“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.” — Warren Buffett in a letter to shareholders
The Most Dangerous Idea in Investing
If I were to ask you what you think the most dangerous idea is in investing that investors must be wary of, what would you say that is? Bear markets? High volatility? Technical analysis? No, no, and again no. The most dangerous idea in investing is the following four words: “This time is different”.
“This time is different” is a result of the hubris of an overly eager investor, the rallying cry of investors that believe they can ignore previous attitudes, beliefs, concepts, or ideas about investing because, “This time it’s different”. When you hear say somebody say that phrase, or something like it, you should run as far away as possible and don’t look back. That phrase has caused more money to be lost than at the point of a gun. I don’t care how different the latest investing craze seems, or how widely innovative some piece of technology is that you’re investing in, there is always at least some similarity between today’s investing experience and experiences of the past. In fact, these similarities may be more remarkably closer than you might think.
This still holds true even in the “wild-west” field of investing in cryptocurrency. As much as we’d like this to not be true, fundamentals will still apply for cryptocurrencies in the long-term. Which cryptocurrencies/tokens will provide actual value in 10–15 years? Which tokens are designed in such a way that it actually makes sense to hold the token for a long time? Is the team behind a cryptocurrency/token experienced, reputable, and trustworthy? Is a cryptocurrency/token addressing a real-world problem, or is a token attempting to create a solution for a problem that doesn’t actually exist (i.e. putting the cart before the horse)? You must be able to answer these questions fully if you want to invest in cryptocurrencies/tokens that will provide you with strong returns in the next few years.
It’s understandable, of course, why one might get into the “This time is different” mentality when it comes to cryptocurrency. After all, usually this mentality is correlated with dreams of unimaginable riches, a belief that this time truly is different, and that previous times in which something similar occurred were fundamentally different (e.g. the dot-com bubble)
During the dot-com bubble, investors had the mentality of “This time is different” as well, because of the innovativeness of the technology and its long-lasting implications. During this bubble, many investors were eager to invest in any company at any valuation, that had a “.com” suffix at the end of its title.
We’re seeing the same thing happening today — A British company called “On-line plc” that invests in internet and information businesses announced that it was planning on changing its name to “On-line Blockchain Plc”. Its shares jumped 394% in one day. This isn’t some wild or extreme case either. A biotech company called “Bioptix”changed its name to “Riot Blockchain” and its stock rose more than 50% ahead of the announcement, and 17% after they formally unveiled the name-change.
This is concerning. The fact that a company is able to simply add a term to its name, and have its stock’s value skyrocket, should show you the irrationality that the market has for anything and everything blockchain/cryptocurrency related. It’s no different than the greater fools willing to pay massive valuations for dot-com companies.
Mark Twain once said, “History doesn’t repeat itself, but it often rhymes”. In no field is this more true than investing. According to the book This Time Is Different, “The U.S. conceit that its financial and regulatory system could withstand massive capital inflows on a sustained basis… arguably laid the foundations for the global financial crisis of the 2000s.” I’ll let you, the reader, decide whether or not this holds true of the cryptocurrency market as well.
Known Unknowns, Unknown Knowns, and Systemic Risk
“There are known knowns, things we know that we know; and there are known unknowns, things that we know we don’t know. But there are also unknown unknowns, things we do not know we don’t know.” — Donald Rumsfeld
If when you hear or see the words “systemic risk”, your eyes glaze over in confusion, then there’s a problem. So I’m going to take the following paragraph to explain exactly what systemic risk is.
Systemic risk is the possibility that an event within a specific company or group could cause massive instability and uncertainty across an entire market. In this case, we’re concerned with systemic risk within the market of cryptocurrencies and tokens. Companies or groups that are systemic risks are sometimes colloquially referred to as “too big to fail”, i.e. if it fails we’re FUBAR, so it can’t fail.
There are many different types of systemic risk, and it all really depends on the industry or field that we’re concerned with. A systemic risk in a particular market could be contained simply in that market, and could have no impact on the wider economy as a whole. Sometimes, systemic risk could cause instability in the entire economy. These are the ones we should be the most concerned about.
What’s particularly concerning about systemic risk is how often people are blind to it, most often unwillingly but sometimes willingly. But wait, why would somebody choose to be willingly blind towards risk? Wouldn’t investors want to be aware of it so they can take caution and take actions to prevent being affected by systemic risk? The answer, simply put, is no.
Cryptocurrency investors can too willingly ignore obvious systemic risk because they’re making too much money to be concerned with some stupid concept like “systemic risk”, because what in the world is “systemic risk” anyhow? Just another term that economics professors (whom they view as charlatans) use to prevent them from making more money with risky investments, in their view. To them, that’s somebody else’s problem to deal with, not theirs.
One of the difficulties of systemic risk is it’s nearly impossible to make exact predictions regarding whether or not it’ll actually affect anything, and how it’ll affect the market, unless one is privy to insider information. The more precise the prediction regarding systemic risk, the less likely it is to occur, and thus people try to avoid calling something a systemic risk to avoid looking like a fool if the supposed “systemic risk” that they declare never takes place. This is one reason, I believe, why the most alarming and obvious systemic risks are willingly ignored.
Let’s say I call something out as being an obvious systemic risk and make a big fuss out of it to everybody that I can so that they’re aware of it. Maybe, just maybe, I could be wrong and nothing bad materializes out of the systemic risk I kept yammering about. Now my reputation is ruined because I made such an uproar about something that, ultimately, was insignificant. Who wants that to happen to them? That’s often why people who point out the obvious systemic risks are the ones at the bottom of the totem pole: they have nothing to lose. If they’re wrong then it doesn’t affect them as much because they didn’t have a reputation in the first place. But if they’re right, they’ll have fame (or infamy) and most likely get book deals, be invited to CNBC, and maybe even be a main character in a biopic if they detect and call out systemic risk for something particularly important (e.g. The Big Short)
One aspect about systemic risk is the idea of the “Cassandra” archetype. What is this archetype? Cassandra was a woman in greek mythology who was cursed to speak true prophecies that nobody else believed. Cassandras exist to this day; these are the people calling out systemic risks in financial markets that people turn a blind-eye to. They’re viewed as obnoxious at best, and harmful at worst, and they’re not redeemed until their prophecies (i.e. systemic risks) materialize and cause catastrophe.
A difficulty that investors might have is distinguishing between the Cassandras of the financial market, and the delusional hucksters. So I’d like to propose some questions you can use when attempting to assess whether somebody is a harbinger of (mis)fortune, or completely deluded. Note that these questions aren’t exhaustive, but hopefully it provides a good jumping off point to allow you to generate your own questions/criteria. Note this doesn’t just apply to cryptocurrency, but almost anything. In any case, here are the questions you should be asking:
Questions to ask yourself to determine if somebody is a quack, charlatan, or con-artist
- Does this person have experience within this field?
- Has this person published any peer-reviewed papers/books on the subject?
- Has this person been accredited by a reputable organization as an expert in the field?
- Is this person knowledgeable of current literature and information in the field?
2. What is this person’s incentives?
- Are they ideologically motivated?
- Are they financially motivated?
- Do they have skin in the game (e.g. do they get affected if they’re wrong)?
3. How accurate is the information they’re using?
- Do they use facts/data to back up their arguments, or do they mostly use conjecture?
- Are the facts they’re using relevant to the claim they’re trying to make?
- Are the sources they provide reputable?
4. Who else is saying something similar?
- Are other reputable people saying the same thing?
- If so, how many people are saying it that are considered experts in their field?
5. How bad would it be to their reputation if they were wrong?
6. How adamant are they about their warnings to others?
Be aware of systemic risks when you are investing in cryptocurrencies. Avoid excessive hubris, and stop telling yourself “this time it’s different” if the fundamentals of a cryptocurrency investment doesn’t make sense. When a so-called blockchain/cryptocurrency expert claims or predicts something, ask yourself the questions that I’ve provided above to figure out how much you should consider their opinion.
Best of luck with your cryptocurrency investments. May the investment fundamentals be in your favor.
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