The Bitcoin Bubble

There’s a lot of talk and hand-wringing about Bitcoin in the last few days/week and a half, as the price climbed from around $10k per bitcoin to $17k at its peak. A lot of this climb in price is expected, as trading on Bitcoin futures begins on Monday, December 18th. I’ve been surprised at the increase in Bitcoin’s value, but generally speaking, the price of bitcoin has been closely coupled to the price of electricity and the number of people mining it, and this has held true for quite a while, but no longer seems exactly true. This last statement might be a little bit confusing if you don’t know much about Bitcoin. If you want a quick introduction to it, read my article where I explain the process before moving on.

Since there is a fixed number of bitcoins in the bitcoin economy, there is a deflationary effect on the price of Bitcoin. Like gold, which we don’t have a way to create more of, the more people that want gold, the more expensive it gets. This is very different than, say, Coca-Cola. If more people want Coke, then the price might go up briefly, but the Coca-Cola company just makes more of it to keep it affordable. In the past, the only way to make money on Bitcoin is to buy Bitcoin, and hope that the price goes up (which it usually does, since its deflationary). If, instead of thinking that the price of Bitcoin was going to go up, you thought it was going to go down? Well, there hasn’t really been a way for you to make money with Bitcoin, so you just ignore it.

The end result of this is that the people who are participating in the Bitcoin economy are (generally speaking) people who think the price of Bitcoin is going to go up. Up to this point, it has also generally been people using their own money to speculate on Bitcoin. This results in a strong bias towards people who are not professional investors (since they are using their own money) *and* people who think Bitcoin is going to go up. This, not surprisingly, has born out to be true. You have a number of people who think the price of Bitcoin will go up, a limited supply, and surprise surprise, it’s relatively easy to sell any amount of Bitcoin at a price higher than what you bought it for, because there’s a large group of potential buyers who think it will go up, and are not quants doing the math. As long as most of those people are not selling their bitcoin, and are instead watching the value of their wallets climb, then the price of bitcoin will continue to rise.

So how does the futures market change the price of Bitcoin? Well, you’re now going to have a group of professional investors, who are not using their own money, and will be able to bet on both the price of bitcoin going up, but also on the price of bitcoin going down. Couple that with a large group of people (let’s call them, I don’t know… maybe… suckers? Yeah, that’s the word I’m looking for) who think the price is going to go up endlessly, but are also somewhat risk-averse, emotional, and using their own money. History has shown time and time again how this is going to play out, and who’s going to make money on it. I can guarantee there will be tons of stories about individual investors (or, more accurately, speculators) who made a bunch of money on the increase of Bitcoin, and it will be completely in the interests of professional investors to pump up as many of those stories as possible. A number of those professional investors will simultaneously be making investments betting on the price of bitcoin crashing at some point. Now, you’ll hear a lot of hand-waving about how those investors aren’t really buying Bitcoin, and that they’re only buying Bitcoin futures, which means they’ll be betting on the price of Bitcoin going up and down without owning any Bitcoin itself, so they won’t have an effect on the price. This misses two very important parts of the equation. One, amateur investors are generally pretty skittish, and if you can manipulate the press, you can probably start a run in one direction or the other. Two, professional investors are going to be using a *lot* more money, and they can buy and sell large enough amounts of bitcoin directly that they can probably manipulate the price of it rather easily.

Now, you’ll hear a lot of explanations on why that won’t be true. A common one is that if you look at the total size of the Bitcoin market, it’s large enough (in monetary terms) that individual investors won’t be able to manipulate the price. There are a couple holes in this theory.

The first, is that the total size of the market is not nearly as relevant as the total monetary value of the transactions that can occur, also known as the liquidity. There can be 100 billion dollars of bitcoin, but if the total amount that can be bought and sold at any moment was only $100k, and you saw $200k of bitcoin being sold in a relatively short period of time, then there’s going to be a perception (and risk) that the price is declining, and a bunch of people will move to cash out. Those people moving moving to cash out put downward pressure on the price of Bitcoin, which just feeds the beast, and you end up with plummeting prices rather quickly, with a much smaller outlay in cash than what people suspected based on the price of the market.

The second thing you’ll hear is that because this is on the CBOE and CME, they’ll be regulated. This is true in the sense that Bitcoin futures will be regulated, and if you buy and sell a future of Bitcoin, that there will be rules enforced on that futures contract. What is *not* true is that it would in any way regulate the Bitcoin economy itself. Bitcoin will continue to be unregulated, and lots of people will now be incentivized to manipulate that market. Even if the CBOE or CME says that such market manipulation won’t be tolerated, what is to prevent my rich derivative trader friends from telling me to buy or sell some large amount of bitcoin. Since I don’t trade on the CBOE or CME, there isn’t anything to prevent me from doing that.

So, in conclusion, my speculation is that there is going to a bunch of upward pressure on the price of Bitcoin as every amateur investor thinks the price of Bitcoin is going to keep going up,  are certain in their beliefs, and are willing to put their money where their mouth is. Meanwhile, there will be a bunch of professional investors who are not as easily phased by large amounts of money, who will not be spending their own money, who are looking for a bunch of marks and suckers that they can manipulate so that they can extract as much cash as possible. My guess as to how that’s going to play out is that the price of bitcoin will continue to climb leading up to the trading of Bitcoin futures, and that there will be a correction either immediately or soon after the futures trading begins, and the price will drop dramatically. There’s a chance that it goes the other way I suppose, but the one thing I’m sure of is that the marks and suckers will fare a lot worse than the professional investors. I’m not (and wasn’t) heavily invested in Bitcoin in the past, but I had a small amount of Bitcoin that I had bought a bit more than a year ago that I had virtually forgotten about that was worth considerably more than it was before. I’ve sold it, and cashed out when the going was good. In the worst case, I made 20x my original investment, and missed out on making more. In the best case, I cashed out at the peak, and made 20x my original investment. Don’t say I didn’t warn you….



Why does Bitcoin have value?

I started this explanation in the article where I talk about why I think the price of Bitcoin will decline in the near future, but the explanation ended up  in the weeds and was long enough that it warranted its own article.  It doesn’t have a point beyond trying to explain why the price of Bitcoin has been correlated to the price of electricity and the number of people mining.  As a warning, this article is also a simplification that isn’t entirely accurate, I’ve removed quite a bit of detail to make it a bit more accessible. My goal with it is less to explain the technical details of how Bitcoin works, instead its meant to convey the economic forces that play a role in determining its price.

Bitcoin doesn’t have a central bank, it’s an unregulated economy. What this would mean in a normal sense is that there isn’t someone determining how much money exists in the economy in total. Not having someone do that is normally a recipe for disaster, since more money can just be created out of thin air, which quickly makes the currency worthless. Traditionally, this has been solved by having a regulator, someone who determines how much money there is in the economy. If we trust that regulator, then everything works fine, and if we lose trust in that person (or institution), then bad things happen. Bitcoin avoids this problem by using mathematics to guarantee that more Bitcoins cannot be created out of thin air at a rate faster than a prescribed rate.

If you buy something from someone using a credit card, there is a bank that is assuring the person on the other end that they’ll get the money from the bank, regardless of whether you, as the consumer, actually ends up paying the bill in the end. If you didn’t have the bank doing this, then basically credit card transactions would just be an “I owe you” promise, and that wouldn’t work nearly as well in our global economy (they’d be unregulated).

Bitcoin transactions don’t have a “bank” that is validating the transaction, instead, the miners are doing that work (as part of the mathematics regulating the system that I spoke about above). They’re saying that they’ve had the opportunity to look at the consumer’s bank account, and yes, there is enough money in that account to pay the person selling. They don’t do this validation out of the goodness of their heart, what happens is that they get paid in Bitcoin for making those assurances, and the way they get paid is by “mining”.  I’m glossing over the details here, by avoiding transaction fees, but they’re not important for the purposes of this discussion. What is interesting about the mining is that the reward for doing so is fixed. There are 12.5 new Bitcoins created, and they are created every 10 minutes. Those new Bitcoins are divided up by the people doing the “mining”. The system itself is built in such a way that you are rewarded for the time spent mining, and not based on the volume transactions itself. In our simplified system, if there is 1 miner, then he can mine all day long (validating transactions). Every 10 minutes, that single miner would earn 12.5 Bitcoins. If you have 2 miners, you would think that would allow twice as many transactions to be validated. Instead, the difficulty of the mining is increased, so that the same number of transactions get mined, it’s just twice as difficult. Because you have 2 miners, they’re working twice as fast as a single one, and you still end up with 12.5 Bitcoins in 10 minutes. Since there’s 2 miners, they split the value of the reward to receive 6.25 Bitcoins a piece.

So how does this correlate to the price of electricity? To “mine” Bitcoins, you have a computer that has to do a bunch of work for 10 minutes, and then you get rewarded some piece of that 12.5 Bitcoins based on the work you’ve done. If you did 100% of the total work that occurred during that 10 minutes, you get the entire reward. If there are 2 people that did it, you each split it equally. Now let’s say that the computer required to run 10 minutes of mining costs me $0.10 every 10 minutes, and the price of Bitcoin is $1 per Bitcoin. That means that for $0.10 of electricity, I am earning $12.5. That’s quite the profitable business. Now, another miner comes into play, and there are 2 of us. It still costs me $0.10 of electricity every 10 minutes, but I only make $6.25. The other miner is the same. More miners will continue to come into the system as long as it remains profitable vs. the price of Bitcoin to do so. So at some point, we end up with 125 miners, each of us earning 1/125th of $12.5 (or $0.10), and it costs each of $0.10 in electricity to the mining. It wouldn’t make sense for any new miners to start mining, since they’d lose money if they did so, and it would become unprofitable for us to continue mining. Either the new entrant drops out, or someone else does, and then mining is profitable again.

The flip side of this coin is that price of a single Bitcoin goes up. It now sells for $2 per Bitcoin instead of $1, bringing up the value brought into the system to $25 every 10 minutes. Now there can be 250 miners paying $0.10 every 10 minutes for electricity while still making money on the rewards they receive. Roughly speaking, no matter how you try and influence this system, these things remain in balance. It’s a bit more complicated in the real world, since the price of electricity varies by country, and there are costs involved in setting up a Bitcoin miner, I could buy a more powerful computer (and do twice the mining as people with slower computers, therefore earning twice the reward. I glossed over that in my example), etc., but more or less, the price of Bitcoin tends to follow an equation based on the price of electricity & the total amount of computing power that is trying to earn Bitcoins. At times, the price of Bitcoin may go higher than this, as people speculate on the price and try and profit, but as they do so, they increase the financial reward for mining, and that brings in more computing power mining for Bitcoin. If the price of Bitcoin drops, then it becomes unprofitable for some miners, and they stop mining, which increases the reward for the miners left. This equation is a rough and simplified explanation, and doesn’t hold 100% of the time, but it does explain the strong correlation between mining/computing power, the price of electricity, and Bitcoin.


TrumpCare begins

Trump has been ranting about the failing ObamaCare market since before he was elected, and has been working tirelessly since to make his predictions come through. After spending months threatening to withhold the subsidies for low-income patients, he finally carried through on his threat last month, but it didn’t matter much. Months of threats and deadlines for the insurance companies to set their 2018 rates meant that without certainty in the rules, a withdrawal of subsidies would get priced into our 2018 rates. Behind the scenes, they worked to change the rules in ways that at best could be described as malicious. These changes have been disguised as much as possible, since they serve little purpose other than to reverse Obama’s policies on principle, with little to no upside for anyone who’s covered. On Nov 1st, 2017, open enrollment was started, and for many of us, it was our first opportunity to even see the rates and changes that we’d be signing up for in the year 2018. I’m a nerd and geek, although one blessed with good health, but nonetheless, I’ve been concerned about my coverage, and have been anxiously awaiting the details of the changes. I received those details yesterday, and the best way to describe them is that…. we’re all fucked.

The first changes that impact us are the changes in the open enrollment period. I didn’t realize the perniciousness of it until after seeing my new policy. The open enrollment period in the year 2016, which is when you were able to sign up for coverage for the year 2017, was available from Nov 15th 2015 to Feb 15th 2016. This was the period of time in which you could sign up for a new policy that would give you coverage in the year 2016. I’m not going to go into details as to why we have an open enrollment period, but essentially it’s there to prevent you from signing up for coverage only right before you get sick. In the year 2017, the open enrollment was changed to Nov. 1st, 2017 to Dec. 15th, 2017, for coverage in the year 2018.

They also reduced the advertising budget for the program advertising this open enrollment period. When I initially heard about these changes, it was obvious that the changes served no purpose other than try and discourage people from signing up, but I missed the sneakiest part of the whole deal. If there are changes in your existing health care policy, those can only be changed at the start of the new year, and I can only change plans to a new one during the open enrollment period. Those 2 events no longer overlap, meaning that I have to be aware that my plan might change, understand the consequences of those changes, and find a new plan before the new plans go into effect. This means I won’t see the first bill, or face the consequences of my new coverage until after the open enrollment period has closed. This incentivizes the companies to try and be as opaque as possible about these changes, so that I’m locked into my new, worse coverage.

The way I was notified about my coverage changes comes straight out of a Douglas Adams book. I’ve signed up electronic e-mail and text notifications, and fittingly, in early October, I received written notice by mail that my existing policy wouldn’t exist in the year 2018, and that I would be automatically moved to a new policy that does exist in that year. It also notified me that I would receive another written letter containing the policy changes in the near future. I logged onto the web page for my health care provider to see if I could read about the changes, and it said that details of my new policy wouldn’t be available until November 1st.

On November 1st, I logged into my health care provider’s web page, and sure enough, I was moved to a new health care policy. This new health care policy has the same name as the old policy, but a different ID number.  The old health care plan I was on was called “Blue Choice Preferred PPO”, and my new policy shows the same name, but shows as a different policy that’s pending for the year 2018. Clicking around in the portal, it didn’t seem like there were any changes. The portal shows me a copy of my health insurance card with helpful (full sarcasm implied with that word) information, which I’ve included here.

DEDUCTIBLE PER FAMILY $9000.00 CalendarYear

My new policy? It shows exactly the same limits. I clicked around to try and find what has changed on my new policy, but I was unable to find any detailed coverage details for the new policy. Any links showing my full coverage just displayed my existing coverage.

In my continued quest to find out how I’d be fucked, I clicked on the convenient online support link on their web page, which is only available from 8am to 5pm, CST, Monday through Friday. After several minutes of trying to figure out why the button wasn’t doing anything, I remembered that browsers now kill popup boxes, and managed to disable the popup killer, and started chatting with a customer service representative. I told him I wanted a list of all the changes to my health care policy that I’d been notified about, and he told me that they had sent me a letter detailing those changes on October 17th. They may have, but I had not yet received anything on November 1st, so I asked if he could list the changes. I’m going to give him the benefit of the doubt and assume that he didn’t entirely understand my question, but after several minutes of back and forth, he finally explained that he could have the system automatically re-send the letter listing the changes, or he could manually post them into the chat window. I told him I wanted both, and he obliged, up to a point. After several pages of changes, he followed up with “and there’s a bunch more like that, and you’ll be able to see them all on the brochure we send out”. None of the changes he showed me looked particularly promising.

So what changed in my plan, and why am I so angry about it? Here’s what I saw when I finally saw my new plan. They have auto-migrated me to a new plan that is “closest” to my existing plan, and there will be no break in coverage. The old plan used to cost me about $900 a month, had a deductible of about $3000, and most services would charge me either a fixed-cost fee or a 20% co-pay amount. The new plan costs $1200 a month, has a lower deductible of $1500, but charges me 50% co-pay on most everything. Looking at their web-page, I can “downgrade” my plan from a silver plan to a bronze one, and instead of paying $1200 a month, I’m back to paying $900 a month. My deductible goes up to $3000, as opposed to the new silver plan’s $1500, but $3000 is the deductible I had in the original silver plan, so no problem there. The interesting part is that my co-pay on everything is 40% instead of 50%. So I called my insurer, and told them that instead of being auto-migrated to the new, more expensive plan, I wanted to downgrade to the cheaper plan on Jan 1st, 2018. No problem, I can switch plans any time up to December 15th, without a problem, so I told them to switch me. They asked for a credit card, which I dutifully gave them, glad that I had found their switcheroo scam before December 15th.

My next shock came in a couple days later, when I noticed my bank balance was lower than I had expected. I checked the charges, and sure enough, right after December 1st, they charged me $900 for my old plan and the December coverage. If I had remained on the auto-switch plan, then I would have been charged again on Jan 1st. Since I called them a couple days after the 1st of December to switch to a plan that was cheaper and provided a lower co-pay than their original plan, they decided they needed to charge me ahead of time for that plan so that it could start on the 1st of January. Now I do reasonably well, and so I was able to afford the extra $900 it cost me early to switch my plan, but the whole thing just reeks of scaminess and profiteering.

The whole business plan is to give the least amount of coverage at the highest price possible, and you can see it at work here. The ACA requires them to provide (at least) a minimum set of benefits. Since Trump refused to make the CHIP payments, and his lack of commitment to even that principle, meant that insurance companies weren’t able to move forward on disclosures for their 2018 plans. However, insurance companies, never ones to leave profit on the table, also took this moment of confusion to create a new plan, significantly worse than my old plan, and more expensive as well. They then helpfully offered me a transparent switch-over to the new plan, while waiting as long as possible to disclose any of the terms of the new plan to me, and requiring a preemptive effort on my behalf to get them to tell me what the changes were. Finally, as a nail in the coffin, they structure the whole thing in a way where I have to absorb higher costs before Christmas, instead of waiting for the new year, to charge me for the switch over, even though they don’t charge me the same way if I stay on the worse, more expensive plan. The final product is then packaged up so that its not obvious to me what the changes and/or charges will be until 2 weeks after the deadline for me changing the plan. This is our wonderful free market at work, where as consumers, we can spend infinite amounts of time and energy to try and prevent companies from taking additional advantage of us, while the laws work in their favor to help obfuscate what they’re trying to do to me. It’s one thing when it’s a non-essential consumer product, like a new TV, or a gym membership, but its another thing when it’s literally our health that is at stake.