Spoiler alert, the fun is over for now in crypto land. The entire sector had a great run. Really, a GREAT run. But, all good things must come to an end, and the crypto rally was no exception. As far as bubbles go, crypto was up there with the best of them. So much so, that perfectly sane investors began to question if it would ever descend back to earth. Bubbles are like lightening, and they rarely strike in the same place twice. That is because painful lessons are learned once the bubble pops. They are the kind of lessons that burn deep and make you promise never to make THAT mistake again.
Take a look at the chart of Bitcoin below. Everybody, and I mean everybody, that bought BTC within the past year and a half is underwater on the investment. Some of course, are more so than others, but all of them are seeing red when they check their crypto holdings. Ouch! Some of those that bought at the top are unlikely to buy again for a long time, if ever. Those are the "dumb money" that the market often refers to. They buy at the top, and sell at the bottom, swearing never to make the same mistake again. And do you know what? They probably won't. At least not in the same asset class. No, it takes a whole new batch of investors to believe the hype and drive the price of the next boom to to the moon with diamond hands. (a crypto reference for not selling regardless of volatility)
Bubbles typically experience a pre-bubble that looks very much like the real McCoy. So much so, that we can analyze one to see what kind of common characteristics it might share with other bubbles. Let's take a look at the long-term monthly chart of ETH, which is the second largest cryptocurrency behind Bitcoin. This chart would look quite similar to any number of bubbles in history.
First, notice the insane capital gain leading up to the top. Those were heady times! By far, the final bubble stage is the most fun. Any dip buyers are almost immediately rewarded as the price soars ever higher. In a bubble, the price will often double or triple in the space of just a few months leading to the top. This is when the bulk of the retail investors get sucked in. As mentioned above, the market has a rather unkind term for them, referring to them as "dumb money". This block of retail investors are needed to provide the buying power to lift the price into the stratosphere. The problem is, they are the people at the end of the line. There is nobody left to buy once they have exhausted their funds, and the price then drops as quickly as it climbed.
But, and this is a big but, there is almost always a large countertrend rally following the initial decline from the top. That is because buy the dip investors have not yet realized the party is over. They have been waiting to buy the dip on the way higher, and missed the grand finale. They may have watched it, but they watched it from the sidelines and they promised to buy the next pullback. We can see that on the chart below where the price plummeted, and then experienced a sharp rally.
Notice the price peaked on this chart in January of 2018. It then plummeted into March, where it experienced the powerful post bubble, buy the dip rally. Only this time, there were plenty of HODLers (crypto-speak for holder) waiting to "sell the rip". Those are the people that bought the top, and promised to exit if they can only be made whole again. As the price is driven higher, waves of selling cap the price and it ends up rolling over and getting down to the real business of losing money.
The initial decline once a bubble bursts is typically breathtaking. The decline that occurs later is more of a long, relentless grind lower. We can also see this take place on the chart below.
Unfortunately, there is no bell that gets rung at the top. Instead, a dip simply no longer gets bought, and the price plummets, much to the surprise of the retail traders that bought the top. Buying the top is no fun. Instead of enjoying a nice rally each day, the price seems to plummet with nothing but air beneath it. Awww, but the dip crowd is tenacious if nothing else. Eventually, they won't be able to stand the incredible bargains to be had, and they step in and buy with both fists. This causes the dying bubble to thrash and we see one more big gasp for air as it attempts to re-inflate. Unfortunately, there still is no-one left to buy and the price rolls over and gets down to the business at hand, which is fleecing traders of their hard earned dollars.
As the price declines day after day and week after week, people slowly give up on the entire sector and the price eventually levels off. Notice the size of the candles shrink as volatility collapses and traders leave the sector for sunnier climes.
Typically when a bubble bursts, the sector goes flat for a long time. When the sector re-inflates depends on the sector. Occasionally, people will collectively lose their heads and create a bubble in something that forever pops—enter the Tulip mania in the early 1600's. At that time, Holland was the place to be. At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled artisan. But, and again, this is a big but, bubbles never last forever. The top came, and obviously we haven't seen those prices since. If we had, I would have had carnations at my wedding instead.
Other assets that are more useful, like stocks, can experience multiple bubbles, but these are typically separated by at least one generation. Remember the saying that kids never learn? At least in the markets, its true. The children of those that got burned in a bubble don't learn from their parent's investment mistakes. No, they must learn their own painful lessons. That is why a generation later, there tends to be another major bubble in a different asset class. The creation of bubbles is fun stuff. In fact, they are fun enough that we can expect them in the future in our lifetime. So, learning how to spot one can be helpful.
We spotted and analyzed the mini bubble that occurred in ETH in the charts above (did you notice those charts were from 2018?), but that wasn't actually the grand finale for crypto. No, that was still to come and the top didn't occur until last fall. The chart below shows the current bubble with all of the characteristics that we discussed above.
Looking at the most recent monthly chart of ETH above, we see many of the common characteristics of a bubble. Notice the steep rally that led to the bubble top, followed by an equally steep initial decline that gets bought by the buy-the-dip crowd. Then notice how it rolled over into a lower high, and has now broken beneath important support.
So, is it a time to buy? For that answer, look again at the previous bubble and you will see that it took years before people were willing to take a chance on crypto again. Remember, everybody who joined the crypto party in the past year and a half is now underwater. That represents a ton of sellers that are just waiting for a chance to get out at break-even. They have given up expecting to make money, and have instead made a deal with themselves that they will exit as soon as the price recovers to what they paid for it. But the price is still in the declining stage! It hasn't even entered the flat stage when a truce is reached between the bulls and the bears and the price volatility evaporates while the price either slowly declines, or flatlines.
Although we are still in the breathtaking declining stage of the bubble, we will soon reach the point where the price stabilizes and the air leaks out more slowly. More and more investors will have given up, taken their losses, and went home. This is not a fun time to be in crypto. This is a time to ignore those that are at the door, urging you to stay, telling you that the party is just getting started.
That doesn't mean that crypto is dead. We have always believed in the utility of crypto, and continue to do so. In fact, the uses for the technology are only likely to grow. But, the euphoria that surrounded anything crypto related is now fading fast. Most of the get rich quick schemes that popped up near the bubble top are going to go to zero. During the dotcom bubble, most of the stocks that drove the bubble disappeared forever, crypto will be no exception. Most current coins will also disappear. But, just like in the dotcom bubble, there will be survivors. Amazon is an example of one that survived the bursting of the dotcom bubble, and managed to go on to thrive and reach much higher levels.
We expect it will be similar with cryptocurrencies. Some of the late comers will disappear. But the "blue chip" currencies like bitcoin are likely here to stay, even if they are repriced and no longer offer the same kind of exciting investment opportunity.
To summarize, the speculative part of the party is over for crypto. The days of being able to buy any random coin in the sector and mint money are now past. We will likely look back ten years from now and see a very different landscape than we currently have. Crypto will remain because it will continue to serve a purpose, but it likely won't be a vehicle for unbridled speculation again for a long time. That doesn't mean there won't be winners that go for 100%, 200%, even 500% wins. But the days of minting coins and seeing almost immediate 10,000% gains are likely a thing of the past.
I've been trading and traveling my entire adult life. I'm currently trading from my boat in the Caribbean. Over the years this has gotten easier and easier to do. Drop the anchor, tether your phone to your laptop, browse some charts, and trade. At Wanderer we first began investing in Bitcoin in 2017 when it was worth $2,500. Fortunately, we recognized its potential, unfortunately, we didn't realize it even earlier. Today it is worth about $50,000, and we believe it is here to stay. Bitcoin will have its ups and downs along the way, but years from now we expect it will be much higher, and we'll still be bopping around in the islands.
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