What a week on the roller coaster that is Bitcoin. Of course the thrills and spills shouldn’t surprise us too much if we have a rough and realistic sketch of its future trajectory in mind. Exercise a little skepticism toward the overly optimistic calls and all should be relatively well in the land of bitcoin. And this fortnight’s article will look at exactly this, the tendency to accept an overly rosy view of price development, only to have hopes dashed yet again on the too great an expectation. In particular, I’ll focus on the notion of cycles. and question whether they might be the most fruitful way of projecting future development going forward.
As followers of my Twitter account are no doubt familiar, I’ve been working with a lengthening cycle theory as applicable to Bitcoin for quite some time. The general assumption is there are cycles at work in Bitcoin with my particular variant being that these may be lengthening. Though the early parabolic spike in 2019 [‘mini’ parabola] threatened to invalidate the theory, the subsequent correction served instead to further corroborate it. And yet again we see another parabolic rise, which once again looks likely to correct. Though the lengthening cycle theory is as yet intact, the dynamic of recent price development [subsequent parabolas] may be starting to throw the general theory of nice neat cycles into doubt. The reason being that cycles are about finding a regular pattern, and what is unfolding on the chart looks to be becoming increasingly irregular. Instead of a long arcing cycle as seen previously, we are now seeing something quite different.
On the chart, the ‘cycle’ seems to be breaking up just as giant ice-sheets would in warmer waters. Nor should this surprise us in the face of a general principle, where a maturing market and increasing liquidity is understood to lead to reducing volatility - the single major volatile spike [and correction] may be broken up into a series of more minor volatile spikes [and corrections]. And so it is that the increased liquidity of a maturing [and very speculative] market suggests a re-visiting of what has to be the current ‘orthodoxy’ of cycles. The nature of all such questioning remains exploratory and theoretical [see Hedging article for further on this], and so should not be the cause for strong disagreement at the hypothetical level - all we can do is make provisional statements in regard to the future, and then wait to see what develops - whether those theories are falsified/ invalidated or not [Popper]]. Any strong disagreement to a theory usually arises from its ‘unorthodoxy’ - the dominant paradigm, or the ‘normal’ science/ theory [Kuhn] that is generally accepted will naturally be defensive. The new idea will seem almost unintelligible, for it’s only by the prevailing theory that we interpret [and make intelligible] otherwise random phenomena as intelligible. Such are the facts of collective human behavior. Perhaps first a quick sketch of the dominant paradigm, that of the four year cycle, is required in order to more clearly perceive an alternative.
Four year cycle theory is founded on the solid fact of halving. Every four years, difficulty adjusts and the supply of Bitcoin to the market halves leading to an eventual cap on the amount to be produced. On the chart, thanks to this cap, you see the rate of supply diminishing. This tapering off of the supply naturally [or artificially] creates a logarithmic growth curve - explosive growth at the beginning tapering off to a plateau at the end.
Here you have some fixed points with which to create a mathematical model, and a rational theory that is pre-determined in nature. With laws of supply and demand in mind, demand is thought to increase as supply/ ‘flow’ decreases. This law is then thought to lead to a causal determinism, where price becomes a function of supply. It’s also thought that the exponential rate of price increase, as seen in the past, will remain relatively constant and be reflected into the future. There is an efficiency and a rationality thought to apply to the market here - price will inexorably march up step in step with the diminished supply and increased demand. What’s of interest here is that the market discovery of price is viewed along the lines of a calculating machine. Though some would view the market [and market history] as positively mad at times, the picture here is rather one of ‘the wisdom of crowds’. What you have here is a Rationalism [see Hedged article contra Rationalism] at work advanced by some very astute and knowledgeable minds. And yet of course the problem is that very advanced and specialized theories can often take us down the garden path. Consider that it was not long ago that quant theory, thought to eliminate risk, nearly blew up the financial world with the sub-prime disaster. And there are plenty of books to be read making us wary of those theories that seek to placate us with cast iron certitudes. In contrast to looking for consolation in a theory [for it removes all doubt], it’s the opinion of this author that such assurances should be viewed with a dose of skepticism - we should always hold them critically at arm’s length, for at the end of the day they are fabrications, even if very clever ones.
Where some see efficient and rational markets, others see them as perfectly irrational at times. Where some see the wisdom of crowds, others see the madness of crowds. And of course, it doesn’t need to be an either/ or. Markets could be both at various times - a manic market may become an overly sober and cautious one, before turning manic again. It’s those with ‘the tragic vision’ of human nature [less optimistic than the purely rational one] who will see idiosyncratic and capricious human nature at the heart of all markets, not some giant invisible calculating machine. And so too with the Bitcoin market. As long as one is concerned with the market price of Bitcoin, the driver of that price, especially in an increasingly liquid market, will be the mass of participants who will be primarily motivated by speculative and psychological factors as opposed to purely rational ones. This is where behavioral economics will come to the fore as opposed to quant theory, which, from the perspective outlined above, starts to look a little quaint.
But Dave, the reader may be asking, what about halving, the mechanics of increasing scarcity, surely it’s the primary force behind the market. To which I’d reply, it may not be the particular mechanics of scarcity at all that is of significance to the market here, but scarcity per se. It is scarcity itself [just as gold is scarce] that will lead to the increasingly frequent episodes of speculation, and it is this speculation that wreaks havoc with the chart [or our neat ideas on how the chart should develop]. As speculative episodes become more frequent, so too might they become a little more restrained in their magnitude. In the aggregate, the volatility will reduce - what could be considered in this ‘cycle’ as increasing intra cyclical volatility, as relative to the previous cycle, may also be read as a breaking up of that grand cycle altogether. In contrast to this, the current ‘cycle’ could also be considered a transition of sorts - a lengthened cycle with increased intra volatility morphing into what comes later - something messier and defying the notion of grand cycles altogether. In this scenario, mini parabolas, of the sort seen recently, would supplant the cycle, with those mini parabolas/ manias [speculative episodes] themselves reducing in volatility. And herein would lie the road to price discovery, which is also price stabilization, mass adoption, and a nascent currency full capitalized along the lines of Gold.
It’s been my intention to outline another perspective here, and in doing so to cast some doubt on cycle theory that has today effectively become an orthodoxy. As investors, we can not afford the solace of certitude, however attractive and persuasive it be. Like the sirens of old, with their sweet-sounding songs, the chances are we’d soon be shipwrecked on the rocks in following them. Am I saying cycle theory is necessarily wrong? Not at all, only that it could be [only future events could falsify it]. Keep in mind that a theory is like a fiction. It is similar to a fiction insofar as we can suspend our disbelief and get carried away with it… for a moment [at least the actual theater is only for the moment]. It is different to a fiction insofar as we consciously treat it as a hypothesis, a theory, an ‘as if’, where in doing so we actively suspend our belief - it is only ever a provisional and pragmatic truth as long as it works, or saves the phenomena. And this is the business of pragmatic investors, who will be more comfortable without that closure as opposed to comforting themselves with cast iron self-evident ‘truths’.
The thoughts as outlined here need not invalidate the idea of a lengthened cycle. A current lengthened cycle may indeed coincide with these ideas, but what would it really mean if that theory could not be applied to what comes after in the not too distant future. Another lengthened cycle? And then another one? It all looks unlikely. More likely is the breaking up of the cycles into a more random set of mini manias and subsequent corrections, ones that increasingly lessen in volatility, and in turn lead to price discovery. As for the theory of repeating four year cycles of equal magnitude, I think it’s likely to be invalidated for the reasons outlined above and possibly in this very ‘cycle’. Of course, the jury is still out. Anyone subscribing to pragmatism, and having their ideas tested empirically, that is by experience, will have to wait on a not too distant future for the verdict one way or the other… as this picture of cycle theory would suggest.
Some readers may be a little disconcerted to think I might be promoting here a program of radical doubt toward prevailing theories and models. Nothing could be further from the case. In the real world [as opposed to the ideological one], the logical law of the excluded middle need not apply - one does not have to either believe [fervently] or not [fervently]. That I advocate some skepticism toward models [my own included] does not mean complete doubt. Rather, it entails a moderate doubt that is mixed with a moderate belief. Once again, we are back at the spectrum, where the extremes are at either end and connected by transitional phases. As I mention often, we are prone to taking paradigms too seriously. In doing so, we take the paradigm [the interpretation] as a fundamental truth. Here an ideological and static use of language [as opposed to a fluid one] becomes not just the cause for disagreement with others, but that of complete estrangement from them. The prepositions in italics here are significant - there is room for tolerance in the first, but not in the second. Of course, the digital medium we use these days does not help much [the medium is the message], it tends to foster an unwillingness to engage with other perspectives, it’s so much easier to subscribe to the bandwidth you’re comfortable with. But is it… if it proves illusory in the end? To finish, the line ‘ignorant armies clashing by night’ comes to mind. And the irony has to be that our ignorance consists largely of [dogmatic] Knowledge today. Where you had a positive feedback loop [a virtuous circle] in the above diagram, focused as it is on real world experience, in the digital world you get a negative feedback loop, or a vicious circle. The circle has a gravitational pull of its own, and one comes to belong to it. One is either in or out of the circle. Of course, anyone valuing real freedom and independent thought tends to run a mile from such nonsense.
Until next time,
Stay safe out there~
Karl Popper - The Logic of Scientific discovery
Thomas Kuhn - The Structure of Scientific Revolutions
Nassim Taleb - Fooled by Randomness
Charles Mackay - Extraordinary Popular Delusions and the Madness of Crowds