This essay was originally posted to Medium on Mar. 29, 2021.
I have one more prediction about Bitcoin.
I recently learned about George Soros’s theory of reflexivity which explains so much about how markets often become detached from reality when pricing a new asset. At first there’s a slow buildup of hype and excitement that spurs further investment and price rises. But if the asset is actually fundamentally overpriced and the market collectively realizes this, then the psychological feedback loop in the other direction is usually much faster. The most famous example of this effect was the Dutch tulip mania (major acceleration from 1634 up until it dramatically collapsed in 1637), followed by the dot-com bubble of the late 1990s.
Update: I recently learned that another term for the onset of a market collapse brought on by reckless speculative activity during an unsustainable bullish period is a Minsky Moment, named after economist Hyman Minsky.
In previous essays, I explained why I agree with the traditional economists who have been warning for some time that Bitcoin is ultimately worth nothing, because it’s very slow and inefficient to use for transferring money, especially compared to newer blockchains which are likely to replace it entirely. But then why is the price holding steady above $50,000? Because people are speculating on it and believe it can hold its value as an asset.
I’ve been very concerned that non-billionaires will invest too much into cryptocurrencies and lose it all when investor sentiment changes and the mass sell-off begins. Many average people lost a lot of money in the dot-com crash. But now I have a different theory, which I think will help investors predict the further rise and ultimate fall of Bitcoin in particular, as well as who will be left holding the bag (useless BTC that they can’t sell) when this Ponzi-like scheme finally collapses.
Let’s rewind to the Bitcoin genesis block, and its embedded message: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” The philosophy of many early Bitcoin enthusiasts, still believed today, is a lack of confidence in central banks, and a fear that quantitative easing (“printing money”) will lead to hyperinflation and a devaluation of the US dollar, Euro, and other currencies as a consequence. So far that inflation hasn’t happened.
Bitcoin is sold to enthusiasts as a way to “get back at” the traditional banking system, as a hedge against the looming fear of dollars becoming worthless, as well as a new “get rich quick scheme” to get back at the ultra elite billionaires who have accumulated so much money through capitalism and tax avoidance. But those elite wealthy people are now getting into crypto themselves, and they have much more money to move the markets. That hasn’t stopped the fervor. Bitcoin fans are happy to see Elon Musk getting rich by buying in. His investment validates their faith, rather than raising any concerns. They don’t hate all billionaires, but only the ones seen as “old money”.
There’s one psychologically-powerful symbolic tipping point that could cause a sudden lack of faith in Bitcoin in particular. The algorithmic logic of Bitcoin and other proof-of-work currencies is based around a belief that it would be too expensive for any one bad actor to control 51% of the machines mining coins and processing transactions. For smaller cryptocurrencies, 51% attacks have already happened.
I’ve been reading articles about big banks like JPMorgan Chase and Bank of America creating new investment vehicles for themselves and their wealthy clients to make it easy to buy and trade on the price of Bitcoin. JPMorgan Chase is going to sell a cryptocurrency exposure basket, and suggesting that their wealthy customers can invest up to 1% of their portfolio in cryptocurrencies, while Bank of America, despite some analysts warning about the volatility and environmental cost, have also been bragging about wanting to invest the most in cryptocurrency and control the most blockchain-related patents.
I’m sure you can find other examples of large commercial and investment banks charging ahead after an initial reluctant skepticism has left many of them feeling left out. And the big money doesn’t want to feel left out.
My prediction is that at some point later this year, perhaps 6 to 9 months from now, the major commercial banks and their very wealthy clients who have accumulated Bitcoin at premium prices will control 51% of the Bitcoin in circulation (we can probably assume that many early mining wallets have been lost or the owners can never cash out without attracting unwanted attention), and then the media will start to write stories about how the billionaires, big commercial banks, hedge funds, and other “bad guys” are now dominating a technology that was promised to free the “smart people” from domination by the already wealthy.
It’s possible that Bitcoin will collapse long before this 51% tipping point in coin ownership, but I don’t think it will collapse as long as wealthier and wealthier people still want to buy in. Somebody is going to be left holding the bag when Bitcoin is ultimately discovered to be worthless. But I think this story may have a happier ending than I had feared.
In a typical pyramid scheme, it’s the people at the bottom of the pyramid who suffer, while the profits are funneled up to the top. Bitcoin was developed largely due to fear of the power of central banks to mismanage their currencies, when really it’s the big commercial and investment banks who mismanaged their investment instruments that led to the global financial crash of 2008. They’re at the top of the financial pyramid today, including their control over the Federal Reserve.
Acquiring 51% of the coins, even by a single entity, wouldn’t present a technical threat to the Bitcoin network, but I believe that once the hyper-wealthy have collectively bought up a high enough percentage of coins in circulation, it will present a uniquely powerful psychological threat that will cause the general public to turn against Bitcoin as yet another tool of the rich.
Bitcoin is a form of counterfeit money, in a sense, because it has no ultimate value once the mining networks inevitably shut down, to be replaced by newer and less environmentally-disastrous technologies. I think the biggest banks and the most wealthy individuals will be the last to buy in, will invest the most in trying to greedily accumulate more and more, and when the crash comes, they’ll discover that their vaults are empty.
By Soros’s general theory of reflexivity, this will likely trigger a collapse, especially as skeptics exercise their options bets on falling prices. The taking of such large quantities of fiat currency in exchange for worthless tokens cashed in by savvier speculators could become the biggest collective bank heist in history, and perfectly legal. What do you think?