Peak Prices: the Problems of Money Illusion and Regularity of Returns
Dear Readers,
With BTC currently breaking to new highs, people are naturally focused on possible peak price, for as we all know - Bitcoin is volatile. This article will look at the way in which the peak can be both under-estimated on the one hand, and over-estimated on the other. In the first case of under-estimation, I’ll describe the way in which money illusion, the focus on nominal values as opposed to real values, contributes to this. In the second case of over-estimation, I’ll describe how a bias toward non-diminishing returns [or regularity of returns] leads to a possible exaggerated expectation.
If these two cases provide the extremes, then a more modelled and technical projection of peak prices will lastly seek to provide a moderate and realistic price projection between them.
- Lower Projections Resulting from Money Illusion
Money illusion is nothing more than a distortion that comes with focusing on the nominal numbers of price at the expense of real values. This distortion can lead to an exaggerated sense of price movement. For example, the price of Bitcoin now moves in thousands of dollar - 80K, 90K, 100K, back to 90K etc. These changes in price may seem huge if the focus is on the multiples of thousands. However, if the focus is instead on real values, in terms of returns or percentages, the moves are not really that large at all. This is easily seen in the following charts [also showing how important using a chart actually is].
In the first chart, the units of the number [in this case 10K] at the top of the chart are exaggerated - they suggest an equal move to the 10K units lower on the chart. In the second chart, you can see that these units are reducing visually, which reflects their real value as relative to the return on current price. A 10k move from 100k to 110K is nowhere near as much as a previous move from say 30k to 40k. The further you move down the chart, the larger the gap widens, which reflects a larger return/ ROI.
The significance of the log chart, of using real values, is that while price can get big fast, it can still be considered ‘business as usual’ from a returns perspective. For example, a similar percentage move up results in a very different price differential as the next chart depicts. A 33% move, nothing you’d think unusual, results in a 37K difference from a base of 110K, whereas previously from a base of 30K it resulted in only a 10k difference to 40k. The point of this is that if people were solely focused on price [nominal not real values], that 147k price might seem awfully high, when in fact it isn’t really. Number get big fast.
- Higher Projections Resulting from a Bias toward Regular Returns
The equal and opposite error, in my opinion, is a bias toward assuming regular returns…. or, in other words, a rejection of diminishing returns. Of course, the reader could object and say that diminishing returns is itself a bias or assumption. And there would be some truth to that… if the long-term chart suggested otherwise; and that further, diminishing returns [the LGC, logarithmic growth curve] has performed well over the years as a macro model.
Add to this the qualitative insight that the market is maturing, with Bitcoin in a process of capitalization, and you have some serious weighting to what would otherwise just be an unsubstantiated idea. Take the following long-term chart for example, and you get a reasonable theory, substantiated over time, that diminishing returns is occurring. Clearly, returns appear to be diminishing with price heading toward price discovery [capitalization] as per below.
Consider also that those with the expectation of regular returns [non-diminishing] were caught out last time. Where they expected something similar to the previous cycle [a 76x], they only saw a 20x eventuate.
And yet perhaps the lesson has not been learnt. Those still failing to account for diminishing returns may now be looking for a repeat of that 20x, when, according to the LGC model, a 10x may ‘only’ eventuate [it’s still a good return].
Of course, the less critical outlook of a regular return is more popular for the mass of market participants. And given the contrarian principle that the market likes to frustrate the many, this only adds further weight to a more modest diminished return.
While the ‘regular returners’ are not over-awed by the money illusion of large nominal values/ prices, they tend to give too much weight, on the other hand, to the hyper-inflationary thesis… where the pricing mechanism of USD is thought to become so compromised that prices would thereby balloon out. If such a scenario occurred, it would effectively make the USD redundant as a pricing mechanism, and so too the chart. It would then be priced in terms of gold.
But this scenario, while always possible, is not so relevant to the immediate future as it is to the more distant one. Accordingly, while the USD remains relatively stable, it functions well in describing the process by which Bitcoin is capitalized. I say relatively because at some point, given the annual depreciation of the dollar, the LGC must face an inflection point [as the ‘LGC with inflection point’ chart above depicts]. This would become noticeable, in the not-too-distant future, after most of the exponential gains had been made.
And so finally to the happy medium, where prices are likely to be higher than those focused on nominal values/ prices while lower than those that are focused on regular returns.
- A Moderate Technical Projection of Possible Peak Prices
A more technical projection of prices avoids the dampening distortion of money illusion on the one hand, and the exaggeration of regular returns on the other.
First of, the LGC model itself provides a range by which price should top out. Keep in mind that the LGC channel provides a range within which price should move, while it does not provide the timeframe for ‘cycles’. Given that the four year multi-year pattern has previously played out, this is something to keep in mind. But also keep in mind that at some point, in a maturing market, this repeating pattern is likely to break - there is always the possibility of the peak being front-run this time round [an argument could be made that it was front-run last time… momentum wise].
Zooming out on the LGC [performing since 2018], you can see that price is already well above the previous peak while still only just above half-way through the channel. This is looking very bullish for the price with room to run, and where those numbers get big fast.
On zooming in, to have a closer look at the possible area of peak prices, a technical metric can be used to give something by which to hang your hat on, and something by which to correct those over exuberant expectations. Combined with the model, a fib extension comparison gives something like 180K. Of course, this speculative target itself should be given a right weighting - technical analysis about future prices is never an exact science like math and geometry. In other words, always hedge and never bet the farm.
Given these factors, I’d be surprised if price peaked above this in the near future. Of course, price is likely to go well beyond that on the multi-year time-frame. And of course, there is also always the possibility of a ‘midway’ correction, where previous resistance/ peaks could become support…. given the remarkable technical nature of this run so far [so far, no manic parabola]. But at the moment, the momentum is upward and we may see those higher prices sooner than expected.
Until next time,
Stay [relatively] safe out there,
Dave the Wave.