Jesse Lawler

@Lawlerpalooza

The Bitcoin Market is a T-Rex

If you feel like you’ve had your financial torso bit in half by the negative spikes of Bitcoin prices over the past couple weeks, it may be easy to convince you that the market is a T-Rex. Right now, everything hurts. Your portfolio is mangled. Body parts are missing.

As I type this, the dollar-price of Bitcoin is down about 40% over the past ten days.

At first glance, this sounds apocalyptic. Depending on when you closed your eyes and stopped looking, something like $45 billion of market cap has been wiped off the books in the blink of an eye.

For those of us who own Bitcoin and haven’t panic-sold yet, this is a gut-check. Is now the time to bail before things get even worse?

Or is this a blood-in-the-streets moment the investment-savvy people are talking about when they say “buy when there is blood in the streets”?

Or is now the time to sit tight and do absolutely nothing — like a deer in the headlights — and not make financial decisions while under the influence of unpredictable emotion?

Feeling myself pin-balling between all three of these positions, I figured it was a good time to try to figure out what this price-dump actually means. As in:

Where, exactly, did that $45 billion dollars of value go?

The answer, of course, is that it’s all T-Rex chow. But that’s actually not as bad as it may sound.

Bitcoin and Eminem: “I am whatever you say I am.

The first thing to come to terms with is that Bitcoin is totally useless except for its being an unforgeable digital asset. There is nothing to maintain its price other than the subjective opinion held by everybody else.

Bitcoin can’t be repurposed, sold for scrap, recycled, or used as a paperweight.

Its only value, ever, is what you can exchange it for to someone else. That could be another currency, or a Lamborghini, or a used couch.

So when the value of BTC on the major cryptocurrency exchanges drops by 40% in less than two weeks, what exactly has happened?

Nothing more (but nothing less) than this:

People who were looking to sell Bitcoin could find no one willing to buy it from them for more than…(checks current price)…$3,949.

In other words:

  • It’s not that $45 billion dollars worth of something got destroyed (e.g. one billion apple-carts holding $45 of apples each were overturned).
  • It’s also not that $45 billion is now in some different person’s pocket.

It’s just that the people who want to buy right now can find sellers willing to sell at around $4,000 per bitcoin. Previously these sellers weren’t willing to sell — or if they were, they demanded a higher price. For the past 4–5 months, that price had been hovering around $6,500.

Sellers being more eager than buyers drives the “market price” down. (And vice-versa.)

This is Economics 101, but it’s easy to forget how this theory derives from real-world practice.

And this relates to — and, in fact, drives — Bitcoin’s famous price volatility, both on the upside and the downside.

Nobody asked your opinion.

Let’s say you’re the proud owner of one bright, shiny bitcoin. Two weeks ago, it was “worth” $6,500. Today, $4,000.

Take note that at no point during that timespan did anyone ask you what you though the price should be.

For the sake of argument, let’s say that you got your bitcoin on a lark years ago, and you’ve always thought it was overvalued. You think it’s worth, at most, $1,000. But you’ve been busy with other stuff, and never got around to unloading it. (After all, what’s the hurry, since there’s seemingly other suckers out there willing to overpay whenever you’re ready?)

The fact that you were busy with other stuff — not transacting or letting anyone else know your subjective selling-price for Bitcoin — has made your longstanding opinion totally invisible to the market.

You’re probably not like this, though.

You hodl your bitcoin because you think — eventually — the price will go to the moon. But consider:

The die-hard hodler’s opinion of Bitcoin’s price is totally ignored by the market.

This is worth re-reading a couple times, because it’s not intuitive.

The hodl-or-die crowd, Bitcoin’s most fanatically loyal enthusiasts (and, one can assume, a disproportionate share of its owners) are neither selling nor spending their bitcoin. Thus, they are — by definition — totally invisible to the exchanges that define Bitcoin’s market price.

Here’s where we get to the T-Rex. Remember Jurassic Park, where the T-Rex could only see movement? If you could just hold (hodl) still, you were invisible?

The market is that T-Rex. It can only “see” financial activity.

What this means is: a small sliver of the overall group of people who own Bitcoin are the only ones determining/asserting/revealing its market price.

A small tail can wag a 100-billion-dollar dog and whipsaw its valuation while almost no actual value changes hands.

Say it again, with potatoes.

Imagine a community of ten people, where the local currency is PotatoCoin. Each PotatoCoin has been worth 100 potatoes for as long as anyone can remember.

Eight of the ten people go on vacation, leaving Alice and Bob behind. Alice needs some cash for a purchase, but luckily she’s got some potatoes. So she goes down to the market with 100 potatoes to get a PotatoCoin.

Everyone is out of town except Bob, and Bob is sick of potatoes. (Bob is also kind of a dick.) He’s only willing to give her 0.1 PotatoCoin for her 100 spuds.

Alice protests — this is a rip-off and both of them know it — but she needs the cash and no one else is in the market.

Grumbling, she sells Bob 10 potatoes for 0.01 PotatoCoin. (She’s unwilling to sell all 100 potatoes at this price, so she makes the minimum sale for the short-term cash she needs.)

With this transaction — since there no other PotatoCoin sellers present — the “market price” of PotatoCoin has fallen by 90%.

When the other eight PotatoCoin holders get back from vacation, they’ll be shocked to find their financial “savings” in ruins. Their PotatoCoin accounts — which held millions of potatoes-worth of funds previously — suddenly equate to mere hundreds of thousands of potatoes.

All of this based on a 10-potato transaction.

We can imagine the PotatoCoin market cap quickly recovering when the returning vacationers begin transacting again, assuming that other people like potatoes more than Bob, and as much as they always have in the past.

But this silly example underscores a point that’s easy to miss when you see “billions of dollars of Bitcoin wiped out in two-week slide”: the actual value of the transactions responsible for this change is nowhere close to the change in perceived valuation.

All we know for sure is that there has been a short-term asymmetry between would-be buyer and would-be sellers.

Hodling in plain sight (?)

There may be millions of hodlers out there who believe that in the future, their bitcoins will be worth hundreds of thousands of dollars each. These people, if they stick to their guns, will have no interest in selling at $4,000, or $6,500, or $20,000.

The only things we can infer about this group of hodlers is that, currently, they have decided:

  1. their Bitcoin exposure is already high enough, or
  2. they think Bitcoin will stay cheap long enough that there’s no hurry to buy more right now, or
  3. they’re broke.

Now that we recognize why hodlers are invisible, we can better come to grips with the reasons behind Bitcoin’s legendary volatility:

  • Ownership is clustered in a comparatively small demographic of techies, currency speculators, and Millennials.
  • The most enthusiastic subset of this group refuses to spend or sell — so the market only knows their opinion of Bitcoin’s price when they are ready, able and willing to buy.
  • Very few people use Bitcoin for day-to-day transactions (e.g. groceries), which would reveal their beliefs as to Bitcoin’s value. What the market sees is the extremely short-term beliefs of speculators who, for the most part, are buying/selling based on their beliefs about the beliefs of other speculators.

If this sounds like a snake-eating-its-own-tail, you’re not wrong.

I know that none of this will make you feel any better if your portfolio just got crushed, you need to buy potatoes, and your only liquid cash is Bitcoin.

But if you’re stocked-up on potatoes (or you’ve got another currency handy), the good news is this: there’s every reason to suspect that a large number of your fellow hodlers think today’s Bitcoin price is wildly low, and they still won’t be selling even if the price doubles, or 10x’s, or whatever.

As long as these currently-invisible people remain unwilling to move, the Market T-Rex can’t see them, it won’t sniff out their price-opinions, and a small handful of willing sellers can aggressively boost the perceived market price when buyers come a-knockin’.

In a market like Bitcoin’s, the serrated teeth of volatile prices can definitely cut both ways.

Fun Fact: Even on the most transaction-heavy day of the recent price rout — November 19th — the total volume of BTC trading across all major exchanges was under $2 billion. The “great, silent majority” has remained on the sidelines, hodling. (h/t to: bitcoinity.org, Taylor Pearson)

More by Jesse Lawler

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