Business Acumen and the Bitcoin Bubble

The Guardian newspaper in the UK just published an article “Is Bitcoin about to change the world?”. When I see articles like that, it’s a big red flag; like appearing as Man or Woman of the Year on the cover page of Time magazine, which seems to always come before a fall

The price of a Bitcoin has just topped $1000. This year it has raised 78 fold, I don’t even want to think about how much inflation that is; I warrant that it must put it at Weimar or Zimbabwe levels.

So Bitcoins are supposed to be ”mined” by computers using “fiendishly difficult” algorithms that limit the amount of money you can put into circulation and there’s an overall limit on the amount of money that can be mined. Do you understand all that? This sounds to me like the argument “respectable” economists used at the beginning of the US housing boom that there was a shortage of land that would guarantee that housing prices would keep rising.

Every time you have a bubble, there’s always a “limit”. High quality tulips in Holland in the 17^th century, the number of South Sea islands in the 18th. Now the 21^st century equivalent is a limit to how fast someone can solve these Bitcoin mining equations. How about a limit on common sense?

I started to really get worried last week after Ben Bernanke spoke at a Senate hearing supporting the use of Bitcoins. This from a man who didn’t see any problems in housing prices several years ago during the US housing mania and utterly failed to predict the boom, bubble and crash.  One commentator described the hearings as a “love fest” between the Bitcoin promoters and the Senate interrogators. That doesn’t sound good to me. Whenever important “experts” and officials bless a massive rise in prices for anything you can be sure something bad is going to happen.

My company’s mission has been the development of psychometric assessments to identify and measure business acumen. Our research shows that about 12% of people have the innate behaviors that create capital, and around 44% have behaviors that consume capital. In other words, 88% of people either break-even or consume capital. These behaviors are a result of unconscious cognitive biases that lead to systematic distortions in decision-making that lead ineluctably to certain financial outcomes, unless they wise up, which most people don’t.

Our research also shows that your level of education, intelligence and qualifications don’t make any difference to the above. In fact being high on all of the above might make things worse. That’s at least partly because of the tendency for academically smart, highly educated people to be over-confident and to over-rate their abilities. That is particularly the case with central bankers and economists with too many PhDs and not enough common sense.

Bitcoins looks like the latest iteration of this phenomenon in business acumen, namely that smart, educated people are the quickest to head into the latest toxic financial fad. That includes the Feds, the Fed and many people who should know better.

OK, you might say, but there are people who are actually making real money with Bitcoins, so surely it must all add up? Well you could have said the same thing about the Dutch tulip mania, South Sea Islands and real estate in the US in the period up to 2008. In the early stages of a bubble people make money, and that’s what draws in the suckers, who will of course lose it all, and more, later.

BTW and just as an extra caution, there are reports that the mysterious and retiring oriental, Mr Nakamoto, who is reputed to have started the Bitcoin phenomenon, might have a financial relationship with one Dread Pirate Roberts, the alleged founder of Silk Road, the notorious online marketplace for nefarious dealings. The Dread Pirate, you might recall, was arrested by the FBI recently. So what’s the founder of Silk Road doing swapping payments with the founder of Bitcoin?

As they say, if it looks too good to be true, it probably is. I don’t think this Bitcoin thing is going to end well for most people although it might do a lot of good for “Mr. Nakamoto” and his associates, whoever they might be. If I was one of the experts at the recent Senate hearing, I might also want to do a little bit of soul-searching.