Peter McGahan: The bitcoin bubble’s logic

Recently published revenue guidance has confirmed that losses incurred on selling crypto currency holdings are eligible for capital gains tax relief
Institutional investors own the majority of bitcoin these days

In the second of what will be a series of columns on cryptocurrency (bitcoin et al) I’ll cover each of your concerns, but, remember that the thinking that applies to the logic of bitcoin or other such ideas, applies to most financial matters.

Confirmation bias is worrisome: ‘But surely…’, is not a start to a good analyst’s research. ‘Maybe I could be wrong’ is. ‘Who do I know who is bright and cynical, and what would they think right now?’, is great self-mentoring.

As the little child in the Sixth Sense movie says: “I see dead people, walking around like normal people, they don’t know they are dead. They only see what they want to see”. Confirmation bias is behind most bad decisions. Couple it with the Fear Of Missing Out (FOMO), and you have a lethal concoction.

In our last three days of our life sitting in our armchair listening to the birds, looking back, we won’t be self-congratulatory about a fluke decision we never understood that went our way, but we will live longer by making robust non-fancy financial decisions that were based on logic that allowed us to sleep. If you haven’t read the book: ‘Why We Sleep’, you might like to.

Who better to confirm about good decision making, than a fellow white-haired man (but a tad brighter) - Albert Einstein. He explained that if “you couldn’t explain something simply, you didn’t understand it”. Therein lies the valuation of crypto coins.

In 2017, I wrote on bitcoin and repeated a few columns on it over the years, but, in 2021 I was asked if it was a bubble yet, and the answer was no. Some economists stated that the bubble had already burst. My response was: “I wholly disagree and would like to know who is feeding them. I personally think cryptocurrency hasn’t displayed the middle stages of a bubble yet let alone the final stages.”

That remains true. Look a little closer at the timeline to see how the bubble inflates. Firstly, institutional investors own the majority of bitcoin which they must clearly have bought during the lull to avoid detection.

On December 11 2017 we were allowed access to the futures market in crypto, so everyone thought that was the ‘start of being a serious player’ as I wrote in January 2018. Futures allow ‘investors to bet on assets to go up or down’. Think. At the time of writing the futures hype had driven bitcoin up 900% in the previous five months.

They can make money on shorting – betting on it going down. In the next four months it fell 65% and was lower than that two years later.

Exchange Traded Funds (ETFs) were then introduced in October 2021 that allowed large funds to trade as above. The price rose temporarily by around five per cent, having rocketed up to that point when people knew in advance such ETFs would be coming. Bitcoin then fell 75% over the next year.

For futures in bitcoin to work and function, there needed to be a ‘long’ investor where that money stayed in the market for longer as it was impossible for those futures market makers to play both sides of the market without introducing risks for them beyond their appetite or abilities (hacker risk, illiquidity, credit etc).

Peter McGahan (Mal McCann)

Last month, hey presto, we have the announcement that the spot crypto ETFs (they will physically hold the asset as opposed to betting on its futures up or down).

Where this takes us, is beyond my wee brain so remember not only the point above regarding ‘understanding simply’ but also remember another Einstein quote that ‘not everything that counts can be counted, and not everything that can be counted counts’.

  • Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have an investment question, call us on 028 6863 2692.