Bitcoin Crash Lessons: Passionate Belief Still Needs Risk Management

Bitcoin is a new asset class. And I don't mean it's just "digital gold."

I mean it's an entirely new asset class that is at least an order of magnitude superior to gold in terms of every financial metric, from transparency, fungibility and decentralization to storage, security, and physical mining energy requirements.

As an outsider who didn't even understand anything about the blockchain until 2017, I appreciate the stunning innovation it stands for. I wrote about it often that year...

Blockchain 101: If Bitcoin's a "Fraud," How is Ethereum Different? (from 11/07/17 when I addressed the Jamie Dimon aspersion)

Bitcoin: $20,000 Before Zero (from 11/15/17 when I became convinced this was a powerful and innovative new digital asset class)

Bitcoin or CRISPR: Which is the Bigger Disruptor? (from 11/29/17 when I thought comparing the two "blockbusting" innovations was valid -- and before I knew who Cathie Wood of ARK Invest was)

12 Lessons Before You Trade Bitcoin Futures (from 12/07/17 when I addressed how futures would be good for BTC and why it mattered)

I share all these links because their "outsider" perspectives are still extremely valid and insightful, if I dare say. I still don't know much about BTC mining or nodes or forks.

But I do know a lot about markets, and the human behavior that creates price moves in assets.

So today, I hope my outsider perspective will be an aid during the Bitcoin crash that touched $30,000 the morning I was filming the video attached here.

Revolutionary Asset Class Still Has Price Fault Lines

My whole purpose today in this article and video is to convince traders and investors that even though Bitcoin is a revolutionary asset class the likes of which we've never seen, it still is exchanged at market prices.

And that means it is subject to the vagaries of every other market and asset class: irrational human extremes.

You may think it's irrational that Bitcoin was trading back below $40,000 because certainly it's going to $500,000 in your lifetime.

And you would be right. Why didn't it hold what should have been support between $45,000 and $40,000 when MicroStrategy MSTR CEO Michael Saylor was adding another 229 "coins" worth roughly $10 million on May 18?

The answer is the same reason it didn't hold $55,000 when he bought 271 coins worth $15 million on May 13: markets are irrational beasts driven by human emotion.

And if you read Nassim Taleb in any form, you know he pays significant homage to the great "fractal magician" Benoit Mandelbrot who coined this mathematical description for the behavior of human asset markets: "wild randomness."

Together, they may have taught 21st century investors and traders the most important lesson of their lives: historical volatility need not apply for any positions in the risk management department. In other words, the limits of what happened in the past do not limit what can happen in the future.

After I read them both, I came up with this handy aphorism to remember their lessons: "When anything can happen, there is no standard for deviation."

But in reality, you could have used Bitcoin's historical volatility (standard deviation) to give you some clue to how much it could correct, or crash.

If you've followed this new, revolutionary asset class as closely as I have since 2017, you may recall when hedge fund veteran Mike Novogratz, CEO of Galaxy Digital Holdings, was banging the Bitcoin gong then about "the herd is coming."

He was so right. When major financial institutions start getting interested, your BTC will be trading for 5-digits faster than you can say "Elon Musk is a crazy genius promoter who got a pass from the SEC."

I believed Novogratz at the time and he has been proven right. When BTC was in a tight consolidation last year between $9,000 and $10K, a little announcement from Square SQ in late July about purchasing $50 million worth was enough to leave 4-digits behind for good.

Then in October, PayPal PYPL announced their intentions to support BTC transactions after their "conversations with central banks." I wrote about that historic statement here, as BTC surged past $12,500...

Digital Gold: PayPal, Square, and the Fed Send Bitcoin Soaring

I didn't know it at the time, but my buddy Oliver J. Renick, anchor extraordinaire of the TDA Ameritrade Network programming, was also becoming very bullish BTC by October when the new "precious" was shooting for its old highs near $20K.

In the video that accompanies this article, I show his Twitter feed and LinkedIn articles that describe his turn of favor this spring when the 300% rally to $60K started to look a bit frothy compared to other risk assets.

And therein lies the node of contention. Bitcoin can still be an extraordinary new asset class not beholden to the whims of interest rates, gold, stocks, commodities, or regulators, but it's still a market that can trade up AND down on human whims, emotion, and Elon.

4-D Chess With Elon

If only we could know (even understand) the Tesla TSLA Technoking's next tweet, we might be able to time our BTC entries and exits better, right? Or maybe just changing CFO Zach Kirkhorn's title to "Master of Coin" was enough to convey long-term commitment and stability.

I mean they filed these title changes with the SEC in March, so it has to be super legit and wonderful, right?

Alas, as quickly as he ignited the BTC run to great heights with the company's February announcement of a $1.5 billion stake and plans to accept the digital currency for sales of new Teslas, he helped get the crash going with a reversal on "BTC for Model 3" on "environmental" concerns.

And he has also removed the "Technoking" moniker from his Twitter description.

Too much Dogecoin crypto jokes and cute Shiba Inus on his mind? I really don't know. So let's move on from Elon right now. (And, my advice is to pay more attention to what @Jack Dorsey of Square says about Bitcoin).

I'm currently working on a book on "must-have market mindset" titled 3 Secrets of Trading Discipline.

Early on I describe how one has to approach the market in at least 4 dimensions in order to fully grasp the reality of potential outcomes.

If you don't like chess, it doesn't matter. You will still benefit from this view of the 4 dimensions of markets...

1) Fundamental: What is a company/asset worth based on what it produces and profits? What will institutional investors pay for those cash flows?

2) Technical: What does the price chart tell us about where to buy or sell the stock or asset based on multiple time-frame "pictures" of strength or weakness?

3) Behavioral: How is the emotional crowd (gamed by algo precision and randomness) acting that will drive this asset to extremes of optimism or pessimism?

4) Psychological: Who am I interacting with this asset market and how much will my programmed beliefs, biases, and behaviors be influenced by the price swings and news?

Guess which dimension I believe is the most important. You can probably tell already. But if not, watch the video and see how I describe the Bitcoin "faithful fundamentalists" as ignoring all the other 3 dimensions.

And if you want a preview of where I'm going, let me share this Twitter exchange with the excellent Steven Goldstein of the AlphaMind podcast from May 4...

@AlphaMind101: Why do people with no skin in the game and no axe in crypto get so fired up about Bitcoin and other cryptos? I don’t think any other asset class does this. (Or does it?) and I assume we are all advocates of open markets and know how they can behave.

@KevinBCook: Crypto has both revolutionary & religious appeal. We know how those human belief dynamics play out with zealotry and blissful faith. Humans seek to find something perfect, ordered, & mysterious and BTC seems to fit the bill for 'overthrowing the corrupt system' and being 'pure.'

To make this more concrete, now allow me to bring in NVIDIA NVDA CEO Jensen Huang in a way he didn't imagine...

NVIDIA and Jensen Huang are Empiricists, not Idealists

Think about what NVIDIA has created in the past 5 years for R&D into machine learning, deep learning, and artificial intelligence (AI).

They are totally focused around the software and hardware "stacks" that can help companies, universities, and crypto miners achieve maximum velocity of insights and results from data mining, automation, and the frontiers of AI.

While NVIDIA sells a good amount of data mining "rigs" to crypto diggers, they can remain indifferent about the utility or profitability of any given crypto "currency" because they are focused on technology that achieves a task.

In that sense, they are empiricists about potential crypto evolution and not idealists about pure monetary perfection.

This is a very important distinction. You could easily say that providing the pick axes and shovels is more important than speculating about whether or not Bitcoin is a significant store of value and an uncorrelated hedge against monetary debasement.

It will probably be the former at some point, but it is definitely not the latter. The market just proved how correlated BTC could be with other risk assets. And if you doubt this, just watch the weekly price moves over the rest of the year.

BTC will follow NDX (the Nasdaq 100) as sure as night follows day. It may even follow any bear episodes in bonds.

As you can see, it's not only markets in general but technology in particular that even I can sometimes get fanatical, and emotional, about.

I still believe that software and semiconductors are the most important industries of disruptive innovation and that Bitcoin is one of their cutest and most promising offspring. But it's still just a kid, and one among hundreds of heirs that make human life and culture advance.

The Most Important Bitcoin Fork

I admit in the video that I still don't understand what a Bitcoin "fork" is, or was. But I do know about an important philosophical "fork" that is centuries old and can still help us today.

Hume's Fork is a description of an 18th century dilemma initially ignited by the British philosopher David Hume (1711-1776) who argued that there existed a strict division between "relations of ideas" versus "matters of fact." From the Wikipedia entry...

By Hume's fork, a statement's meaning either is analytic or is synthetic, the statement's truth -- its agreement with the real world -- either is necessary or is contingent, and the statement's purported knowledge either is a priori or is a posteriori. An analytic statement is true via its terms' meanings alone, hence true by definition, like Bachelors are unmarried, whereas a synthetic statement, concerning external states of affairs, may be false, like Bachelors age badly.

Based on this fundamental split in the philosophy of knowledge ("epistemology" we used to call it), one can explore the world of ideas vs. the world of experiments.

Clearly, Bitcoin ideology is both a marvelous thought experiment and a real-world "proof of work" that cannot be denied.

What the faithful might have overlooked is that the same energy, enthusiasm, and euphoria that drove it above $50,000 can also cause an implosion of belief as prices cascade.

Even companies with tens of billions in sales and profits for products and services that we use every day have seen their share prices implode during market panics. We only need look back to the Corona Crash to see this.

History Teaches Bubbles and Crashes Happen

I've studied financial asset bubbles for the past 25+ years. While I truly want Bitcoin to exist outside the realities and parameters of most human behavior extremes, why would that be rational? You can't make money as an investor off of purely rational markets.

And look how long it took for Apple, Microsoft, Google, and Amazon to reach trillion-dollar market caps as they provide empirical goods and services to billions of citizens around the globe!

Why should Bitcoin surpass or sustain $1T without empirical goods and services that are comparable to the topline sales or AMZN, AAPL, GOOGL, MSFT or a dozen other tech operators with massive revenues?

Yes, one could argue that physical gold breached the $10 trillion mark as a physical commodity -- and deemed as its own asset class -- but that took centuries of tradition and belief, and the backing of central banks as a form of hard currency.

Whether or not Bitcoin is a "currency" now will be debated hotly, especially given the crash. But if it becomes a stable store of value at some point, and potentially more important than gold, that will require more large financial institutions taking bigger stakes to create that stability.

I'm talking about BlackRock, JPMorgan, and even the Federal Reserve. And that will take many more years.

BTC could exceed $100K before then. Who knows? In the meantime, invest and trade it like it's merely a digital commodity (even though we know better).

Kevin Cook is a Senior Stock Strategist at Zacks Investment Research where he runs the TAZR Trader portfolio.

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