Crypto bros, and why there is nothing as disturbing as seeing your friend get rich

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My favourite non-fiction book of 2021 was Gillian Tett’s Anthro-Vision: How Anthropology Can Explain Business and Life. In the book, Tett uses a key principle from anthropology that “listening to someone else’s view, however ‘strange’ does not just teach empathy for others, which is badly needed today; it also makes it easier to see yourself” and examine many different things.

In the last few months, I have tried to implement this principle by speaking to a few people in their 20s and early 30s to understand why they speculate or invest in crypto. Different reasons emerged from this. Of course, this wasn’t like a well-calibrated survey, where the set of people I ended up talking to reflected the characteristics of the underlying population. So, to that extent, this exercise had its limitations. Nonetheless, a few learnings stood out.

     

FOMO or the fear of missing out.

This was the most common explanation where individuals started investing in crypto because they had seen their friends make money. Such people had no theoretical or intellectual reasons for buying crypto.

They bought because others they knew bought and did well. In that sense, this was a very what you see is what you get kind of situation. Or as Charles Kindleberger writes in Manias, Panics and Crashes: “There is nothing as disturbing to one’s wellbeing and judgment as to see a friend get rich.”

Of course, the fact that the entire process of starting to invest could be carried out sitting at home helped. Before we go any further, look at the following chart. It plots the price of bitcoin, the most popular crypto, over the last two years.

What this chart tells us is that anyone who stayed invested in bitcoin (and other cryptos as well) over two years must have made a decent amount of money, despite the recent fall. But I found out through my conversations that the amounts invested were small – nothing that would have helped an individual build a significant amount of wealth in any way.

This is something that the RBI Governor Shaktikanta Das said very clearly in November: “The total account balance is just about ₹500, ₹1,000 or ₹2,000, and that covers about 70 to 80% of the accounts.” Clearly, most so-called investors were making a small punt. This reminded me of people playing the housie game (also known as tambola) in the 1980s and 1990s in the public sector colony I grew up in. The idea was just to buy a ticket (even more than one) to not miss out on the fun. If on a lucky day, the individual happened to win a prize, anything from the fastest five to a housefull, it was just an added benefit.

Short-term horizon

Another interesting point emerged: most individuals who invested in crypto wanted to make a quick buck. In a few cases, I tried to initiate a conversation explaining the benefits of long-term regular investing in building wealth, however boring that may sound. But that did not find an audience.

It reminded me of a fascinating example in a very different context that economist Thomas Sowell recounts in Knowledge and Decisions. Sowell talks about the time horizon of the youth who commit petty crimes. As he writes: “Most crimes are committed opportunistically by youths who want small amounts of money right away.”

In that sense, will a job training programme wean away youth from a life of petty crime? Over a long-enough time horizon, it is easy to see that a job training programme is likely to increase the earning ability of youth much more than a life of petty crime. The trouble is that the youth may not be making this calculation and may want money tomorrow morning, and this “may nevertheless be as rational” within the time horizon of the youth “as the opposite result is for those with a longer time horizon”.

The time horizon taken into account is very important here. The same thing can be said for individuals who have made some quick buck by investing in cryptos. Trying to explain to them the benefits of long-term regular investing where money compounds at a rate of, let’s say, around 12% per year, turns out to be a waste of time for them.

Of course, on the flip side, some invested in cryptos when prices peaked and are sitting on huge losses or have already booked losses. The price of bitcoin as of 10 November had stood at $67,567. A little over two months later, on 12 January, it is down by 35% to $43,949.

Like one particular gentleman in his early 20s told me, I waited for nearly six weeks for things to turn around, but they didn’t, and then I sold out. The point is that the short-term horizon can hurt both ways.

The influencers

Other than the FOMO crowd, there was also the crowd who thought they were doing a smart thing by investing in crypto, as this is something that other smart people have endorsed. Everyone from Elon Musk to Jack Dorsey to Gary Kasparov has endorsed crypto at some point in time.

The assumption here is, and as Thomas Sowell writes in Intellectuals and Society: “Superior ability within a particular realm can be generalized as superior wisdom…overall.” Nonetheless, that is not how things actually are.

In fact, as Steve Pinker writes in Rationality—What It is, Why It Seems Scarce, Why It Matters: “In their article “The Nobel Disease: When Intelligence Fails to Protect against Irrationality,” Scott Lilienfeld and his colleagues list the flaky beliefs of a dozen science laureates, including eugenics, megavitamins, telepathy, homeopathy, astrology, herbalism, synchronicity, race pseudoscience, cold fusion, crank autism treatments, and denying that AIDS is caused by HIV.”

Human expertise tends to be in extremely narrow areas. Nonetheless, the influencers of any era, including the present one, don’t bother with this nuance. They make their arguments with authority. Roy Harrod writing about the British economist John Maynard Keynes in The Life of John Maynard Keynes, said: “He held forth on a great range of topics, on some of which he was thoroughly expert, but on others of which he may have derived his views from the few pages of a book at which he had happened to glance. The air of authority was the same in both cases.” (Cited by Sowell in Intellectuals and Society).

Similarly, there is no doubt that Kasparov was a great chess player, and Musk and Dorsey are great entrepreneurs but do they really have the ability to predict the future direction that money/crypto will take. I am not so sure. There is nothing wrong with having heroes in life, but when those heroes start making confident statements about stuff they possibly do not understand, one needs to take it with a pinch of salt.

Insiders versus outsiders

As with every other form of investing, the crypto investing space also has insiders and outsiders. The insiders are those who latched on to cryptos before others did. It is in their interest that crypto prices keep going up, and for that to happen, they need more and more outsiders to invest in crypto.

As Kindleberger wrote in Manias, Panics and Crashes in the context of real estate and other financial securities: “The purchases of securities or real estate by ‘outsiders’ mean that the ‘insiders’ – those who own these assets – sell them and realize profits; if the outsiders are buyers, then the sellers must be insiders.” This is as true about cryptos as it is for other investment asset classes.

Given this, as I had written in my edit page column in the Mint last week: “So, the insiders need to be perpetually positive.” If you are a newbie crypto investor following an insider just because they are positive, then something doesn’t make sense here.

The crypto influencers are basically like someone who enters a multilevel marketing scheme early and then needs to make sure that more people keep entering the scheme in the time to come to ensure that it keeps running.

The narrative

Every bull market has a theory behind it. So do cryptos. Or, if we were to put it in a way more in line with the times we live in, every bull market has a narrative behind it. In my interactions, I found that a few investors were invested hard in the crypto narrative, even though their understanding of things was largely superficial. Such investors had gone much beyond FOMO. In fact, there is a term for such investors. They are called crypto bros.

Before we get into the detailed crypto narrative, let’s first try and understand what the word narrative itself means. Anthea Roberts and Nicholas Lamp explain this in their book Six Faces of Globalization – Who Wins, Who Loses, and Why It Matters. According to the authors, any narrative has four building blocks. The scene is first set for analyzing an issue in a particular way. After this, winners and losers or villains and victims are identified. This provides a plot that leads to the moral of the story. And finally, a prescription is provided.

Let’s try and understand this in the context of crypto. The scene is that since 2008, when the global financial crisis started, the Western central banks have been printing a lot of money, something they have continued with as the covid pandemic has spread. This makes central banks and governments the villains of the piece.

All this money printing can lead to high inflation, reducing the value of savings and the incomes of ordinary people. Their purchasing power will go down. This is the plot, with the ordinary people who risk losing the value of their savings being the victims of the piece. The moral of the story is that what the central banks have been doing can hurt people. So, what is the way to protect ourselves from this? What is the prescription? Buy cryptos in general and bitcoin in particular.

This is the narrative that has been set. The original crypto bitcoin was built around this narrative. While governments and central banks can create unlimited money, bitcoin has been so built that only 21 million bitcoin can ever be created. In that sense, bitcoin, like the paper money of this era, cannot be continuously created out of thin air.

This has led to comparisons with gold or, in particular, with the stock-to-flow model of gold. Eswar S. Prasad explains this model in detail in his book The Future of Money. As he writes: “ The total stock of gold that exists in the world (above ground) is estimated at about 185,000 metric tonnes. Roughly 3,000 tonnes of gold are mined each year, about 1.6% of the existing stock. Thus, the stock-to-flow ratio is about sixty.”

So, it would take many years of gold production (that is, the annual flow) to match the total current stock of gold. This is why gold is valuable. It cannot be created out of thin air, and there is no danger of a sudden increase in supply leading to massively knocking down the price of the existing stock of gold. This is why gold has been a popular store of wealth over the centuries.

Those who believe in the narrative around bitcoin believe that it is like gold. As Prasad writes: “Around 2022, bitcoin’s stock-to-flow ratio is expected to overtake that for gold.” What does this mean? Gold’s stock to flow ratio is around 60. If bitcoin’s stock-to-flow ratio reaches sixty, what does that mean? It means that the amount of bitcoin already mined is about sixty times the total amount of bitcoin that will be mined in that given year.

Also, as the mining rate of bitcoin slows down in the years to come, the stock to flow ratio will go up further. And this means that bitcoin will only become more valuable.

There are largely two basic problems with this argument. The first is that neither bitcoin nor any other crypto has emerged as a medium of exchange that can take on the existing paper money system. This was the original idea behind cryptos. The reason for this is very simple. The bitcoin network can handle around seven transactions per second, while Visa can handle 65,000 transactions. The newer cryptocurrencies are trying to solve this problem.

The second reason is that while there is a cap to the number of bitcoin that can be mined, anyone with enough expertise can launch their own crypto, and it can turn out to be better crypto than those in the market right now. So, competition will ensure that the current cryptos may not be the most popular cryptos going around in the years to come.

As renowned investor Ray Dalio put it in a note on bitcoin: “Competition will play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works.” Nonetheless, gold will continue to be gold. It was around. It is around. It will continue to be around.

To conclude, the question is, has the crypto narrative been punctured? Perhaps. The Federal Reserve of the United States has decided to stop printing money by March later this year. That explains the recent fall in the price of crypto along with the fact that most investors have a very short-term investment horizon, hence, when prices start falling, they tend to sell out quickly, thereby adding to the fall.

As I finish writing this on the evening of January 13, Rishabh Pant has just hit Keshav Maharaj for two big sixes in two balls. Just a few days back he had gotten out playing a rash shot, which contributed to the Indian loss. Bitcoin and crypto are like Pant on any given day, you really don’t know what to expect at a given point of time. It probably depends on which side of the bed the crypto bros have been getting up from…

Okay, that was just me trying to have some fun! Now don’t send me those have fun staying poor jokes. I am currently going through a JOMO (joy of missing out) phase.

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Written by Vivek Kaul. Edited by Saikat Chatterjee. Produced by Nirmalya Dutta. Send in your feedback to newsletters@livemint.com.