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Sunday, September 26, 2021

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Photo of Paul Krugman. Credit: Ed Ritger, The Commonwealth Club.

The hysteria surrounding Bitcoin and the crypto market at large is at an all-time high. You know something must be up when your uncle with a gambling problem posts on social media phrases like “bull market”, “HODL”, and “When Lambo?”.

Although Bitcoin erased all gains made in 2021 over the course of 24 hours last week, momentarily trading below $34,000 (it now trades at $40,000, more than 30% down from $60,000 in April), the crypto market’s extreme volatility hasn’t scared young investors — on the contrary, it’s made them more drawn to it than ever. As of April 2021, more than 21.2 million American adults, or about 14% of the U.S population, own cryptocurrencies such as Bitcoin or Ethereum.

According to a report released by Gemini crypto exchange, the number of people invested in crypto is set to double this year as people fear missing out on what they believe is the opportunity of a lifetime. After all, in just a couple of months in late 2020, Bitcoin surged almost 300%. Becoming a crypto billionaire in the new mantra for 2021.

But the vast majority of these new retail investors are not aware of the risks they’re facing. A recent survey found that only 16.9% of investors who have bought crypto “fully understand” the value and potential of cryptocurrency, while 33.5% of buyers have either zero knowledge about the space or would call their level of understanding “emerging.”

Aside from FOMO (fears of missing out), extra cash to spare from all those stimulus checks, and the daily rush of trading, new investors are drawn to a sense of community. But Paul Krugman, a Nobel Prize-winning economist, believes this so-called community is nothing but a “cult that can’t survive indefinitely”.

Krugman, who won the Nobel Prize in economics for his work on global trade theory in 2008, had publicly criticized Bitcoin, as well the other 10,000 ‘alt coins’ out there at the moment. In a 2018 column for the NY Times, Krugman said that compared to fiat currency (‘normal’ currency backed by the government such as USD or Euro), crypto tokens cost more to transact in and have no value “backstop”, or reinforcement, like traditional government-backed currencies.

“Their value depends entirely on self-fulfilling expectations — which means that total collapse is a real possibility. If speculators were to have a collective moment of doubt, suddenly fearing that Bitcoins were worthless, well, Bitcoins would become worthless,” Krugman wrote in 2018.

It’s not hard to see where Krugman is coming from. There is a strong sense of belonging among crypto enthusiasts, who tend to only share positive news and support each other when the market is down. There’s this strong sensation in the crypto communities that there is only one way to go from here — and that’s up. In fact, one of the most common replies to crypto content on social media, which is almost always positive and ‘game-changing’, is “to the moon”.

In a blog post, Louis Petrik wrote that there are “almost no skeptics” in the countless subreddits dedicated to cryptos and crypto trading. “The fact that there are almost no skeptics has a reason: censorship,” he wrote.

Most of today’s crypto devotees seem to be made from a different cloth than traditional investors in stocks, bonds, and other assets. They protest against Wall Street capitalism, seem to enjoy the disruptive market, and seem to see trading Bitcoin and other crypto assets as their best chance at beating the rat race.

This behavior, say economists George Akerlof and Rachel Kranton, can be explained by “identity economics” — a branch of economics that describes behaviors at odds with traditional models of rationality. Identity economics can explain why some people choose to stay in a job that pays less than they could make elsewhere, why people vote against their economic interests, or more recently why crypto traders stake their capital on the riskiest possible bets with scant regard for corresponding returns.

Whether or not these traders will come out alive when the crypto growth cycle inevitably heads south in correction territory (bear market), what seems certain now is that the “crypto cult” is a force to be reckoned with. There are hundreds of billions traded in crypto markets on a daily basis. On top of that, these investors are more irrational, injecting further volatility into an ever-fluctuating market.

Will the crypto cult collapse at the first turn for the worse or will it “HODL” as its members proudly claim? Time will tell — but for now, there are quite a few lambos.

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