So, Bitcoin is soaring and very few people understand how this will all end and whether these cryptocurrencies will even be viable economic variables. We’re in that early part of a mania when there is a very serious risk that the price of the asset is disconnected from its actual utility.

I call this a price compression. Basically, it means that investors price-in lots of future cash flows into the present and this creates a serious behavioral risk in the asset in the case that those cash flows don’t come to fruition. Think of it like a start-up firm that promises lots of profits in the future and raises tons of venture capital money. The VC’s are bidding up the price of a profitless entity with the hope of earnings in the future. But if the cash flows never come then the valuation and price will decompress.

Price compressions are an element of all financial market bubbles because we don’t really know that much about the underlying assets. There’s a great deal of future promise, but very little real utility. So there’s a lot of guesswork that goes into how those assets get priced at first. But here’s a dirty little secret – you don’t need to be the first mover in an asset bubble to benefit from the development of this new technology.¹ 

Let’s look at the most classic price compression in modern financial history – the Nasdaq bubble. This was a bubble where you made 10X your money invested from 1990-2000. That’s about 26% per year. That’s turning $100,000 into $1,000,000 by doing nothing. Of course, that’s not what happened to most people. Most people didn’t invest in tech stocks in 1990 mainly because they couldn’t. So they waited until the bubble had already started developing. For most retail investors there were very limited options to choose from and most of the big tech funds didn’t start developing until 1998 or 1999. The Nasdaq 100, for instance, didn’t even roll out until March of 1999. So most investors were already late to the party.