As the chart above shows, the biggest names in crypto all got 2018 horribly wrong. Why were they so wrong? I think they’re all smart guys and I applaud their work and the important contribution they’re making to the ecosystem. I think there are two main reasons why they’re so bad.
1. Accurately Predicting The Future Values of Assets is Not A Thing
I know that every day on CNBC, you’ll see stock market strategists giving forecasts of where the market is going to be in 3, 6, or 12 months. Yet, we don’t get 3, 6, or 12-month forecasts for the weather on the Weather Channel? The weather channel forecast out that long, because that’s not a thing that has any predictive value. While meteorologists can forecast one day out pretty well, by 10 days out, the variance is pretty significant:
The weather in a month can’t accurately be predicted because that forecast has to take into account a number of large-scale phenomena, each of which is governed by multiple variables and factors. To start, the sun does not emit a constant amount of heat. Once the sun’s variable level of heat hits the Earth, it’s impacted by air pressure differences causing winds as well as how water-changing phases (from ice to water or water to vapor) which affects the flow of energy. The weather is even impacted by the planet’s rotation in space, which moves the Earth’s surface beneath the atmosphere. Small changes in any one variable profoundly affect the weather. An MIT meteorologist, Edward Lorenz, came up with a great description of this phenomena in 1960. Lorenz called it the butterfly effect
The butterfly effect refers to Lorenz’s belief that a butterfly flapping its wings in Shanghai can dramatically alter the weather in New York City. Lorenz eventually fathered a new branch of mathematics called Chaos Theory “which focuses on the behavior of dynamical systems that are highly sensitive to initial conditions. “Chaos” is an interdisciplinary theory stating that within the apparent randomness of chaotic complex systems, there are underlying patterns, constant feedback loops, repetition, self-similarity, fractals, self-organization, and reliance on programming at the initial point known as sensitive dependence on initial conditions…”.
The stock market is the same as weather. While the weather channel never trots out weather experts to tell is where the weather is going to be in three months, CNBC fills its day with analysts projecting out three months or longer. Below is a chart with 19 predictions (as of September 5th, when the S&P was at 2,886) for where the S&P was going to finish the year:
With the S&P currently at 2,633, the average prediction above is off by 12.6%, and the closest of the 19 is off by a woeful 6.3%.
And by the way, it’s not just the experts that are way off. It’s the layman as well:
2. Bitcoin Is A Store Of Value, And, Over the Long Run, It Should Provide Returns In Line With Other Stores of Value (i.e. Gold)
The simple idea of a store of value is that it maintains “buying power” even as a currency inflates. Since 1971 (when Nixon ended the gold standard), inflation has averaged about 4%, meaning your buying power got cut in half about every 17 years (per the Rule of 72):
So what cost $1 in 1971 costs $6.51 today. It turns out the dollar is a terrible store of value. Gold, on the other hand, has held its value well since 1971 when we went off the gold standard and gold began its transition to being a store of value:
But if you look more granularly at the data, you would see that gold rocketed in price the first four years, as the world adjusted to the fact that gold had become a store of value:
Interestingly, if you take out the gold’s price increase in these first four (transition) years, you get an average price increase in gold that is less then 1% above the inflation rate during that period. That’s a GREAT store of value:
So, undoubtedly, Bitcoin is still in that early phase of transitioning to a store of value. And like gold in its early days as a store of value, Bitcoin has seen a dramatic rise in value (112% IRR over the last two years) in its early years.
So just like the stock market forecasters who ALL expected the S&P to go up, ALL the Bitcoin forecasters expected it to go up in 2018 (it finished 2017 at $13,791). But trees don’t grow to the sky, and nothing always goes up, regardless of what the forecasters forecast.
Where Is Bitcoin Price Going?
I don’t know where the Bitcoin price is going. The truth is, no one knows where Bitcoins price is going. But I think there are three possible outcomes for Bitcoin
- Bitcoin fails as a store of value — In this case, I think Bitcoin is toast
- It surpasses gold as a store of value — In this case, with the total amount of gold bullion currently at about 2.5B ounces, and gold bullion market cap at $3.1 trillion, each Bitcoin will be worth north of $145,000
- Bitcoin takes second place as a store of value — Silver is broadly considered to be #2 player in terms of stored value. There is currently about 4.0 billion ounces of silver bullion, for a total market cap of $58 billion, which would result in a price for Bitcoin today of $3,346. Bitcoin currently has a market cap of $62 billion.
So take each scenario, and estimate a likelihood of happening, total the values derived, and you can get your own forecast for where Bitcoin is going to be valued down the road.
But that’s using my framework. One of the most interesting things about Bitcoin is, if it can evolve, that it can be anything. So everyone can have a different framework for what it can be and what that would be worth. And maybe I can be all those things?
But I won’t be making a prediction of where Bitcoin is going to be in a year, because I believe in the butterfly effect and as such, I don’t think predicting asset values is a thing. But even at low likelihood of Bitcoin surpassing gold, it still looks like a VERY compelling investment from a risk/reward standpoint, (using my framework).