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CONTRARIAN AND ANTI-CYCLICAL
INVESTMENT IN BITCOIN


December 3, 2019



Timing Bitcoin is a tough task and only recommended for people with trading experience. Traders train themselves to keep a cool head and stay rational during wild price swings. But short-term trading is highly risky and basically a full-time job. The much safer and more profitable option for many people is to buy and sell according to the cycles of Bitcoin. But sometimes even long-term Bitcoin investors have to stay calm, because Bitcoin exhibits much more volatility than traditional assets.

Estimating Bitcoin's cycles seems to become easier as Bitcoin matures and reveals more information about its price dynamics. But never underestimate Bitcoin! Bitcoin may contradict existing price models in future and has a tendency of shaking out even determined investors with crazy short and mid-term price action. Bitcoin's volatility makes sure that as few as possible people really benefit from it. Thinking long-term, reiterating Bitcoin's innovative properties and practicing tranquility is the best protection against it. Holding Bitcoin for a decade and not checking its price might definitely be the best strategy for some people.

Bitcoin Cycles

A Bitcoin cycle consists of a bull market with prices steadily going up, interrupted by 35-50% dips, followed by a bear market with whipsaw action and declines of 84 to 93%. As one Bitcoin bull market dip in April 2013 was 75% (similar to an altcoin dip in mid 2017), it is not easy to distinguish dips from crashes. A dip could basically be the beginning of a crash.

There were various theories about the Bitcoin cycles in the past, but since the 2017 all time high (ATH) it became more and more clear that Bitcoin appears to follow a 4-year-long cycle, which is very likely advanced by the so-called halving.



The Bitcoin C++ code that produces the halvings every 210,000 blocks.

A fixed number of new bitcoins is created every ten minutes on average by so-called miners when a new block with transactions is attached to Bitcoin's blockchain. The halving reduces the amount of newly issued bitcoins by 50% and occurs every 4 years. The first two halving events happened in the middle of the bull market of the second and third cycle. The first cycle in 2010/2011 occurred before the first halving, so it is very unlikely that it was influenced by it.

As with other assets the price of Bitcoin is mainly driven by supply and demand. Bitcoin’s supply is reduced every four years by the halving until issuance is stopped at 21 million coins around the year 2140. So we can speak of a fixed supply. Demand grows over time as more and more people think and talk about it. But demand also decreases with falling prices in bear markets or during dips in bull markets. This means that demand varies in the short run but in general increases over time.




The four Bitcoin cycles in a logarithmic chart. Green areas are bull markets. Red areas are bear markets.

The first atypical Bitcoin cycle in 2009-2011 was purely demand driven as the supply increased a great deal during the first three years of its existence. This initial demand was induced by Bitcoin's innovative technology, which convinced so-called cypherpunks as well as geeks, nerds, libertarians and criminals. They were the first to explore Bitcoin's potential as a new type of collectible and money. A lot of chaotic events took place during this time, but Bitcoin proved itself and became interesting for a larger audience including the first investors from Wall Street.

The second and third cycle had a similar 4-year-structure, but played out a bit differently. The second cycle (2011-2014) had a few big moves whereas the third cycle (2015-2018) was a continuous climb that accelerated. The current fourth cycle, which started in December 2018, rather resembles the second cycle with a wild run in the first half of 2019 and big calm down in the second half. A next big move in 2020 might again be surprising.

Noteworthy is the final bull run that was initiated in all three past cycles when Bitcoin came close to its previous ATH. It is likely that this will happen again in future. The road to retaking the old ATH was always thorny and the halving might be the biggest factor in achieving it. After retaking the ATH big enthusiasm has always erupted and new people, hungry for profits, entered the market spurred by mainstream media and tales of unforeseen riches.


"In this sense, it's more typical of a precious metal. Instead of the supply changing to keep the value the same, the supply is predetermined and the value changes. As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value."

Satoshi Nakamoto (2009)

Of course, such a mania cannot last forever and many people jump off the train again, usually too late to avoid larger losses. Luckily some people stay or do not lose interest in Bitcoin, which makes sure that the next price bottom is much higher than the last. Most people came to become rich, the ones who stay become enthusiastic about the idea of Bitcoin itself. You could compare Bitcoin with a financial and ideological pandemic that spreads in multiple waves. Satoshi Nakamoto, the anonymous inventor of Bitcoin, already played with this idea, but probably did not dream that it would work so effectively.


What is Bitcoin Worth?

The fixed supply and intermittently increasing demand makes Bitcoin's price go up more and more over time until a saturation point will be reached in the future. Bitcoin is not different in this regard from other phenomena like the internet, new technology or ground-breaking ideas as described by Everett Rogers' innovation diffusion theory. So at a certain point there will be an end to Bitcoin's growth and it should become less volatile. No one knows when and at which price this will happen. It mainly depends on what makes Bitcoin valuable. There are very different views on this topic.


"As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties: boring grey in colour, not a good conductor of electricity, not particularly strong, but not ductile or easily malleable either, not useful for any practical or ornamental purpose and one special, magical property: can be transported over a communications channel."

Satoshi Nakamoto (2010)

So-called maximalists think that Bitcoin will take over the whole financial system (hyperbitcoinization). A more modest and realistic thesis is that Bitcoin will become a precious digital commodity similar to gold. Others only believe in Bitcoin as a means of doing payments that are not possible with the old system or are less expensive. Voices calling Bitcoin a Ponzi scheme will become more and more silent as Bitcoin keeps on working as intended year after year. The most absurd theory so far is that Bitcoin is a never-ending pyramid scheme.

Nothing like Bitcoin existed in human history before, which is why many people extremely overestimate or underestimate it. Even Nobel-prize laureates and top economists have huge problems grasping it and inadequately compare it to existing phenomena. Bitcoin is basically decentralized money in the shape of software, maintained by a collective of ten thousands of computers and propagated over the internet. No one controls it, no one can stop it and everyone can join without having to ask permission. As it is flexible and adaptable unlike any other type of money or real-world asset, different narratives about it dominated at different times. We may even see a new narrative emerge in future as people explore, experiment with or enhance Bitcoin even more.




The tiny orange line in the bottom right corner is Bitcoin with just 130 billion $.

Lets play with the assumption that Bitcoin will conquer a fraction of the total value of gold. All gold in the world is currently worth around 9 trillion USD. Bitcoin is worth 1% of all gold with 18 million bitcoins issued. Assuming that Bitcoin will reach as much value as 10% of gold one day, means that 1 Bitcoin would be worth around $50,000 ($50k). At 20% parity with gold it would be worth $100k and at 100% it would be priced at $500k. If gold should triple its value in the next 10 years (which usually happens every 20-30 years), Bitcoin could reach a value of $100k while still being only worth 6.66% as much as gold or $500k while only being worth 33% of all gold.

Bitcoin is currently uncorrelated to any other asset class when looking at longer periods of time, probably because it is still growing. Therefore it could be said that it is not really part of the global economy. This makes it a great hedge against economic risk and valuable as part of long term investment portfolios. But when a large minority will use it for this purpose, it will be correlated with the global economy and lose its hedge functionality. But at that point Bitcoin would already cost much more than today.

Of course, both scenarios may never happen and a lot of unknown factors may play a major part in how things will develop. No risk, no gain.


The BEAM Indicator

BEAM is an abreviation for "Bitcoin Economics Adaptive Multiple" and is an indicator that I developed recently. It is meant for identifying promising times during a cycle for buying and selling Bitcoin or other crypto currencies.



A BEAM value near zero or below indicates that Bitcoin (or another asset) is underpriced or oversold and means that buying might be a good idea. A value near 1.0 or above means that the asset is overpriced or overbought and selling is recommended.

BEAM also displays three types of zones. A green buy zone indicates that it would be wise to buy Bitcoin. A red sell zone makes clear that selling Bitcoin might be a good idea. A gray hodl zone signals that it is advisable to keep on holding Bitcoin even if the price already seems rather high. At the start of the hodl zone there is usually also a new buying opportunity. The BEAM Bands variation of BEAM can additionally predict possible future prices.

For more information on BEAM check out the BEAM Indicator article.

 

Other Signals

Under no circumstances should buy or sell decisions be made with the BEAM indicator alone. They are better based on a wide variety of indicators, models, sentiment signals, observation of experts and maybe important news events. Only if most of these signals produce a confirmation, it is time to think about buying or selling.

For similar indicators I recommend having a look at the MRVR(-Z) as well as the VWAPR. Both are based on blockchain metrics and are more volatile than BEAM, but seem to possess a similar prediction power. The Mayer Multiple is very popular, but makes it very hard to spot ATHs and shows a wider bottom area. The Power Oscillator is great for picking tops, but less conclusive for bottoms. Nevertheless, all of these indicators measure something similar, so they may fail all together in future.

For price models I recommend having a look at PlanB’s popular stock to flow model. It predicts a mean price for the mid period between two halvings, currently 100k for 2021. For a great time-based model see Chris Burger's power law model, which predicts upper and lower future price ranges for Bitcoin. Also check out Philip Swifts indicator based on 2-year-MA-Multiplier. Another effective indicator is Bitcoin Difficulty Ribbons, which compress near price bottoms and after halvings, because some Bitcoin miners have to give up their business or new more efficient mining computers have to be used.

Other indicators that were effective in the past were Google searches for "Bitcoin" and Twitter tweets with the term "#Bitcoin". They mirror the general enthusiasm for Bitcoin and thus its price chart.

Sentiment signals are the bread and butter of contrarian investing. At the end of bear markets people are in a bad mood and there is little interest in an asset. There is also a larger amount of negative articles published. Near ATH people get overenthusiastic and more and more new people stream into the market. When no one doubts anymore that the price frenzy will go on for a long time, it is time to sell. If you do not know other investors or people in the business personally, check out articles and read prominent twitter channels to get a feel for the sentiment.

Related to sentiment is to investigate what experts and opinion leaders do or say. Some of them will warn that it is time to sell near an ATH or time to buy near a bottom. Others will do more or less the opposite. It can help to scrutinize the motives or tendencies that drives these people, but looking at the context of the statements may also help.

When a bull market has progressed a lot, you should rather listen to people indicating that an ATH may be reached. For example, Charlie Lee, the founder of Litecoin, sold all of his coins very close to the ATH in December 2017 with a lot of apologizing. As he recently admitted in an interview,Vitalik Buterin urged the Ethereum Foundation to sell 70k ETH near the top in 2017, although he apparently did not sell his own coins. His tweets in December 2017 posing the question if the crypto market has earned such high valuations could have been taken as a wake-up call. There were also several other experts in December 2017 urging people to sell or claiming to have sold.




On the other hand, in December 2018 Joe Lubin, another co-founder of Ethereum, called out a bottom. He observed other crypto people around them and noticed that many lost interest and he concluded the right thing. Later various other people of crypto-fame made similar statements.

However, there were some people who called a bottom earlier when Bitcoin was still above $6000 instead of $3200. Others predicted sky high prices for the end of 2018 instead of lows. Again others thought Bitcoin would go lower than $3200. So without other criteria, it is difficult to place these calls into the right context.

Another big sign was CBOE announcing the closure of their Bitcoin future in March 2019, which actually started near the ATH in 2017, so it was both a telling sign for the ATH as well as the bottom. Theories that these dollar settled Bitcoin futures caused the 2018 crash are exaggerated, because such price crashes already happened in a similar fashion in the past. It was more a “buy the rumor, sell the news” type of event and used as a trigger to sell by big holders.


(Not) Investing is Harder than Hard

If you decide not to invest in Bitcoin, do not to start with it when everyone boasts with their profits and buying appears the most reasonable thing to do. This is the worst possible time as I know from my own experience. Unfortunately, it is also the time when most people start investing, because they cannot resist social pressure and spasms of enthusiasm.

If you are not used to do the opposite of what most people tell you, you are probably not good at investing. Famous investors have only succeeded because they kept doing what they were doing despite people telling them that they are crazy and irresponsible. But often it is a fine line between doing something crazy and doing something that people think is crazy.

You can only avoid an investment mistake by researching your investment object with utmost precision and persistence. Rather than taking investment decisions too lightly, you have to torture your head and look at it from every conceivable angle. This requires due diligence and unrelentless introspection, which is why being a good investor is a very hard job and requires a wide range of skills.

Risking all your money on one investment is never a good idea. With Bitcoin’s huge growth potential you do not have to do it anyway. Investing a small fraction of your money is sufficient and makes sure that you only lose little, but are able to win big. As with all other investments you can risk more if you are younger and have little money and you should risk less if you are older and have already accumulated some wealth.

In the end it is your own decision and you have to bear the consequences: Good or bad.

Good luck!



Disclaimer: This is not financial advice. For educational purposes only. Do your own research. Do not invest in Bitcoin! You will lose money. Speak to a psychotherapist if you experience addiction symptoms. Do not bet the most precious part of your body on Bitcoin reaching a certain price in a certain year. Do not sell your house to buy Bitcoin. Do not neglect your partner or kids because of starring at a stupid line in a stupid chart. Don't forget to enjoy life!