by Ron William, CMT, MSTA
LAT Senior Lecturer & Trading Psychology Coach
History rhymes, but does it repeat? The cryptocurrency linear price behavior, notably Bitcoin, is very much a unique anomaly, having already significantly outperformed all known historical bubbles. In relative terms, we are comparing babies to giants. The age-old South China Sea bubble has proved to be a mini-bubble, up 1000%; only ever exceeded by the Tulip mania, by its rise of 50,000%. Bitcoin in comparison, has so far, ascended by a spectacular 100,000,000% from its original price of USD 0.008 (less than a cent!)
Even so, the Newtonian laws of physics still dictate that price acceleration is unsustainable in the short-term. Primarily, for this reason, Bitcoin’s correction fell by almost 50%, and still has further short-term downside risk under 10k, with a risk of wider market contagion, before resuming the long-term trend higher (Fig 1.0-main chart A). A sustained break would trigger a sharp move to Bitcoin’s price exhaustion gap between 9192-8325, with further potential risk into 7-6k.
The recent price drop happened after a sharp 2-year linear rise of 3,314%, which lost momentum ahead of the all-important 20k psychological glass-ceiling, while also marking an interim peak in sentiment (as measured by google searches of “Bitcoin bubble”). The latter stage represents a parabolic risk cycle, with poor risk/reward potential (Fig 3.0). Akin to a sports car racing with worn tyres, being more prone to accidents. While a quantum doubling up to 40k is possible, the asymmetric risk is now greater for a violent drawdown of at least -85% remains, in-line with Bitcoin’s historical volatility signature.
In this polarizing Crypto debate, it is important to recognize that the irrational price behavior of Bitcoin is simply diverging from the longer-term blockchain disruption opportunity. Blockchain technology is here to stay, with or without Bitcoin. Here and now, the speculation mania is only approaching an interim peak-stage. From a sentiment perspective, it is also noteworthy, that only a week beforehand, the CBOE and CME futures exchange had announced plans to incorporate Bitcoin, and by doing so, triggered a short-term contrarian signal. This helped release some of the excessive speculative froth, mostly fueled by inexperienced and over-leveraged traders. Further healthy price shakeouts and regulatory support would naturally give Bitcoin more credibility, thereby providing further infrastructure for creating ETFs, and other related digital investment vehicles. This is all required for “smart money” to build-up within this space and create more sustainable growth; not only in the financial sector, but across many other vital areas of the economy.
Still of concern, is that many so-called experts have no way of knowing which cryptocurrency will be the winner that survives and takes-all. Bitcoin, albeit still a major player, only accounts for half of the crypto market capitalization, and will likely moderate as new ones are developed. In 2017 Bitcoin was surprisingly one of the worst performing of the top cap cryptos, and may in time serve as a fallen poster-child. Competitive gaps are spreading across the board; notably technological efficiency, transaction speed and cost. Meanwhile, rising stars like Ethereum and Ripple overtook in a very short-time (Fig 4), by 10,000% in 16 months and 3,500% in only 11 weeks!
In this respect, crypto rotations are similar to the tech mania of 1999, where stocks like Myspace fell from grace, and despite the long-term disruption opportunity of the dot.com revolution, tech stocks still suffered a 90% crash. This is part of the creative-destruction paradox. Fig 5 illustrates how the Crypto currencies are likely in late stage 1 (of 3), with further long-term potential ahead. However, in the short-run, it’s more insightful flag Bitcoin’s latest irrational price behavior, as part of the broader euphoric social mood in many markets, warning of a late-cycle stage of the equity market. It is a sign of the beginning of the end of the cyclical bull-phase.