A few thoughts - Thursday, February 26, 2015

[Steve Sokolowski]

A few thoughts for today. I'll start with a brief comment on /r/bitcoinmarkets.

What happened to /r/bitcoinmarkets?

First, I'll start by stating that I told my brother to stop posting links to these posts, so today's link will be the last one, for no other reason than that they were being downvoted and I obviously don't want him polluting the forum with content that people dislike. You can still continue to read posts here if you're interested. The following comment about /r/bitcoinmarkets is not related to these downvotes.

I've looked at the replies that he has been getting in response to his posts in /r/bitcoinmarkets, and I'm less than impressed. When I posted there regularly last year, people were generally interested in debate. There are some comments that agree or disagree with what he has to say, but the majority of the replies now contain personal attacks against me, him, or someone else. This also seems to be the case in /r/bitcoin, but to a lesser degree. The problem with such attacks, as he pointed out, is that people don't come to /r/bitcoinmarkets to read personal attacks; they come there to discuss bitcoins. I largely stopped reading the forum because there are so many posts where someone makes a post, and then another user replies with a comment like "your account is only 3 months old, and two days ago you said this, but now you say that," rather than actually reading what the user had to say.

The other problem there is lying. The moderators have really been lenient in terms of people being excellent to each other. There are comments all over with unproven accusations against people, like the motivations of the bitcoin or altcoin developers. One should assume good faith until proven otherwise.

"Freedom of speech" involves allowing people to express their views on the issues, but it does not give people the right to write lies or to conclude things that aren't proven. What's happened in /r/bitcoinmarkets is that the moderators are not policing the forum to ensure that statements are factual, and therefore users are brought into this culture. Since everyone else is doing it, it's fine to say things that aren't backed up. It's a sad state of affairs, but it's not my forum, nor do I have time to be more strict with moderation in a new forum.


The bottom is about to fall out

In early July, the price of bitcoins, which had been rising remarkably fast until that point, stalled for several weeks. At the time, I recognized that, with July 24 approaching, the bubble that was occurring was false, and the bottom would fall out. I switched my flair to bearish and posted about it. Sure enough, right on July 24, the crash arrived, and even I was shocked at the precise timing.

The reason that the crash occurred is that bitcoins need to continue to grow in order to become viable as a world currency, and people recognize that. When growth stalls, people see the danger signs and jump ship. This pattern is true in business as well - you always want to be part of a growing company, because companies either grow or die. In economics, nothing stays the same for an extended period of time.

I see the same pattern happening again. After the panic a few months ago, things stabilized and started to rise again with great gains and high volatility. Then there was a fall, a rise to a lower plateau, and a long period where nothing has happened. This pattern repeats itself over and over. Every bubble, including the November 2013 bubble and the later false bubble in June, had a period of high growth, a fall, and then a second period of stability before the bottom fell out. Even though this time hardly qualifies as a bubble, we see that in January there was a period of significant growth, then a crash, and now the price has maintained a second plateau for an incredibly long period of time.

There has never been a time when this has ended well. When bitcoins stabilize, people see that growth has stalled, and they leave. What's happening now makes it extremely difficult for me not to sell everything and get out, but I never sell. If I didn't already have all the bitcoins I plan to ever buy, I still wouldn't buy in this market.


Worse than July

I think that the current conditions are worse even than they were in July. One of the reasons for this is actually presented by the people making the case that bitcoins are going up: the venture capital totals.

While price, transaction volume, and sales volume at merchants are all stagnant or in decline, venture capital is rising at a ridiculous pace. Venture capital amount doesn't signal some sort of uptick in bitcoin usage. Instead, this is the definition of a tech bubble. Venture capitalists go broke in bubbles too; technology and real estate are two fields that come to mind where VCs recently invested huge amounts and lost all their money.

One lesson I learned from all the failed businesses I started is that the product is either good or bad (and it's impossible to tell the difference until you see if anyone uses it or not). No amount of money can make a bad product succeed in the long term. Money can only be used to sustain bad products (such as by heavily advertising them) so that they garner current sales. As soon as the money goes away, bad products fail. Indeed, the whole purpose of venture capital is to lose money initially in the hopes that, once the funding is spent, the business sustains itself.

VC funding is not a relevant metric because such funding doesn't lead to the success of bitcoin products. If people don't find bitcoins useful, then it doesn't matter how much money VCs waste on Coinbase. Given that transaction volume is also not a reliable indicator because it depends too much on spam, the most useful indicator for determining the health of the bitcoin economy is the simplest one and it's what I've maintained all along: the price. If people buy bitcoins, then they obviously want them for some reason. If they don't buy, then they don't find them useful. Why are people trying to find complicated answers to the uptake question in all sorts of useless statistics when the one with the highest correlation is the most obvious?


The bubble cycle fails

The reason I wanted Chris to post one more comment in /r/bitcoinmarkets despite his previous comment being downvoted is because I had said in August that I believed that bubble cycle was still holding and a recovery was likely before the next 234 days or so elapsed. While technically there is still a week to go, given what I've said above, I'll take a risk and state that I'll be wrong on the cycle.

Since I was so wrong, it obviously doesn't make sense for me to offer predictions as to what will replace the cycle. I'll only attempt to guess at why I was wrong, and let someone better than I am figure out what the future holds. When you fail, you move on to something else you are better at, not continue to do the same thing in the hopes that it will work.

Long ago, I said that the cycle would hold despite exchange failures and product failures and so on because bitcoin was simply a superior technology to the messed up system of banks and paper money that exists now. That clearly remains the case. In some ways, I was exactly right: the only way that bitcoins could fail is if, for whatever reason, people chose not to use them. I suggest that the reason the cycle model failed is because there is limited use for bitcoins. reddit is full of plenty of talk about the possibilities of bitcoin in the Third World and as a way to handle contracts, but the truth is that sites like proofofexistence.com have been around for two years. If such uses of the blockchain had the potential for wide usage, then they would have exploded - most likely during the last bubble. If poker, for example, were the killer app for bitcoin, then Seals with Clubs would have been inundated with millions of players before they shut down.

If you don't believe that, then there is a new application out that allows users to text a request to the company, which will provide any service at all for a fee. Someone posted this app to a news site and within two days, they had enough work for 10 people. The owner has so much business that he hasn't even had time to perform analytics to determine who his customers are. He can't keep his database online and find enough staffing to handle the demand even now. That's what happens to something that is destined to succeed wildly.

I think that the cycle would have held if people were interested in using bitcoins, but it has not been shown that they are. It's still possible that there will be a "killer app" that comes about, but the problem is that if this is truly a revolutionary idea, then why would bitcoin usage be limited to just one app? While there are probably a few exceptions, most people didn't buy phones to call one person. They installed phones so that they could get in contact with a lot of friends and businesses.

It's not as if people who previously decided not to buy clothes with bitcoins are going to suddenly start doing so once the the killer app takes off. They'll use the killer app and continue the rest of their lives as before, since the existence of the killer app isn't going to change the experience of buying clothes with bitcoins. And an ETF, it one ever does appear, actually makes this problem worse by shielding potential buyers from actually being able to use the bitcoins for any purpose other than investment.

In conclusion, I was wrong about the cycle, and I think it has been permanently broken. The previous cycle was dependent upon the continued growth of bitcoin's userbase. With userbase no longer showing the potential for organic exponential growth it once had, the dynamics of the markets have permanently changed. While bubbles are almost a certainty, future bubbles will be driven by different factors that are not yet clear. People need to understand that the underlying factor supporting the previous cycle has changed, and that price growth in the future will occur for different reasons.