Preface: Happy New Year
Happy New Year! While 2017 was both a success by quantifiable metrics and by the beauty that unfolded, I told myself I would resolve to write more in 2018. By that, I mean communicate more. Writing is a great form of communication in itself, but most of all, they help me structure my ideas into words and concepts that make it far easier to communicate. So cheers to clearer communication with myself, with others, and with you. Cheers!
The Greater Fool Theory
A definition of the Greater Fool Theory is:
The greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. In other words, one may pay a price that seems “foolishly” high because one may rationally have the expectation that the item can be resold to a “greater fool” later.
Bloomberg Technology published an article about a week ago entitled, “Bitcoin Traders Claim There’s Method to Their Madness”. Here’s a greater fool theory being implemented to near perfection:
Balaji trades almost entirely on how he thinks other people will act in the very near term. He tries to anticipate the market by monitoring the movements of a handful of sophisticated players with huge holdings, while also gaming out the psychology of others who have no idea what they’re doing. Another trader, who asked not to be named because he didn’t want to attract negative attention, boiled his trading strategy down to coming up with the most superficial understanding he can imagine, then assuming that’s how the market will act.
On Nov. 17, Balaji made a significant bet that many newcomers didn’t realize they can buy just part of a bitcoin. He assumed new investors would set up an account on the popular exchange Coinbase hoping to buy bitcoins, balk at the price, then settle for a cheaper alternative. So Balaji bought litecoin, which was the lowest-price cryptocurrency trading on Coinbase at the time. When he bought his stash, the price of a single litecoin was $67, compared with about $8,000 for bitcoin.
Balaji’s hunch paid off. The number of new Coinbase users shot up around Thanksgiving, and the price of litecoin spiked, too. Balaji doesn’t think much of litecoin, deriding it as nothing more than “a copycat of bitcoin.” But supporting litecoin was never the point of his trade. He sold his holdings on Dec. 12 when litecoin was worth $387, a 570 percent gain that was far higher than bitcoin’s appreciation over the same period. He was vague about the exact profit, but said it was in the six figures. Litecoin declined in price soon afterwards.
I admit: I bought more Litecoin (LTC) based on a nearly identical theory as the person in the Bloomberg article. While I had held Litecoin since it was introduced to Coinbase on the fact it was a decent fork of Bitcoin, I figured:
- The price of Bitcoin brought a rush of newcomers.
- Due to the ease of use of Coinbase, most would use this as the way to exchange their dollars for cryptocurrency.
- Upon arriving to Coinbase, they were greeted with buying Bitcoin, Ethereum, and Litecoin.
- Given Litecoin was by far the least expensive – the newbies would buy Litecoin as a “cheap Bitcoin”.
Within a few days, my Litecoin stash that was purchased for under $100/LTC each was now worth over $350/LTC! Where was it headed? $500? $1000? More?
Now, let’s face it – this type of trade is based on a hunch. Perhaps it worked at least somewhat for the reasons I thought it did, but perhaps it didn’t.
So, fast forward several more days: Litecoin was below $250. Oops.
Lesser Fool Theory
Here is Lesser Fool Theory:
While anticipating the actions of greater fools – your actions have already been anticipated by lesser fools.
So let’s look what happened right around the time Litecoin started to move down in price.
Charlie Lee, the creator of the Litecoin, sold nearly all of his holdings at right around the all-time high of $375.29 on December 20th.
Right then and there, I could have sold my holdings. At least in the short-term, right? But not only did Charlie offer his own explanation of a “conflict of interest” – there was no shortage of people on Twitter explaining away his actions as a positive sign. I think when you are in the fool echo chamber, this is what happens – up becomes down, and down becomes up.
Fourteen tweets to deny the obvious. Every professional investor knows what a founder selling their entire stake means. https://t.co/WUGH7dcBmn
— Naval (@naval) December 30, 2017
I admit I have little experience with timed trades. I have been investing in Bitcoin since 2013 with a mostly “buy it and forget it” approach. Periodically I have educated myself on cryptocurrencies from the technical perspective, as well as traded for the long-term based on some basic fundamentals.
Unfortunately, you cannot have it both ways. If you want to acknowledge Greater Fool Theory, and apply it as a reason to trade – you should take into account some form of Lesser Fool Theory.
Cryptocurrencies are inefficient markets controlled by insiders. There’s a reason people study the movement of the “whales”. It’s naive to think to think as an outsider that it’s more beneficial to understand what a greater fool will do, as opposed to a lesser fool.
Charlie obviously epitomizes a Lesser Fool in this scenario. You could go as far to say that he is the Least Fool in the Litecoin world – he’s the creator of Litecoin. He also happens to be the ex-director of engineering at Coinbase. My greater fool theory was a play on Litecoin, and to a lesser degree, on Coinbase. And he didn’t just “take money off the table” – he sold just about all of it, admittedly.
And up until that point of him selling – there’s no way to tell what his intention was for the project. The fact he timed the market perfectly may be partially chance. But after he sells virtually all of his holdings at the all-time high, one should at least take that as a signal that something is going on up above that you do not understand, and most certainly do not control.
To date, Charlie Lee sold his Litecoin at the all-time high. And I didn’t sell any Litecoin at the all-time high.
I still even hold Litecoin. I hope I can use it someday soon to actually buy something!