âThere 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.â
~ John Maynard Keynes, âThe Economic Consequences of the Peaceâ (1919).
In 2008 MarketPsychâs 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 worldâs 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 weekâs 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 âalternative economyâ 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 â 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 âminingâ 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 âOptionalityâ â 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 Iâve honed a keen intuition for identifying the really good ones. The problem is, I often donât 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 donât own any Bitcoin. Iâve 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 donât ask their wives to nag them. But Iâm a lucky man - my wife doesnât nag - so if she were to nag, the logic went, I would be sure to pay attention. But this wasnât a foolproof strategy.
As I had requested, my wife did nag me at the appointed times, âRich, buy Bitcoin. Rich, did you buy Bitcoin yet?â 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: âRich, please take out the garbage, the kitchen is getting stinky,â âRich, please buy gas for the generator, another big snowstorm is coming,â and âRich, donât forget to brush your wild-man-just-rolled-out-of-bed hair before you present at that important meeting.â
But getting into cryptocurrencies isnât 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 didnât 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, Iâm 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 doesnât 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⦠(donât 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. Youâll 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, youâd be better served moving to a currency with less expressed confidence. Keep in mind weâre looking at the top ten global currencies based on past yearâs 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.
