Bitcoin has fallen 50% since November. This is not unusual for a cryptocurrency; it did the same from April to July 2021, and quickly rebounded. From a statistical point of view, Bitcoin looks like a very high volatility asset without strong mid- to long-term tendencies to trend or reverse. It is not a perfect random walk with its future direction independent of past price movements, but it is closer to one than most major assets. This context is important in assessing a tweet by Nassim Nicholas Taleb of Black Swan fame that garnered considerable attention: “For a contagion-focused asset with no economic peg like #BTC, a drop in price doesn’t make it” cheaper” and more attractive. . A falling price makes it less desirable [and]paradoxically, more [expensive]. Why? Because the price is its only information.”
This is empirically not true about Bitcoin’s short history. In the past, buying Bitcoin when the price was falling was just as attractive as buying it when it was rising. But Taleb made an economic assertion, not a statistical one.
The first thing to note is that there are many other “contagious” assets without an “economic anchor”. Art, diamonds, gold and many other things have value only because other people appreciate them, not from direct economic use. A particularly important contagious asset with no economic anchor is the US dollar. Unlike Bitcoin, it has a strong trendline. If the value of the dollar falls due to inflation, it is likely to continue falling. No one buys the greenback because it is cheap in times of inflation or sells it because it is expensive in times of depression. The opposite happens.
The dollar has something Bitcoin does not have, which is a government and banking system that sometimes acts to stabilize its value. But it’s not an anchor, and the US Federal Reserve isn’t trying to bring the dollar back to pre-inflation values. Rather, it is an engine to prevent the ship from drifting too fast. If the dollar quickly loses value, the Fed would generate forces that could slow the decline, but not reverse it back to its previous value.
The world’s main reserve currency dropped all economic pegs in 1971 when President Richard Nixon ended the gold standard – and that was just a loose peg to gold, which itself didn’t. no anchor – and after a decade of mismanagement, he established a rough belief that its value would not erode too quickly, to make it useful for trading and saving. This confidence was shaken during the financial crisis of 2007-2009, but because of fears of institutional collapse and not of inflation. Another major currency, the euro, went through an even deeper crisis from 2009 to 2014, mainly driven by fears of government and central bank failures.
This is the world in which Bitcoin was born and won the trust of techies, financially repressed people, and government and bank skeptics. Bitcoin was a lifeboat for those thrown overboard by the government ship, and for everyone else in case the traditional financial system’s lack of anchorage caused it to fail. Lifeboats don’t need anchors.
However, as bitcoin grew in value and acceptance, it gained an initial economic foothold in the form of the belief that certain official currencies and financial institutions would be unattractive enough to many that there was a significant demand for bitcoin transactions and savings. Later, as crypto projects provided real services to willing clients, the value anchor for Bitcoin became the belief that it would be a major store of value for the crypto-economy and a primary currency of exchange with the traditional financial system.
Over the past couple of years, progress in the crypto economy has been roughly in line with expectations, with no major breakthroughs or setbacks. It is the traditional financial system that has been upended by the pandemic, lockdowns, supply chain issues, aggressive fiscal and loose monetary policies, political dysfunctions and threats of war. Therefore, it seems to me that the volatility in the number of dollars people will pay for Bitcoin has more to do with uncertainty about the long-term value of dollars than with reassessments in the outlook for the crypto industry. When Bitcoin’s price drops in dollar terms, it doesn’t say much about whether Bitcoin is cheap or expensive, but it does suggest that people trust dollars more, perhaps due to the expected tightening of Fed monetary policy, lower expectations for government spending and also lower pandemic and war fears.
Traditional financial markets give their opinion on these issues via interest rates, equity volatility, exchange rates and inflation thresholds. These are good indicators of median opinions. The bitcoin and crypto markets help us understand the opinions of, say, a 5% tail of naysayers, skeptics, tech pundits, and also those who are financially suppressed. Savvy investors would listen to both voices.
Aaron Brown is a former Managing Director and Head of Capital Markets Research at AQR Capital Management. He is the author of “The Poker Face of Wall Street”.
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