Thoughts

Bitcoin started as a libertarian experiment, the plaything of geeks and those interested in Austrian economics. It couldn’t even be traded properly until 2010, with the rise of MtGox, and was held and used mainly as a curiosity.

That started to change from 2011, as exchanges came online and speculators got involved. ‘Investing’ in bitcoin was a high-risk activity, though holders were rewarded handsomely for their foresight. Prices rose from a few cents to dollar parity in February 2011.

Over the next two years this soared to more than $1,000 in the 2013 bubble. This was partly driven by activity on the darkmarkets – real demand raising bitcoin’s profile – with speculators playing a major role in bidding the price up. Then came the bear, and crypto’s time in the wilderness.

Things started to change again in 2016, and 2017 was the year of mass retail interest, as ordinary people heard about crypto and took a punt – largely via secure, professionally-run exchanges like Coinbase. Bitcoin gathered steam once again, recovering from around $500 to almost $20,000.

2019 will be the year of institutional money. (It’s not likely to be much before then due to the delays in the SEC’s decision on the SolidX-VanEck ETF. If the main ETF is denied, there will likely be other products arising in due course.) What can we expect at that point?

Big money

Institutional money accounts for a large proportion of stock market wealth. It’s hard to say how much, but we can make a few rough estimates. We do know that financial institutions own approximately 80 percent of major stocks. In other words, for every dollar of shares held directly by retail investors, four dollars are held by investment managers. Assuming bitcoin ultimately follows the same pattern, then what?

This does not logically mean a 500% increase for crypto. It means that when they market settles with institutions having taken their stake, just one fifth would be owned by individuals. But that process of accumulation is likely to have a far, far greater effect than just 500%. A little money can move the needle a long way. Institutions may end up with 80%, but the value of the 20% remaining will be worth many, many times what it is today. There are no guarantees, but $100k+ valuations are not unreasonable by any means. HODL.

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In a previous article, we looked at NVT, the Network Value to Transactions ratio, which is a basic way of valuing a crypto network.

NVT is simply the overall market cap of a crypto divided by the volume of transactions that take place on its blockchain. The thinking is pretty straightforward: more valuable blockchains should see more transactions. Comparing NVT for different cryptos, you should be able to see which are under- or over-valued. And changes in NVT do broadly correlate with price inflections.

But it’s not a particularly sophisticated metric, and doesn’t account for a lot of important factors (a spam attack, for example, sees a lot of transactions on the blockchain, but doesn’t reflect underlying value). A more nuanced approach is NVM, or Network Value to Metcalfe ratio.

NVM is not nearly so simple as NVT to grasp, but it turns out it’s quite good at predicting when bitcoin is over- or under-valued. Robert Metcalfe was an early Xerox PARC employee, and came up with the principle that the value of a network is proportional to the square of its nodes or users. So a telephone system with 200 users is four times as valuable as one with 100 members – not twice as valuable, as you might first think. This is why bitcoin is so valuable: its network is that much larger than any altcoin’s network, and the impact of that difference is squared.

Taking different implementations of Metcalfe’s law, Cryptolab Capital has come up with a model that works surprisingly well. Read the article in full for a proper overview, but the take-home message is that a rise in value should be accompanied by a rise in Daily Active Addresses – if not, price may be getting ahead of ‘real’ value (i.e. a bubble).

This may all change with the introduction of proper custodial services and exchange-traded products, but in the immediate future it’s another useful tool to add to the crypto investors kit.

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It’s only natural that the massive run-up in bitcoin’s price should be accompanied by an explosion of online interest for the currency. Millions of people who had never heard of it before suddenly saw it soaring in value, and wanted to find out more. That’s why Google Trends has traditionally correlated well with the price of bitcoin.

After all, what do you do as a newcomer if you read about bitcoin and decide to buy some? You don’t have a clue where to start, so your first move is most likely to Google it. Armed with that information, you register with Coinbase or another major exchange, go through KYC, and a few days later (or perhaps weeks, if you take your time to think more carefully about it) you are the proud owner of your first bitcoins. So all things being equal, Google searches should pre-figure price movements.

That’s more or less what we found last year and this year. Google searches spiked in December and dropped off a cliff when the bubble burst, just like price. Google shows interest as a percentage of its maximum, rather than as absolute search numbers, but the picture is clear: https://trends.google.com/trends/explore?q=bitcoin

The week before 17 December 2017 was the high for bitcoin searches, the same day that bitcoin hit its all-time high. Unfortunately, the page doesn’t give data more granular than a week, so we can’t tell precisely which day was the peak. But the date given is the last day of that week’s results, so we can say that the week leading up to the all-time high was the most active for searches – confirming the theory of interest leading price. Searches bottomed out in June and July, twice touching just 9 percent of their December high.

And what now? It’s a little early to say, but keep an eye on the Bitcoin Trends page, because it looks like interest might be just starting to pick up again.

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You might think that Jimmy Wales, founder of the world’s largest and most famous open-source encyclopedia, might be a fan on bitcoin and blockchain. Not so.

Wales is well known as a crypto critic. Back in 2014, Wikipedia started accepting the virtual currency, as it still does today. Bitcoin is one of many ways supporters can donate to the Wikimedia Foundation. As an open-source initiative without obvious revenues, the platform is constantly soliciting donations to cover its costs.

But Wales himself is a skeptic.

‘I have reservations about blockchain,’

he said after a recent conference.

‘It’s a super-interesting technology, but it’s clearly a bubble with a lot of mania and hype around it.’

ICOs in particular have come under Wales’ fire. Wikipedia itself will never hold an ICO and never issue a virtual currency, he says. He sees no need.

Maybe he has a point. There’s a reason that Wikipedia is the fifth most popular site on the web. And so far, its army of volunteer editors have been happy to give up their time for free to add value to the site for the benefit of all.

Legitimate and genuine kudos goes to Wales for building such a massive, open and valuable community with so little funding. But you have to wonder whether that approach is sustainable. Newer wiki-style platforms are arising, which pay contributors in crypto – Lunyr being an obvious example. If the market functions as it should, why would someone write for free when the same effort could earn them a reward? Sure, some people will do it out of public spirit. But many will want to reap the financial benefit of that work.

There is definitely room in this world for a ‘public service’ resource like Wikipedia, and the anti-fake news WikiTribute that Wales also set up. News without the distortions of financial interests is vital to free speech. But the landscape of open source platforms is shifting with the rise of blockchain, and it’s anybody’s guess whether such resources can survive in the long run.

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One of the big criticisms of bitcoin by mainstream media and much of the public is its volatility.

How can anything that claims to be a currency expect users to put up with 5-10% daily swings in value, or a 70% loss over the space of a few weeks, as happened at the beginning of 2018 

And they have a point. While bitcoin has proven a good long-term store of value (ask anyone who bought it more than a year ago), it fluctuates a little too much for the likes of ordinary folks. If bitcoin grows by another 10x or 100x, and especially if institutional money and derivatives come in, that volatility will be attenuated. Right now bitcoin is just a tiny, $100 billion commodity, which is nothing in the grand scheme of global finance. At $7 trillion – roughly the value of all gold – those swings would be far less, thanks to the deeper orderbooks and higher liquidity. (Though remember: gold itself isn’t exactly stable, despite its reputation as a store of value.)

So how do you get from $100 billion to $7 trillion?

The only realistic way for this to happen is through speculation. Price discovery, turbocharged. Bitcoin needs greater awareness, it needs to consolidate and increase its network effect, and it needs to pick up a whole lot more use cases – not least those ETFs and futures we’ve been hearing so much about. It needs to be used as a global means of transfer, as an asset used in retirement funds and by investment managers.

Speculation is a reflection of its potential: a feature, not a bug. It goes with the territory at this point. Sometimes we overdo it. Sometimes we go too far the other way. Price almost never coincides with value. It’s all part of the process of figuring out – as fast as we possibly can – what we collectively think bitcoin is worth.

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Look at a bitcoin price chart. What do you see?

Red candles, green candles, volume bars?

Perhaps you’ve trained yourself in TA and you can see the patterns behind the bars. Support, resistance. Trends, ranges.

Or just maybe you see between the lines, the music behind the words. Greed. Elation. Caution. Panic.

Ultimately, a market is the reflection of all of its traders’ decisions, and many of those decisions are driven by emotion – particularly in a market like bitcoin, where institutional players are still just starting to come in.

That’s why Sentiment Analysis is an important tool, alongside Fundamental Analysis and Technical Analysis. What’s the market’s approach to this right now? Are they confident, fearful, interested, averse?

Take a look at The Fear and Greed Index: an analysis of emotion and sentiment taken from different sources and consolidated into a single figure. Zero means Extreme Fear. 100 represents Extreme Greed. You’ll see from the Crypto Fear and Greed Index that fear tends to correlate with buying opportunities, and greed with selling opportunities. It uses volume and volatility, social media and survey data, as well as bitcoin dominance and data from Google Trends.

It’s not a perfect measure, but it’s another useful tool for the smart bitcoiner’s toolkit.

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You may be surprised to hear that PayPal’s former CEO, Bill Harris, doesn’t like bitcoin much. He has called it the biggest pump and dump in history, a scam that he says is going a whole lot lower.

“There’s just no value there.’ It’s a cult, he states, that is not useful, globally accepted, secure, free, fast… or anything else that its proponents claim.”

Harris goes up against crypto industry giant Brian Kelly, who does a pretty good job of stating the case for the technology – which, he admits, does need to develop. But that’s where the investment opportunity lies.

Harris is an old-paradigm thinker who is viscerally opposed to crypto. We already have digital currencies, he says, which are more secure and stable. They’re called the US dollar, Chinese Yuan, and so on.

Here at Inferno, we are enthusiastic contrarians. We have seen a long bear market, which has brought critics out of the woodwork – claiming that the fall in price justifies their skepticism. What’s jaw-dropping about Harris going so publicly on the record about bitcoin is that he comes from Silicon Valley and the e-payments industry. More recent PayPal execs have been far more open to bitcoin and blockchain technology. But Harris evidently cannot break out of his existing framework of very conventional thinking.

His comments came at a time when bitcoin was trading at a local low, bumping along at the $6,000 mark and looking like it might crash a whole lot lower. It has since recovered. Harris may just have encapsulated the bearish pessimism that characterises the point before a reversal. We won’t know until a little way down the line, but in forecasting bitcoin’s demise, he may actually just have called the bottom.

You can see the discussion here.

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Back in April a serious bug was discovered in Bitcoin Cash, the controversial fork that claims to be the ‘real’ bitcoin. A developer anonymously sent a report to the team, and the issue was rectified before potentially billions of dollars worth of damage had been caused. Now, Cory Fields — a Bitcoin Core researcher — has written a blog stating that he discovered the bug and sent the report, and explaining why he did so anonymously.

‘A successful exploit of this vulnerability could have been so disruptive that transacting Bitcoin Cash safely would no longer be possible, completely undermining the utility (and thus the value) of the currency itself… In short, a portion of the transaction signature verification code was rewritten, but the new code omitted a critical check of a specific bit in the signature type. I refer to that bit in the disclosure as SIGHASH_BUG. This omission would have allowed a specially crafted transaction to split the Bitcoin Cash blockchain into two incompatible chains.’

This whole episode should be profoundly embarrassing to BCash, for several reasons. Firstly, their shills — especially Roger Ver — claim the protocol is technically superior to Bitcoin Core. In reality, without unsolicited help from a Bitcoin Core dev, it would quite possibly be worthless. Secondly, Bitcoin Cash changed just a small amount of code when they forked from Bitcoin Core, and yet they somehow managed to introduce a fatal bug into this altered code. Worse, the code review process was abysmal, as Fields writes:

‘I noticed that one of the most critical pieces of transaction validation had been refactored. The changes jumped out at me immediately because they seemed so unnecessary. Curious about the reasoning behind them, I took a look at the public review the changes had undergone. There was no justification other than “encapsulation,” it had only two reviewers, and review only lasted a week before the code was accepted… After seeing the minimal review the changes had undergone and the large number of lines changed, I thought it reasonably likely that a bug might have slipped in, and so I went looking. It took less than 10 minutes to find SIGHASH_BUG.’

Not only that, but Fields found it extremely difficult to report the bug at all, due to the lack of proper process or even contact details available. Days were wasted as he tried to contact the team. He explains his reasoning behind maintaining his anonymity throughout: should an attack have been carried out before the issue was fixed, costing users billions of dollars, he would fall under suspicion. People have been killed for far less.

This whole episode betrays a profound lack of professionalism at the heart of Bitcoin Cash. A lot of the crypto community are already extremely wary of BCash, due to the scammy marketing techniques and the attempted land-grab of the ‘Bitcoin’ brand. This bug and the process of fixing it suggests that incompetence should also be added to the list. If you want to entrust your money to the Bitcoin Cash network, Caveat Emptor.

Read Cory Fields’ blog post here.

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Ever noticed how big money makes more money, and the smaller investors always seem to get fleeced? You’re not the only one. So did Richard Demille Wyckoff, a stock broker and one of the early figures behind the discipline of technical analysis. Something of a prodigy on Wall Street, in the course of his work he noticed the chart patterns that signalled how large players were positioning, almost always at the expense of retail traders. By learning how to align their trades with big money, though, ‘ordinary Joe’ traders could emulate their success.

His method has proven successful in any large and liquid market in which institutional and large investors are active, stripping money from retail traders as they make profits. What’s true of the regular markets is especially true of bitcoin, where emotion and a lack of regulation have led to a lot of inexperienced investors losing badly.

Wyckoff had a number of important insights, and this overview is well worth reading. One of the most relevant for our purposes is the Wyckoff Accumulation, which occurs at the end of a bear market, before the next price rise. With bitcoin down 65% from its high and currently trading in a range, studying his method could prove profitable. It is especially interesting since we know that big money is piling in and positioning to come in right now.

Looking at the chart for bitcoin this year, you should immediately recognise the pattern. The Selling Climax occurred on 6 February, with the brief but high-volume spike below $6,000. We then saw the Automatic Rally back above $10,000. The Secondary Test, and further tests, took place in April and after. And at the present time, it looks like we’re forming a Spring, a shakeout below the Trading Range we’ve established between about $6,000 and $10,000. Of course, judging where that is going to end is a different matter; bitcoin’s signature volatility makes it hard to know whether $6,000 or $4,500 will be the bottom.

All of that paves the way for the next bull market, which has its own jumps in price and pullbacks, and culminates in a Distribution phase at the top, just as a bear market ends with an Accumulation phase.

Wyckoff’s insights are keenly relevant right now, and used well will help you make a good entry point as the bear market plays out its final stages. Add it to your toolbox – and good luck!

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If you’ve been tracking analysis articles in the crypto world, you’ll likely have come across the term NVT as a rough metric that is – more and more frequently – used to value bitcoin and other cryptos. So what is it and why is it important?

Network Value to Transactions is simply the ratio of the market cap of the crypto to the volume of daily transactions. If a network is more frequently used, we would expect its value to be higher. Comparing different networks, we can see whether one has a significantly higher or lower valuation than we might expect for the amount of actual use it supports.

Comparing different networks’ NVT values, we can see that LTC has a higher NVT than BTC and is – by this metric – more overvalued than bitcoin.
Conversely, DOGE could be considered more undervalued than bitcoin.
NVT is a good and logical starting point, but it’s a blunt metric. It doesn’t take into account a number of significant factors, such as: off-chain (exchange-based) transactions, spam attacks (lots of useless transactions), the difference between old and new addresses, and so on.

A more exciting, complex and nuanced approach along the same lines is Network Value to Metcalfe (NVM) ratio. We’ll be looking at that in a future article, but you can read more about it here.

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