Understanding Crypto · Lesson 4 · Beginner
The anatomy of a bubble
You recognize why a rising price alone does not make good money and how supply-driven bubbles build up.
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The easy-money trap
Ammous's core thesis: anything people buy as a store of value attracts more production. The supply inflates, and at some point the price tips over.
Five phases
Savers buy, the price rises. Producers see the price and increase supply. The supply inflates. The price crashes. Wealth transfers from late savers to producers.
Example, the Hunt brothers: in the late 1970s they drove silver up, and ended with over one billion USD in losses.
Anatomy of a bubble in the chart
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Test yourself
A token 10x's, hundreds of new mining providers and clones show up. Which phase is this?
- Supply inflation, just before the tip-over
- Stable mature market
Who typically loses in the easy-money trap?
- The late savers who bought near the top
- The producers
Does a rising price make a good into good money?
- No, it only attracts more supply
- Yes, a high price proves value
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The key points at a glance
- Whatever gets used as a store of value attracts additional production.
- The mechanics: savers buy, price rises, producers increase supply, price crashes.
- Wealth flows from late savers to producers and early sellers.
Deep dive
Supply-driven vs sentiment-driven bubble
Ammous describes the supply-driven bubble: savers buy an easily produced good, the price rises, producers deliver more, supply balloons, the price crashes. The Hunt brothers tried to monetize silver in the late 1970s and lost over one billion USD.
Alongside it stands the sentiment-driven bubble. Both overlap right now in crypto: a hype attracts capital and, at the same time, hundreds of new clones and mining providers.
The Rodrigue model: four phases and the bull trap
Rodrigue's diagram describes four phases in which the same emotions produce the same pattern year after year. Two traps are instructive: the bear trap early in the cycle shakes out skeptics, the bull trap after the top lures latecomers back in.
- Stealth phase: smart money buys quietly
- Awareness phase: first institutions, a sell-off and the bear trap
- Mania phase: the public, media, greed, belief in a new paradigm
- Blow-off phase: denial, bull trap, fear, capitulation
Why FOMO is most expensive at the parabolic top
The sequence at the top runs breakout, FOMO, super-FOMO, panic buy, then collapse and panic sell. If you enter out of fear at the steepest point, you buy where the risk-reward ratio is worst. According to Goodman, FOMO is the single most common reason for losses in leveraged day trading.
- Only buy within about 5 percent of the breakout point
- Chasing missed breakouts is the road to ruin
- Compulsive re-entry bleeds out in many small losses
- Only enter on a clean second breakout
Sources: Ammous, Burniske/Tatar
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