Short-term winners — and losers — in the digital currency boom

I went into this column expecting a rather different response to a Bitcoin story. The story, which I am sure other prominent financial writers will advance in the coming weeks, concerns three former top Wall Street executives who attempted to invest in Bitcoin with the promise of a big return. That kind of story used to be commonplace, but it’s pretty rare these days. And it’s even rarer still if the story is accurately reported. I stand by my belief that they were duped. And I stand by my concern that, just like the financial crisis of 2008, this stuff will be coming back. But I am not going to pursue that angle. What I do intend to pursue is the investing method for speculating on the virtual currency: over the short term.

This is not to say that some people have a long-term investment plan with Bitcoin. But that’s not really how the experience should be measured. It’s not, for example, like buying a stock when you expect the company’s fortunes to be much better in 10 years’ time, or when you think its prospects look somewhat better now. Instead, people should be measuring what kind of opportunity they think is available: Is the price of Bitcoin increasing? If so, do they expect the price to go up at an increasing rate? How is that happening? And if the answer is yes, is it because the value of Bitcoin is increasing and scarcity is spurring demand — or is it because people are short-selling Bitcoins and are desperate to get their hands on them?

Here’s how it works.

Generally, you want to make a speculative play, not a shrewd long-term investment. So here’s the appropriate technique: You want to speculate on Bitcoin, and to do that, you have to figure out whether the price is rising quickly or (because the product is increasing in popularity) falling. Any systematic approach for buying Bitcoin is to bet on it to go up. For most purposes, that’s fine. But some people invest because they think it will go up sharply over the next few months, but I don’t see what that can achieve for these three investors in their particular case. The analysts I’ve interviewed understand this. So what is the value of speculation? Well, once you have a theory, you can set a target. That target is the price that you think Bitcoin should be worth, and you compare that price with the price. Over time, if you do well, you’ll end up with some nice profits — if you do badly, you’ll learn to live with a couple thousand bucks. What would those losers do if you had taken the long view, and hadn’t been too quick on the trigger? Maybe they’d still turn out to be fools — but you would have paid them attention as a novice who happened to make a mistake, and they might get their lesson. Some of them could be visionary investors who pick up Bitcoins at favorable prices, and one or two could be competitors who plot to corner the market. The other might be folks who invested because they were convinced they understood the shape of the bitcoin future — I’m thinking of people like Ray Dalio, who has long argued that the next big internet theme is blockchain and virtual currencies. If you were simply a speculator who thought Bitcoin was the next big thing, Dalio would certainly be your target. He is probably the one of the smartest people around; yet he has thrown away more than $30 million of people’s money. So investors who invest over the short term tend to do better, if the data support their ideas. Two years ago, for example, the average price of Bitcoin jumped from about $400 to around $1,100 within weeks. That’s huge. More recently, the price has been trending downward, and that’s understandable, given that the physical Bitcoin isn’t going anywhere, and nobody knows much about the cryptocurrency’s valuation. The more likely prospect is that people have chosen to forgo all of this attention and instead focus on things such as currency. That’s a convenient way to choose not to engage in speculation over the short term, but I still think it’s a horrible investment strategy for most people.

What should you do?

What you want to do is discover the relative attractiveness of Bitcoin with respect to other currencies. If the price of Bitcoin is rising or falling, you have an idea as to what it might be in five years’ time, and the price will reflect that knowledge. But if the price of Bitcoin is rising, you might be a fool. The traders who are profiting from their sense of speculator’s luck are the ones who made their big decisions with contrarian logic.

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