nothing to complain about. I started this foray fully prepared to lose everything, and in two months the gains are meaningfully impacting the total portfolio. I can only hope to be able to control the position size so there is no adverse impact on the overall volatility. It’ll be a good exercise in controlling greed.

Dabbling in Cryptocurrencies

I started dabbling in crytocurrencies in early March. I’ve just scratched the surface of a vast, previously unknown-to-me universe. What follows is a short summary of what I have learned and my experiences so far. This is not to be construed to be a recommendation to put your money in them.

Wikipedia defines cryptocurrency as “a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency”. The best known example by far is bitcoin (BTC). Bitcoin pioneered the use of blockchain, a database of continuously updated transaction records of all coins, whose maintenance and verification by a peer-to-peer network is the basis of this decentralized trust system. Bitcoin was invented and released in 2008/9 by Satoshi Nakamoto, a pseudonym of an individual or a group of individuals whose exact identity is still shrouded in mystery.

One of the more intriguing aspects of digital currency to me is being prompted to reflect on the nature of currencies in general. Due to my interest in gold, I have always understood the value of a medium of exchange which is a great simplification of what would be an impossibly unwieldy barter system in its absence; and the trust necessary in this medium. Gold achieves this trust by its long history of continued acceptance and the impossibility to conjure up matter (not at reasonable cost, i.e. fusion). Government fiat achieves it by the force of law and pain of imprisonment on counterfeiters. On the other hand, bitcoin relies on the impossibility of mustering the computing power to establishing an alternate blockchain. In other words, the solutions are nature, force and math. For those who see gold as a hedge to government monetary policies, bitcoin should have some attraction as a decentralized alternative largely outside of the current global financial system. In practice though, there is an age divide, with bitcoin acceptance far higher in the more tech-savvy young generation than among the grizzled old man whose image the term “gold bug” conjures up.

The title of the post said “cryptocurrencies” pleural. Indeed bitcoin is only the largest and most well-known. The website lists hundreds of alternative cryptocurrencies, aka “altcoins”:

At this moment, the total marketcap of all crytocurrencies are about $48 billion, with bitcoin at $26 billion or a “bitcoin dominance” — ratio of bitcoin market cap to the total of 54.1%. Despite bitcoin trading near $1600 close to a new high, bitcoin dominance is near a new low. In other words, even as bitcoin makes stratospheric gains the altcoins are rising even faster. Just take a look at some of the 24-hr moves in the screen shot! Some of that is due to intrinsic limitations of bitcoin itself such as its transaction speed, some is due some intrinsic advantage of the altcoins, and some due to “pump-and-dump” actions. Such intricacies cannot be covered in a blog post such as this. For example, just in the last two months, I was able to watch the debate on “segregation witness (SegWit)” unfold on Litecoin (LTC), mining pool signaling, UASF, etc. There were many developments like these in the other altcoins — this must be what the wild wild west was like!

Now let’s talk about where I put my money. In early March, I decided to put about 1% of my active accounts into cryptocurrency speculation. I funded an account at Coinbase, a US-based, regulated digital currency wallet where digital currencies are fully insured. I did most of the trading at the Coinbase affiliated exchange, GDAX since Coinbase itself has much higher fees (1.5%). In fact GDAX has the lowest fees (0.25% liquidity taker only, no fee for maker) even among the exchanges. I ended up establishing positions in all three cryptocurrencies that trade on GDAX: bitcoin (BTC), ethereum (ETH), and litecoin (LTC). I traded LTC a little during the aforementioned mayhem. There was non-stop (24/365) action. I could have easily gotten my trading fix there!

My actual numbers are unimportant since I was mostly lucky with my overall timing and the gains can be ephemeral. Suffice it to say that I plan to pull out a big chunk of my initial funds and let the rest ride. My advice to anyone dipping their toes into this market: control the position size and don’t be greedy! I see the likely longterm outcome as binary which justifies some speculative capital. For the individual coins though I think only a handful will survive. Forewarned is forearmed!