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Bitcoin Bubbles: A History | Seeking Alpha


The top joke on reddit.com last week was a Bitcoin joke. It goes as follows.

A boy asks his Bitcoin-investing father for $10.00 worth of currency.

Dad: $9.67? What do you need $10.32 for?

It underscores the obvious, and literally ridiculous, volatility of Bitcoin’s price. Futures on Bitcoin have just begun trading and one generally expected result, with notable dissenters, is that they will temper this volatility a bit (see Why Futures Spell the End of Bitcoin Mania). What this does not mean, however, is that Bitcoin will be immune from bubble popping. Given Bitcoin’s more than 1000% run-up over 2017, does it really make sense to buy in now?

I think it does make sense to take a position, if one is willing do one (or both) of the following: use only a small speculative portion of one’s portfolio, or hedge one’s position. Yet, in order to hedge one’s position, one will need a sense of how Bitcoin operates in a massive price decline. The present article aims to give the reader that sense.

What I hope to lay out is an historical review of Bitcoin’s three largest bubbles, one in 2011 and two in 2013. These are the three times Bitcoin’s price has “gone parabolic,” and it did crash each time. Yet these crashes often did not have 24-hour swings of 20% or more (even though we have recently seen one such swing intra-day). Bitcoin crashes are slow-ish, taking about 100 days historically, and big one-day draw-downs just as often occur before a “recovery” period as during the initial decline.

A review of the data on previous bubbles suggests that one’s position in Bitcoin might be well-hedged if it expects a 40%+ draw-down over a 30-day period. This has happened in every single Bitcoin crash. One might also want to consider renewing this strategy for three-month periods when a significant decline begins, since this is about how long most crashes take. Whether one wishes to hedge one’s entire portfolio, or only a part, is for each to decide. What the present historical review hopes to establish is the target range of decline, and over what period of time. There is much to review; I begin with the 2011 crash.

The 2011 Crash

Bitcoin began the 2011 year at $.30 a coin, and on June 8th hit an intra-day high of $31.5, for a 105x return (10,500%) in less than half a year. Not even a month later it had declined some 65% to an intra-day low of $11. Less than month after that, it had dropped to $7.80, and about one month after that it closed at $4.77 for an 85% decline in just over ninety days. The highest loss, from one close to the next, was recorded at the beginning of this decline, on June 10 at nearly 39%.

[Data Source: Cryptocompare.com]

Yet, there were “just” seven 24-hour periods where Bitcoin dropped by 20% or more from close to close (technically one is just over 19.5% and I rounded up), and three of them occurred at the end of the decline, as Bitcoin was transitioning into another bull run. So one should not think that after the big decline that one is safe from this sort of volatility.

What the following chart shows is the distribution of daily price declines relative to the price 30 days earlier, for 2011. The bins are 5%, except for the end of the scale, where I had to use 50% bins to accommodate the few cases of massive upswings in Bitcoin’s price (four cases of higher than 650% in 30 days).

[Data Source: Cryptocompare.com]

As one might expect, in a year of massive declines, most of the daily price movement (relative to the price 30 days earlier) is in the negative. Of the 47 days where Bitcoin’s price was 40% or more below what it was just a month earlier, it is significant to note that those days were temporally dispersed. One can find 40%+ declines on a monthly basis for the next three months after Bitcoin’s initial decline (in fact, one can find higher than 50% declines, but the present analysis has built in some margin of safety).

This presents evidence for a hedging strategy, if one wants to insure against a Bitcoin bubble pop: pick futures with the expectation that prices will decline by 40% or more on a monthly basis. More expensive options will not be needed to ensure against a Bitcoin price crash.

2013: Two Crashes

The 2013 year was quite a year for Bitcoin, with returns exceeding 100x yet again. It also crashed twice, and the second time it did so in such an extraordinary way that it took literally years for Bitcoin to recover. Here is a quick chart of the 2013 year.

[Data Source: Cryptocompare.com]

While the graph above identifies where the crashes occurred, the second run-up in 2013 is so great, that without logarithmic scaling, it is difficult to identify why the first crash was worse than the second (which was precipitated by the Mt. Gox hack). To remedy this defect, then, the following graph scales the price of Bitcoin logarithmically.

[Data Source: Cryptocompare.com]

What one notices in this chart is that the decline after the first crash is much more acute. It is, as far as reliable data for Bitcoin goes, the single most precipitous decline in Bitcoin price ever recorded. What follows is a chart of the intra-day decline.

[Data Source: cryptocompare.com]

Not even 72 hours after hitting a high of $266, Bitcoin hit an intra-day low of $54.25 (77.4% decline). If this feels like the US stock market before exchanges were regulated to prevent price runs, then that is because this is exactly the position Bitcoin is in. Moreover, it is helpful to recall that even if the United States comes to regulate all Bitcoin exchanges in the US, and does instate mandates that halt price declines, this will not hold for other Bitcoin exchanges globally. There is thus no reason to expect that price runs can in Bitcoin can be halted effectively.

If nothing else, everyone who owns Bitcoin ought to print out this chart and put it near their trading station, just to be reminded: this has happened before, and nothing is in place to prevent it from happening again. This is why one should hedge.

And yet, this was only the first crash in 2013. What follows is a chart of the second crash (through the early part of 2014).

[Data Source: Cryptocompare.com]

While not as acute, this crash was much worse: ultimately Bitcoin declined some 92.5% (from intra-day high to intra-day low) in 83 days. Moreover, since the precipitating event was the Mt. Gox hack, it took much longer for the market to regain confidence in Bitcoin. It took another roughly 580 days (until October 1, 2015) for a significant recovery to begin.

[Data Source: cryptocompare.com]

Lessons from 2013?

If the foregoing reviews that actual declines of 2013, what can we learn from them to hedge our own positions in the present? In partial answer to that question, it is helpful to review the distribution of Bitcoin price movements, and these data are presented in the chart below (with the same bins as before).

[Data Source: cryptocompare.com]

Since 2013 had two bubbles, the period of decline after the first bubble was much shorter. In fact, the first month after the decline has one day where the price is 50%+ below what it was in the previous month, but this does not repeat for a consecutive month. Instead one finds “only” a 37% decline for the second month (though intra-day there are 40%+ declines for both months). After that point, one witnesses a recovery.

In the second decline, beginning in December, the initial fall has no days with 40%+ declines (though this does occur intra-day), a brief bounce-up in January follows, and then one witnesses 80%+ declines in February.

In a “slower” unwinding, then, a 40% target might only be achievable intra-day, though in the following months one finds plenty of fodder for a deeply out-of-the-money contract. Patience, it appears, is rewarded if the source of decline is a material event.

2018: The Mother of All Bubbles?

To conclude the review, I consider a projection. In 2011 and 2013 Bitcoin increased in price hundredfold. In 2017, we have had a tenfold return. Comparatively, it has been tame (despite all the mania presently surrounding Bitcoin). For a comparable return, Bitcoin would have needed to spike from $980 at the beginning of 2017 to $98,000 by July. This might make one wonder whether such fantastic declines will be witnessed in the future. Should one, perhaps, be on the look out for smaller declines, given the smaller run up we have witnessed?

This is, of course, a possibility. The sample set for any Bitcoin analysis irks me methodologically, but one must do what one can with the data one has. But to put the matter in perspective, one should ask: does it seem possible that Bitcoin might crash down from its present numbers (around $19,000) to about $11,500? It is for this sort of eventuality for which the above analysis is intended.

What the present essay suggests is that, on an historical basis, a 40% price decline over a 30-day period is quite reasonably expected. It was, in fact, achieved intra-day on each of the Bitcoin crashes. Since these sorts of declines are the real sources of anxiety for Bitcoin, and since price runs on Bitcoin cannot be practically implemented at a global scale, I think it reasonable to purchase contracts to protect against such declines.

I look forward to your comments as always!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own Bitcoin.

Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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