"There is
no subtler, no surer means of overturning the existing basis of society than to
debauch the currency. The process engages all the hidden forces of economic law
on the side of destruction, and does it in a manner which not one man in a
million is able to diagnose."
~ John
Maynard Keynes, "The Economic Consequences of the Peace" (1919).
In 2008
MarketPsych’s CTO Thomas Hartman worked on a secretive software project in
Panama. The goal of that project was to
disrupt and supplant the global banking system.
The fruits of such efforts are emerging in the increasing importance and
acceptance of cryptocurrencies.
Last week
Eurogroup chief Jeroen Dijsselbloem revealed that the Cypriot bank bailout
package is a template for future euro rescues.
European bank depositors can expect seizures of uninsured deposits if
their bank becomes insolvent. In Cyprus
today bank account holders, including accounts of a Russian MarketPsych team member living in Cyprus, are effectively
frozen, limited to withdrawals of 300 Euro daily.
The freeze
of Euro-denominated bank accounts in Cyprus corresponded with a spike in the
price of gold and a massive bull run in the value of cryptocurrencies such as Bitcoin, LiteCoin, and
Namecoin. As the realization dawns that
similar seizures could happen in Portugal, Spain, and Italy, capital will
continue searching for a haven away from the sticky fingers of banking and
government officials.
Cryptocurrencies are currencies without a
government sponsor, composed of unique cryptographic codes (solutions to
complex mathematics problems), and consensus legitimacy. Their conversion value to national currencies
depends entirely on supply, demand, security, confidence, and the whims of the
investing crowd and businesses who accept them.
The most secure and popular cryptocurrency is Bitcoin. Bitcoin was released in 2009 as the financial
crisis smoldered, and there is now over $1 billion of Bitcoin in circulation
today and hundreds of legitimate (and many sketchy) businesses who accept
it. In the first three months of 2013
Bitcoin has appreciated 6-fold versus the U.S. Dollar. Cryptocurrencies are benefitting from the
loss of public trust in fiat currencies issued by currency war-prone governments.
We are in a unique position to comment on
cryptocurrencies and the psychology of currency valuations.
For one, our
software team includes early crypto-currency speculators and Thomas - an
evangelist in the development of Ripple - an early player in the alternate
currency space whose assets were recently bought by investors with
BitCoin-derived wealth.
Secondly, our
psychological data is the world’s largest database of
currency-related sentiment, and we have been mining that data for currency
predictive models.
And thirdly,
and unfortunately, one of our team members is a Russian living in Cyprus who is
frozen out of his Cypriot bank account.
Needless to say, this week’s newsletter strikes close to home.
Subverting the Banking
System
|
When our
CTO Thomas went to Panama, he was on a mission to help productize
ripplepay.com, an alternative currency money transfer scheme that aimed to
disrupt our current banking system with a decentralized web of trust. Ripplepay had communitarian roots and, some
critics claimed, unrealistic utopian goals. With Ripplepay, anyone could back a
new currency, or issue IOUs in existing currencies, and IOUs could be chained. The Ripple platform was transparent and open
by design.
While in Panama the Ripplepay developers became acquainted with many
projects, and players, in the “alternative economy” space, including schemes
that differed radically from theirs. Of
note they met developers from a software team working to replace global fiat
currency - the BitGold team. The BitGold
team were libertarian and perhaps justifiably paranoid. The below photo is Thomas in Panama.
The effort to productize Ripplepay ended in late 2008, but the
development team stayed in touch and continued to follow developments in the
alternative economy space. When Bitcoin, an offshoot of BitGold, entered the alternative
currency scene in 2009, it created a stir.
It used new algorithms to defeat the problems that had plagued and sunk
prior cryptocurrencies. When a pizza was sold for 10,000 Bitcoin in 2010, this
was a significant milestone, and when Bitcoin started trading against the US
dollar Thomas bought some – despite the
uncomfortable feeling that a paranoid technology had won against the
communitarian ideals his Ripplepay team held dear.
In contrast to Ripplepay and BitGold, Bitcoin had users: lots of them. Additionally, Bitcoin had solved a problem
that BitGold had not. Bitcoin used an
ingenious feedback mechanism that raised and lowered the difficulty of “mining”
depending on how many CPU cycles were aimed at the hard cryptographic problems
whose solutions yielded the coinage (the Bitcoin miners). In short, Bitcoin was a significant step
forward.
In 2013, the Ripplepay intellectual property was bought by a consortium
of bitcoin millionaries, and a true commercial variant of Ripplepay was
launched: Ripple.com. The prospects for
Bitcoin are bright, and we are observing the situation with the new Ripple and
the other cryptocurrencies closely.
Bitcoin
|
In response
to chronic debasement of currencies by governments, cryptocurrencies that live
entirely in HEX codes and magnetic memory were pioneered over the past
decade. None of those cryptocurrencies
had legs until now. Yet following a
massive recent bull run, some are holding virtual currencies worth in excess of
$100 million (e.g., Butterfly Labs, a manufacturer of mining equipment). This New Yorker article explores the murky origins of Bitcoin,
which is also summarized on Wikipedia and in many online chat rooms. The amazing appreciation of the value of
Bitcoin versus the USD has continued up to today. Below is a price chart of the past 1 year of
Bitcoin value versus the USD, obtained from MtGox, the major currency exchange:
Do I Own Bitcoin? Unfortunately Not
|
Really good
investment opportunities contain what Nassim Taleb calls “Optionality” – enormous upside multiples and limited downside. Given a few bubble-ready characteristics of
cryptocurrencies (limited issuance, steadily increasing publicity, declining
trust in the banking system), I knew the conditions were right for a massive
Bitcoin bubble, and since early 2011 I wanted in.
Terrific
investing insights cross my mind occasionally, and in my opinion I’ve honed a
keen intuition for identifying the really good ones. The problem is, I often don’t act on these
golden insights. But maybe once every
two years an insight is so monumental that I tell my wife to hound me until I
make a specific investment. Bitcoin in
2011? Yup, I knew it was set up to be a
classic bubble.
Now to be
clear, when I see the above price charts I feel the pain disappointment. You see, I don’t own any Bitcoin. I’ve watched Bitcoin bounce through $2 twice. When it last was under $3 I asked my wife to
PLEASE NAG ME to buy some. I realize
that most men don’t ask their wives to nag them. But I’m a lucky man - my wife doesn’t nag -
so if she were to nag, the logic went, I would be sure to pay attention. But this wasn’t a foolproof strategy.
As I had
requested, my wife did nag me at the appointed times, “Rich, buy Bitcoin. Rich, did you buy Bitcoin yet?” But somehow I stored her reminders in that
empty space in my brain where most men seem to file non- emergent, quickly
forgotten, and later regretted wifely reminders like: “Rich, please take out
the garbage, the kitchen is getting stinky,” “Rich, please buy gas for the
generator, another big snowstorm is coming,” and “Rich, don’t forget to brush
your wild-man-just-rolled-out-of-bed hair before you present at that important
meeting.”
But getting
into cryptocurrencies isn’t so easy.
Back then it required wiring money to Japan, and trading on an exchange
(MtGox) that was a frequent target of hacking attacks (true story: the login and password of my first Bitcoin
trading account at MtGox are displayed on the internet for the world to
see). In fact, I even bought a Bitcoin-derived
domain name. Ultimately, due to inertia,
lack of urgency, and general busy distraction, I didn’t get around to buying
any Bitcoin itself. (But a disclaimer,
I do own other cryptocurrency).
What drives currency values?
|
Given that
Bitcoin has appreciated 40x over the past 12 months, I’m keen to know how much
longer this rally might continue. Now
the first warning sign that a short-term bubble top is near is the excited tone
of this newsletter itself. Also, bank
research reports will no doubt be issued on cryptocurrencies in the next month
or so. That doesn’t mean the top is here
today, but it does mean that the recent surge of attention, largely based on
the amazing price appreciation, is probably overdone and a retreat will happen at
some point… (don’t ask me when).
In our
investigations of the psychological forces that drive currency valuations, we
performed yearly and weekly studies on our Thomson Reuters MarketPsych Indices (TRMI). As you may know, the TRMI contain 15 currency
and 35 country-specific sentiments derived from social media and news from 1998
to the present. The list of currency
TRMI is below. Each of these is
extracted in references to the currency through a process of text analytics. You’ll see how this is relevant to
cryptocurrencies below.
Of the 15
TRMI, using the past 12-months TRMI average and the next 12-months currency
return, 5 are correlated with future currency price direction with high confidence
(p-value < 0.01). Significantly for
our newsletter today, Trust in a
currency expressed in news is inversely correlated with future currency price direction. When the news media expresses high trust in a given
currency, you’d be better served moving to a currency with less expressed confidence. Keep in mind we’re looking at the top ten
global currencies based on past year’s Buzz in the News, so known unstable
currencies such as the Zimbabwe Dollar are not included.
After the
simple regression, we decided to look at the results of a long-short
arbitrage. The below is an equity curve
of extremity arbitrage, 12-month holding period, in which we selected the 10
currencies over the past 12-months with the most Buzz, then bought the 4 with
the lowest Trust and shorted the 4 with the highest Trust expressed. As you can see, trading against what everyone
else trusts is generally profitable.
Similarly, PriceMomentum (direction of price
trend) reported in news is inversely correlated with future return direction. So when you read that a
currency is trending strongly in one direction, it is likely to be nearing a
reversal.
What does this mean for
cryptocurrencies? Given that Trust in cryptocurrencies is low and
Uncertainty is high while fundamentals are strong, we have a positive set
up. But there are some short-term headwinds coming from the recent strong
uptrend.
Currency Trading Recommendations
|
Using our
currency research, we pulled the best TRMI into a final model. We see a fairly good distribution of
currencies selected by the strategy. The
annual currency forecast of this model as of March 1, 2013 is below. Long Australian,
Singaporean, and Canadian dollars and the Japanese Yen. Short South
Korean, Israeli, Egyptian, and South African currencies.
We also
developed a weekly currency trading model with more than double the returns of
the annual model (assuming no transaction costs). I’ll write more about our weekly currency
trading model in a subsequent newsletter.
We have a new website hosting our annual and weekly currency forecasts
with strategy construction explanations.
Please email me for more information or access.
Buying Cryptocurrency
|
“Lenin is said to have declared that the best way to
destroy the capitalist system was to debauch the currency.”
~ John Maynard Keynes, “The Economic Consequences of the Peace” (1919).
Cryptocurrencies
based on digital bits are emerging as a real phenomenon, used for actual
transactions, beyond the pale of government regulations. Cryptocurrencies have the potential to upend
banking systems and central banks. If
you think banks are OK as is, then consider that most wouldn’t have survived
2008 without TARP. And take a look at
the 720,000 Euros in “Blocked Funds” in this guy’s bank account in Cyprus.
Cryptocurrencies
have their problems of course. The
transaction history of each unit of currency is becoming quite long, leading to
delayed transaction times as each unit of coin is reconciled. Additionally, there may be disputes along the
“Blockchain,” leading to forked transaction histories and multiple species of
the same currency (although this has not happened yet). And of course, some day, with enough
computing power and ingenuity, additional vulnerabilities may be discovered and
exploited. With Bitcoin’s market cap now
$1 billion, the incentive to find and exploit vulnerabilities is present. Yet one could say something similar about
physical currencies – they are inconvenient for large purchases, can be
counterfeited, and are subject to devaluation.
Of course, with physical
currencies there is physical punishment
(prison) for those who counterfeit or sabotage.
Not so with cryptocurrencies.
The takeaway
from this newsletter is to make a psychological shift to treating the ongoing cryptocurrency
revolution as real and not something that can be ignored indefinitely.
If you want
to buy cryptocurrencies, it’s important to get cash in place to buy even if you
don’t plan to so do for months. The cash
placement problem is one of the deterrents that kept me out of Bitcoin early on. If you're a busy person, find someone you
trust who is technically sophisticated and understands cryptocurrencies. Keep in mind that most people feel inertia
around this, and even with nagging, we often wait to make the obvious
investment after it has been proven
valuable (and we are too late in entering).
I’m
personally waiting for a major sell-off on bad news. But that’s what I’ve been doing since Bitcoin
was $10 (now it’s around $90). The past
year has been notably absent of bad news such as hacking attacks and trading
problems, hence the rally. But with
Bitcoin over $1 billion in market cap, the incentives for crytocurrency crime (counterfeiting,
hacking accounts, etc…) have increased as rapidly as the value.
The future of banking is
likely to look far different than it does today. If Bitcoin is in fact
the first secure and accepted cryptocurrency, then it is likely to appreciate
much further and destabilize national currencies that are debauched in the
service of debt payment (i.e., through inflation). Bitcoin may not be the
ultimate cryptocurrency - for example it has major delays such as transactions
requiring at least 10 minutes to be verified and the price is very volatile -
but it is certainly a huge step in the direction of currency outside of
governmental control and the various complexities such a world will introduce.
Housekeeping and Closing
|
We love to chat with our readers about their experience with
psychology in the markets and with alternative economics - we look forward to
hearing from you! We especially love
interesting stories or your or others experiences.
We will be in London at TradeTech Europe and in Dallas in
April. We have additional 2013 speaking
engagements in New York, Orlando, and San Francisco – we look forward to seeing
our friends in those cities! Please
contact Derek Sweeney at the Sweeney
Agency to book us: [email protected],
+1-866-727-7555.
In 2012 we launched the Thomson Reuters
MarketPsych Indices for
monitoring market psychology for 30 currencies, 50 commodities, 120 countries,
and 40 equity sectors and industries in social and news media. This data is used by top global hedge funds
to improve their investment returns.
Please let us know if you’d like to learn more.
Happy Investing!
Richard L. Peterson, M.D. and The MarketPsych Team
Books
Both books named "Top Financial Books of the Year" by Kiplingers.
Both books named "Top Financial Books of the Year" by Kiplingers.
Who We Are
MARKETPSYCH DATA
179 POST RD W, WESTPORT, CT 06880
|
Disclaimer
This material is not intended as and does not constitute an offer to sell any securities or a solicitation of any offer to purchase any securities.
The
information of the MarketPsych Report is presented free of charge. It is no substitute for the services of a
professional investment advisor.
Investments recommended may not be appropriate for all investors. Recommendations are made without
consideration of your financial sophistication, financial situation, investing
time horizon, or risk tolerance. Readers
are urged to consult with their own independent financial advisers with respect
to any investment.
Past
performance is no guarantee of future results.
Screen and model signals and related analysis are for informational and
entertainment purposes only and should not be construed as an offer to sell or
the solicitation of an offer to buy securities.
Most financial instruments (stocks, bonds, funds) carry risk to
principal and are not insured by the government. Anyone using this newsletter for investment
purposes does so at his or her own risk.
Data
accuracy cannot be guaranteed. Opinions
and analyses included herein are based on sources believed to be reliable and
written in good faith, but no representation or warranty, expressed or implied,
is made as to their accuracy, completeness, timeliness, or correctness. We are
not liable for any errors or inaccuracies, regardless of cause, or for the lack
of timeliness of, or for any delay or interruptions in, the transmission
thereof to the users.
As a
matter of policy, we may act upon the investment information that this
newsletter provides prior to making it available to the public. We do not accept compensation of any kind
from any companies mentioned herein.
MarketPsych
is not responsible for any special, indirect, incidental, or consequential
damages that may result from the use of, or the inability to use, the
Information contained on this newsletter whether the Information is provided or
otherwise supplied by MarketPsych or anyone else. Notwithstanding the
foregoing, in no event shall MarketPsych total liability to you for any and all
claims, damages, losses, and causes of action (whether in contract or tort or
otherwise) exceed the amount paid by you, if any, for accessing this
newsletter.
MarketPsych
expressly disclaims all warranties and conditions with regard to the Web sites,
their Content, and the Information, including, without limitation, all implied
warranties and conditions of merchantability, fitness for a particular purpose,
title, and non-infringement. By using the Web site, Content, and Information, I
assume all of the risks associated with their use, and I release and agree to
indemnify and hold harmless MarketPsych from any and all liability, claims for
damages, and losses arising from or connected with such risks.
IF
YOU DO NOT AGREE WITH ANY OF THESE TERMS AND CONDITIONS OR FIND ANY OF THEM TO
BE UNACCEPTABLE, SIMPLY UNSUBSCRIBE FROM THE EMAIL LIST. If you understand and
accept these caveats, feel free to read the newsletter.
No comments:
Post a Comment