Today we begin with the lesson and then we unpack it so you can understand why some people will always be addicted to shitcoins, others will lead a fiat life until they get hit with a tsunami wave and others will understand BTC from the get go. It has a lot to do with circadian oscillations.
Nature is a decentralized energy network and so is Bitcoin. This means there are things in the BTC ecosystem that work like the relationship between predator and prey. It is your job to see and understand this. Why does this idea persist? The algorithm that created bitcoin is really an algorithm of time. It was created to show that timing matters a lot in the coupled system.
FEEDBACK CONTROL OF METCALFE’S LAW: The predatory Bitcoining maximalist act like the predator in this ecosystem. They provide a valuable feedback service in this ecosytem by turning off people from buying Bitcoin. The people turned away are non critical thinkers. Think of them like low dopamine humans in the mitochondrial ecosystem. People who turn away because of hurt feelings exhibit behaviors that place themselves at the back of the line and allow critical thinkers to front run them. In this way, the people turned off, the low dopamine prey, wind up supporting the predators in this coupled system by buying Bitcoin a long time after the predator types. They usually buy into to shitcoins or fiat games before they ever consider buying Bitcoin. This is a key symptom in this coupled cycle. This is how the predator consumes its prey. As a result the price rises for all in the ecosystem. The predators have more than the prey, but both sides of the oscillating system remain viable and healthy. One can not exist without the other. This tide rises all the predators boats as the process evolves and supports the ecosystem expansion.
This predatory oscillation works best on financial journalist, academics, VIPs & think tank types. Those educated by classical beliefs often are the low dopamine prey in bitcoin.
HOW COUPLED OSCILLATIONS OPERATE IN NATURE
Connect one pendulum to another with a spring, and in time the motions of the two swinging levers will become coordinated.
This behavior of coupled oscillators is long a fascination of physicists and mathematicians also can help biologist seeking to understand such questions as why some locations overflow with plants and animals while others are bereft. It can also help crypto owners understand why there is an ecosystem of shitcoins and fiat schemes in the Bitcoin ecosystem. It turns out, the “prey ecosytem” strengthens the Bitcoin network long term.
In nature, we should pay closer attention to coupled oscillations because they determine outcomes. The ecosystem provides the incentives that determine outcomes.
The basic idea of oscillating populations is not new to ecology of any system, biologic or cryptographic.
If you want to understand the complex interactions of crypto assets and fiat instruments you must understand how they work together with timing.
We know that any predator-prey system, say lions and zebras for example, shows oscillations.
If there are lots of lions preying on zebras, numbers of zebras decline; then because zebras are scarce, lions starve and their numbers dwindle, allowing the zebra population to build up again. You see this oscillation, changing on a regular basis from lots of predators with few prey to lots of prey with few predators. The pattern is like waves or pulsations.
What gets interesting is when two independently oscillating systems, such as lions preying on zebras and cheetahs preying on impalas, become connected through the invasion of a third predator” leopards, for instance. This is what is happening to the Bitcoin ecosystem now with shitcoins and fiat instruments.
When they become connected, the situation is very much like connecting two springs together, the ups and downs work in unison to create cyclic patterns who all have a reference to time. This is best represented in the halving cycle of Bitcoin, the alt coin cycle, and the business cycles of fiat systems.
In the case of lions, cheetahs and leopards, bringing leopards into the system causes lion and cheetah populations to oscillate in phase with each other peaking and declining at the same time. This is how BTC and altcoins operate in crypto ecosystems. That works to the leopard’s advantage when both lion and cheetah populations are low, leopards can pounce on the plentiful prey. This is why Bitcoin maximalist focus on alt coins during bull market runs. But then lions and cheetahs increase again, eventually building up their numbers and combined competitive strength enough to drive out the leopards at least until the next low point in the lions’ and cheetahs’ population cycles.
Predator-prey systems can also become coupled when a new prey species invades and competes for resources with prey species in two previously unconnected predator-prey systems. This is where fiat instruments come to play for crypto. For example, an extremely fast antelope might begin competing with zebras and impalas for food. Even though neither lion nor cheetah is fast enough to prey on the new antelope, the antelope’s activity links the previously unconnected lion-zebra and cheetah-impala pairs. In such a case, the ups and downs of the two original prey species are thrown into chaotic but coordinated patterns. Fiat creates the chaos that Bitcoin and altcoins require.
This process is what is known as coordinated chaos a phenomenon that occurs in some physical systems, such as lasers, but hasn’t been pointed out in crypto ecology before this blog. By oscillating out of phase with the other two grazers” zebras and impalas” the antelope can coexist with them, prospering when their numbers are low. Fiat instruments feed both systems during crypto bear markets.
In living systems, considering such scenarios with the aid of mathematical simulations, the models can help address questions biologists have wrestled with for decades, such as how species that appear to be exploiting the same resources can coexist and why some predator-prey systems are particularly resistant to invaders.
In the past, ecologists have taken a traditional Newtonian view of the world, where everything comes into a nice equilibrium. But oscillations sometimes destroy that equilibrium, by design. What I’m suggesting is that we crypto ecologists need to acknowledge the inherent oscillation in consumer-resource systems, such as predator-prey, BTC-shotcoin, herbivore-plant and parasite-host systems, and start approaching these old ecological issues in terms of coupled oscillators. Then and only then will you see the forrest through the trees and understand the ecosystem of Bitcoin, alt coins, and fiat systems for what they are.
HOW TO MAKE SENSE OF THIS FOR BITCOIN
Why do some go irresponsibly long in #BTC? BTC is the only asset that has a Sharpe ratio of greater than 1. The Sharpe ratio describes the increased rate of return received for the extra volatility sustained when holding a riskier type of asset. To understand the Sharpe ratio, one must take into consideration the returns of holding a risk-free asset, compared to holding a riskier asset with higher returns. In this case, a risk-free asset is considered something like a US treasury T-Bill, which is backed by the full faith and credit of the US government, along with the world’s largest economy. This includes FAANG = FB, Apple, Amazon, Netflix, Google. None equal BTC Sharpe ratio.
From 2015-2019 Bitcoin’s 4-year Sharpe ratio was constantly above 2.0, and it has reached above 3.0 in 2019 and was 2.65 for 2020. So far in 2021, BTC is above 3. this defines the parabolic wall of the bull market where Bitcoin dominates as a predator should.
How to interpret a Sharpe ratio?
A ratio higher than 1.0 is considered acceptable.
A ratio higher than 2.0 is considered very good.
A ratio of 3.0 or higher is considered excellent.
A ratio under 1.0 is considered suboptimal.
The negative Sharpe ratio means the risk-free rate is greater than the portfolio’s return, or the portfolio’s return is expected to be negative.
The Sharpe ratio is the difference between the returns of the higher-returning, more volatile assets when compared to the risk-free, much lower returns of a safer asset like US T-Bills. It is important to note that Sharpe ratios only measure the returns based on the amount of risk and the ratio doesn’t actually measure the volatility of the underlying asset itself.
The Sharpe ratio filters out the noise of investor psychology to find the nuances of Bitcoin risk
The Sharpe ratio filters out the noise of investor psychology to find the nuances of Bitcoin risk and reward at different stages of its macrocycle. This can be done by using a simple rolling Sharpe Ratio that analyzes Bitcoin risk-adjusted returns over time.
Ultimately, with respect to BTC timing is critical. Timing is a key feature of coupled oscillating systems. Correct timing matters deeply: while the individual investor may be satisfied with long-run outperformance, Bitcoin’s macrocycles urge further nuance.
Historically, the trade following the Halving represented the most attractive risk-adjusted opportunity in BTCs history. May 11, 2020, was the most recent Halving. Investors with personal savings and unconstrained time horizons will find comfort in the story of Bitcoin’s long-run outperformance. 90% of days BTC has been higher. This is an astounding ratio. Bitcoin returns are disproportionately skewed to the upside, timing matters.
Much like a call option, Bitcoin risk-adjusted returns rapidly decay or improve depending on market timing. The implication of this record? Over any rolling four-year period of BTC history, Bitcoin’s Sharpe Ratio historically outperformed virtually every other asset class. If an investor had held for at least four years during any point in Bitcoin’s history, they would have demonstrated superior risk-adjusted returns relative to almost all other investment opportunities. Nothing is better than it. This defines predatory behavior.
Thinking about Bitcoin’s Sharpe Ratio over four-year intervals may be correct in theory, but it is limited in practice. In reality, markets are governed by animal spirits – the swings of fear and greed – This is how alt coins and fiat fears feed the Bitcoin chaos ecosystem. This is why most “prey investors” are more likely to enter the market after periods of non-linear growth. Altcoiners and fiat players buy after the top because they do not understand the coupling in the Bitcoin system.
BTC is like sunlight, Altcoins are like blue light, and fiat is like gold in this mitochondrial energy analogy. Great quotes do not come from great people. They come from ordinary people who think differently about ecosystems.
Many new entrants are thus destined to enter mid to late-cycle, fated to experience grueling drawdowns after buying local or even global highs. The assumption that investors can and will HODL underwater positions for multiple years is unfeasible, especially with the prospect of underperformance relative to other asset classes. The financial and emotional burden of drawdown will likely lead many to capitulate their positions before they are able to realize an entire four-year cycle. This is why predatory Bitcoiners feed on shitcoiners in bull runs. It is happening as I type this in this halving cycle.
Given the path dependence of returns, the long-term Sharpe Ratio fails to adequately capture Bitcoin risk.
Oscillating around a value of 1, the one-year forward-looking Sharpe Ratio peaks at the beginning of
Oscillating around a value of 1, the one-year forward-looking Sharpe Ratio peaks at the beginning of Bitcoin’s price inception, 2012 Halving, and several months following 2016 Halving. After these three periods, an interesting dynamic at play: aggressive Sharpe Ratio decay from a high of 3 (spectacular) to a low of −1 (abysmal).
Further, examining the 1-4 year forward-looking Sharpe Ratio for Bitcoin from the Halvings (see pic above), we find a similar effect:
- Exposure to Bitcoin for 1 year after the 2012 Halving nets a Sharpe Ratio of over 3, and holding for an additional 3 years degrades this to approximately 1. From a spectacular investment to a “good” investment.
- Exposure to Bitcoin for 1 year after the 2016 Halving nets a Sharpe Ratio of over 2, and holding for an additional 3 years degrades this to less than 1. From a great investment to a sub-standard investment.
How important is market timing when managing Bitcoin risk?
Analyzing Sharpe Ratio decay gives us a powerful risk framework for BTC. Not all Bitcoin investments are made equal: Bitcoin acquired at different points in a macrocycle should be treated differently as part of a diversified portfolio. To illustrate this concept, consider the idea of “time-to-profitability” (TTP) demonstrated in the picture below:
- Bitcoin acquired at the 2011 high has a ≈2 year TTP
- Bitcoin acquired at the late 2013 high has a ≈3 year TTP
- Bitcoin acquired at 2017 high achieved profitability in November/Dec of 2020.
Not only were investors who purchased Bitcoin at these highs faced with absolute drawdown, but they were also faced with relative underperformance against worldwide equity indices (and possibly other asset classes). Bitcoin can be an excellent tool within a diversified portfolio, but most professional investors cannot simply buy and HODL for extremely long periods of time if they are likely to face both absolute and relative underperformance. Regular investors can if they can handle the tax consequences. This idea is critical in trading within an IRA account.
The legacy wisdom of financial markets sometimes cautions investors against market timing, captured by the dominance of indexing strategies and the underwhelming reputation of the modern hedge fund. Whatever the merits of this argument in traditional markets, the wise Black Swan will find a fundamentally different heuristic exists for Bitcoin.
This doesn’t mean that other strategies like buy and HODL are not valid. They are over 4 year periods, but within the coupled system Bitcoin is very asymetric and responds to its main oscilator: Time.
Time in the BTC system is monitored by the difficulty adjustment. The difficulty is a measure of how difficult it is to mine a Bitcoin block, or in more technical terms, to find a hash below a given target. A high difficulty means that it will take more computing power to mine the same number of blocks, making the network more secure against attacks. The difficulty adjustment is directly related to the total estimated mining power estimated in the Total Hash Rate (TH/s) chart.
The difficulty is adjusted every 2016 blocks (every 2 weeks approximately) so that the average time between each block remains 10 minutes. This is one of the most important vital signs I monitor in Bitcoin price.
The difficulty comes directly from the confirmed blocks data in the Bitcoin network. Price falls can be very accurately predicted when you understand how important timing is in this algorithm. Just as sunlight is the key variable for life, the difficulty adjustment is the life blood of BTC pricing.
The bottom-line explanation of difficulty adjustment is that every time a mining rig is shut down, the bitcoin protocol increases the incentive for other miners to stay online to run the network. It’s as if every time a Walmart shuts down, all the remaining stores became more profitable.
Gazed upon long enough, difficulty adjustment can take on a kind of transcendental religious quality. It’s not the reason bitcoin is useful day-to-day, but it is the reason that bitcoin (like other true blockchains, and very much unlike centralized stores) is nearly immune to true destruction, whether by state regulation or market fluctuations. It’s the reason bitcoin is superior to a centralized digital currency system like Gold, even if bitcoin is more expensive to run in aggregate. It’s what makes blockchains more persistently “real” than mere data saved to a hard drive, or even, arguably, to a Google cloud server farm.
This mining process used in Bitcoin, is formally known as Proof of Work. It is also sometimes referred to as “solving a cryptographic puzzle.” Calling this a ‘puzzle’ or ‘problem,’ though, is fairly misleading; solving a “puzzle” often relies on some sort of logical reasoning, but the solution to a bitcoin block is essentially randomly generated by the bitcoin protocol. Mining rigs are making very complicated, equation-backed guesses as fast as possible, in the hope that they’ll be the first to hit the random solution and reap that sweet, sweet, reward, a Bitcoin.
This randomness is key to understanding the difficulty adjustment, just as sunlight is key inside of cells to understand how sunlight creates order out of chaos every day to lead to circadian control of biologic processes inside of us.
Time was built into the BTC monetary network by design using the difficulty correction. It is simply to say that for investors focused on managing risk, timing really matters in the Bitcoin ecosystem because of the difficlty adjustment in the BTC algorithm. The difficulty adjustment mimics the role of the sun in biology. In this way, BTC mimics the Leptin Rx. BTC does this because Nature and BTC both use decentralized network effects to dominate their ecosystems.
A once-in-cycle trade, but don’t forget to expect the unexpected
The historical analysis of BTC behavior leads me to conclude that, historically, the best risk-adjusted entry existed at or within several months following a Bitcoin Halving. The Sharpe ratio remains at plus 3 200-400 days post Halving. Today we have 93 days left in the halving cycle. Each day is worth a lot because the Sharpe ratio is now above three and this is where massive price gains are found. After this time, the Sharpe ratio falls off a cliff.
How institutional investors will change this cycle is now the biggest mystery in my mind. believe the curves will be right shifted for returns and price, just as metabolism is changed by sunlight in spring and summer.
This post-Halving window, when combined with hedging practices like protective puts or a managed stop loss, helps build a case that, on a risk-adjusted basis, Bitcoin will usually outperform other asset classes.
THE KEY PROBLEM IN THE CURRENT HALVING CYCLE:
As Bitcoin has sprung to new highs in 2021, the current reality is that investors will eventually demand exposure to this asset. Ironically, as these requests pile in mid to late-cycle in 2021, money managers and individual investors will be faced with a dicey dilemma: remain on zero as Bitcoin makes weekly headlines or enter a drawdown-prone asset at local or absolute highs. C goes up in 2021 the risk ratio rises as the market comes to a top. Rather than enter as greed floods the market (next few months), the post-Halving window (April 2020- Sept 2020) granted investors an early window to incorporate Bitcoin into their broader macro strategy. This is why the member event on July 4th, 2020 was critical. IT WAS THE BEST TIME TO GET IN. Where are we now? We likely are in the middle of this bull run. I expect it to last into October of 2021 and not just July of 2021.
What drives this cycle? It is the supply and demand curves buoyed by Metcalfe’s law and sculpted by the current difficulty cycle. I think the difficulty cycle adjustments will tell me when the top is in. Price in the Bitcoin ecosystem is wholly determined by these two effects, but timing adjustments will define this halving’s outcome. And the supply and demand curve has an unusual twist in this current halving due to a severely curtailed supply of BTC marked by increasing institutional demand. The current post-Halving window is upon is now as BTC#18 laid out and represents a rare time to add high expectancy, low-downside Bitcoin exposure. That window will only be open for the next few months until the Sharpe ratio begins its cyclic fall. In this cycle, based upon the historical past of BTC, that fall will approximately happen August -November of 2021.
TIMING IS THE KEY FEATURE OF NAKAMOTO PUT INTO THE BTC ALGORITHM TO DRIVE ITS VALUE
If people choose to store their wealth in a monetary good which exhibits less hardness, then the producers of this monetary good are incentivized to produce more monetary units, which expropriates the wealth of existing unit holders and destroys the monetary good’s salability across time.
This is the fatal flaw of soft fiat/gold money: anything used as a store of value that can have its supply increased will have its supply increased, as producers seek to steal the value stored within the soft monetary units and store it in a harder form of money. In this way, over time both instruments act like a negatively yielding bond. Your returns on value diminish by the design of the instrument. Bitcoin solved this problem in its White paper.
The difficulty adjustment in the White paper made Bitcoin responsive to time and that set it up to be the predator to fiat, gold, and now altcoins in the current ecosystem. This has big implications for people who do not understand it. It has bigger implications for nations for do not accept it.
Now are you predator or prey in the Bitcoin ecosystem, right now?