Reverse Speculation and Irrational Exuberance

The other day, a friend of mine accused me of being a crypto non-believer.

I’m not going to mention names. But most of you have probably heard of him.

“You’re different from a lot of early crypto investors,” he said. “Your belief is conditional. I’m not sure I’d even call it a belief.”

“Are you calling me a crass speculator?” I asked, half in jest.

“No, no, more like an ‘informed speculator,’” he replied. “Otherwise, you’d have fled the market by now.”

OK, I was confused. Was this a compliment or an insult? Before I could ask, the conversation veered off in another direction.

But that word “speculator” stuck in my craw. I had invoked it half-seriously… without giving it much thought.

But I’ve heard a lot of people throw this word around as if it were a poisonous dart – something unsavory, stupid, a loser’s game that will ultimately “end in tears.”

Tears… or Cheers?

Here I was, Labor Day weekend, with a couple of hours to spare. So I decided to investigate how “speculation” is defined. Here’s Investopedia’s entry…

Speculation is the act of conducting a financial transaction that has substantial risk of losing all value but with the expectation of a significant gain. With speculation, the risk of loss is more than offset by the possibility of a huge gain. Otherwise, there would be very little motivation to speculate.

That’s a pretty good definition, but it’s missing a big piece. There’s no time element. So I continued my search and saw this definition…

An activity that commits funds in financial or physical assets with an expectation of earning a return in a short period.

Now we’re getting somewhere. We’ve identified three main components of a speculative investment: substantial risk, significant gain and short period.

Still, it doesn’t explain why speculation has become a dirty word to so many. Again, I went in search of the missing component that would explain this. And I found it…

speculative investment is a high-risk one where the purchaser is more interested in price fluctuations than the asset’s fundamental value.

Bam: more interested in price than fundamental value.

But is that such a bad thing? Price is the ultimate bottom-line metric. Quant investing, technical analysis, momentum investing… it’s all about price movement.

Why are those activities given a free pass but speculative investing isn’t?

Bubbles, Irrational Exuberance and the Speculative Investor

If price trumps value… or, similarly, if value is ignored in the presence of surging prices… then isn’t this the very essence of the much feared “irrational exuberance” dynamic?

Alan Greenspan put “irrational exuberance” on the map more than two decades ago. On December 5, 1996, the former Fed chief warned about a potential bubble in stocks (emphasis mine):

How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

Indeed, how do we know? Greenspan clearly did not.

The initial knee-jerk reaction drove stocks down. It didn’t last long. And then the stock market went on a prolonged three-year tear, proving that speculative profit-taking can last not weeks or months, but years.

It wasn’t exactly the lesson that Greenspan had in mind.

In trying to spook the market, Greenspan cast “irrational exuberance” and, by association, speculative investment activity pretty much in the same negative light that continues today.

Practicing Speculation “in Reverse”

Myself? I have no problem with speculation, even if it causes prices to go too high.

This is the nature of free and open markets. Because sentiment plays a key role in how markets trend, assets are either overpriced or underpriced.

They’re rarely priced just right.

Likewise, if irrational exuberance played a role (as I think it did) in driving the crypto market to its highs of last year, that’s not the worst thing in the world.

To quote one of the smartest and richest investors of emerging technology, Fred Wilson, “Nothing important has ever been built without irrational exuberance.” (He himself borrowed this quote from a friend.)

That’s particularly true with regard to blockchain technology and the cryptocurrencies that go hand in hand with the development of this transformative technology.

These crypto tokens are the native asset classes of digital networks. Their value will ultimately be driven by how well these networks address real needs and generate significant efficiencies.

I can’t put an exact number on it, but a lot of speculative money went into financing crypto projects. But crypto investing, as practiced by Adam and me, is NOT speculative.

If anything, it’s anti-speculative.

We reverse the definition. Instead of being “more interested in price fluctuations than the asset’s fundamental value,” we’re much more interested in the factors that drive fundamental value, such as uniqueness of technology, size of the user case opportunities and scalability of the network.

As for price? Our focus is long term. Whether the price is high or low at the moment, we’re so early in making these investments that those crypto companies that do well and hit their marks will ultimately drive value way up into four-digit percentage territory.

Of course, we don’t get rid of risk entirely. What investment is truly free of risk? But our strong focus on fundamentals helps alleviate it.

So, of the four components of speculative investing, we don’t adhere to short-termism or price over fundamentals. We put a big dent into risk. The only component that remains unscathed is…

Big gains… which is just fine by us.

Last year, I said that dozens of industries will be reinvented by decentralized digital-asset-backed protocols.” A speculation?

Let me share with you one last definition. It comes from Bernard Baruch.

Baruch amassed a fortune in the 1890s by speculating on sugar prices. He was also the original “lone wolf of Wall Street” because of his refusal to join any financial house.

He said…

A speculator is a man who observes the future and acts before it occurs.

Adam and I see the future in a certain way. It’s why we plan to continue to invest in crypto assets for the next 10 years, regardless of how prices fluctuate.

I suggest you join us. The least you can do is invest a small percentage of your savings. You won’t need much to make a big difference in your financial well-being.

Good investing,

Andy Gordon
Co-Founder, Early Investing