When engaged in an isolated endeavor like cryptocurrency trading, it’s easy to fall into logically flawed presumptions or otherwise problematic errors. The original fallacy can compound exponentially without social feedback to challenge or correct erroneous thinking. Before you know it, you’re making terrible judgment calls that you ordinarily might not have made had you followed tried-and-true methodologies.
In most cases, erroneous assumptions don’t carry much consequence aside from perhaps bruised egos. It’s one of the reasons why our political discourse is completely out of hand. Too often, people are permanently committed to their ideological silos and their beliefs about opposing viewpoints. Therefore, productive dialogue becomes impossible – but to a little if any financial penalty.
But such assumptions can be incredibly costly to crypto investors. While I’m personally encouraged that more individuals throughout the world recognize the potential of the blockchain and the decentralization of finance, I’m also skeptical that much of this enthusiasm will be sustainable. When people jump into any investment class — be it cryptos, stocks or commodities — under false pretenses, disappointment is almost sure to follow.
Crypto Trading and Cognitive Bias
Invariably, when investment or asset categories reach blistering heights, at least one analyst mentions tulip mania. During the Dutch Golden Age, contract prices for seemingly rare tulip bulbs skyrocketed to unprecedented levels. On its way up, the extraordinary bull market tickled the fancy of everyone, from the common laborer to noblemen and aristocrats.
Indeed, the furor got so intense that any tulip bulb could command a hefty premium — the modern equivalent of the current craze in America’s used car market. Of course, when the price reached too high of a level, enough to sober even the drunkest of punch-drunk aristocrats, valuations plummeted. Recognizing the fallout, others reneged on their contractual obligations, finally popping the tulip bubble.
Since then, the phenomenon served as a powerful warning: don’t fall for the trappings of extreme speculation. Though well meaning, the narrative could also be a false one.
As History.com’s take on the subject notes, “according to historian Anne Goldgar, Mackay’s tales of huge fortunes lost and distraught people drowning themselves in canals are more fiction than fact.” Goldgar further states, “It’s a great story and the reason why it’s a great story is that it makes people look stupid.”
“But the idea that tulip mania caused a big depression is completely untrue. As far as I can see, it caused no real effect on the economy whatsoever,” stated the author who seeks to set the historical record straight.
Still, why did this morality tale linger through the centuries? Part of the reason is driven by efforts of religious moralists to drive home a message about modesty, akin to Dante’s Inferno for financial speculators. But another reason is due to cognitive bias; in this case, a belief that one has superior knowledge and that they won’t fall prey to dynamics that ensnare the masses.
The irony as it relates to the real workings of tulip mania is that investors, particularly crypto investors, need to approach the market free of undue assumptions. Nothing can humble people quite like the blockchain.
A Dearth of Due Diligence
Amid the overall positive excitement over cryptos, a problematic element appeared: too many people afford unquestioned credibility to opinions of high-profile individuals merely because of their status. In other words, several newcomers to the crypto space refuse to perform their due diligence.
As an example, I recently came across an article posted on Yahoo Finance regarding the terminal value of Bitcoin. According to Pantera Capital founder Dan Morehead, that value is $700,000 per coin, with an approximate outlook a decade from now.
Underlining this projection is the concept that, according to Morehead, “the macro story is so positive, there is so much money being printed and so many institutions are coming into the space that over the next twelve months the markets are going to resume their rally,”
Though the money-printing argument is intriguing, it’s rooted in shades of cognitive bias. How so? This same argument about hyperinflation buoyed bullish calls for precious metals back at the beginning of the last decade. For instance, in 2010, renowned gold bull Peter Schiff stated that “People are afraid of the debasement of all the currencies. What’s surprising is that gold is still as low as it is … Gold could reach $5,000 to $10,000 per ounce in the next 5 to 10 years.”
I’m not here to criticize, but gold only reached just under $2,100 in the panic of 2020, despite unprecedented money printing.
Put another way, we’ve seen this story play out before. Moreover, the simplistic thesis assumes that monetary policy alone is enough to drive asset valuations. That hasn’t been the case, though, for assets tied to the valuation of money, like gold bullion. Thus, if the monetary spigot argument didn’t work for gold, it probably won’t pan out for Bitcoin.
Unfortunately, plenty of folks just dive into cryptos under the assumption that naysayers don’t get it. In my opinion, that’s dangerous. An unwillingness to recognize valid points in countering views may lead to the same situation which befuddled goldbugs ten years ago: they’re still waiting for $10,000 gold.
Go in With Eyes Wide Open
For any investment, it’s important to keep an open mind. But that’s especially the case for volatile asset classes like cryptos. With so many ways circumstances can go right or wrong, it’s important not to place too much emphasis on hackneyed arguments that rely on the supposed ignorance of others, nor is it appropriate to outright ignore certain viewpoints simply because they don’t align with personal beliefs.