Last week, the price of Bitcoin skyrocketed above the price of $10,000 per bitcoin (BTC). Currently, the price is hovering just under $12,000 per bitcoin. For all I know, the price could be much higher before I click publish. 1 Bitcoin’s constantly rising price has led to a massive instance of the Fear of Missing Out mental model. The purpose of this post is to use bitcoin as an example of the Fear of Missing Out Mental Model. I’ll begin by discussing my personal journey with bitcoin, and then discuss bitcoin’s intrinsic value. After that, I’ll explain how I see a pervasive Fear of Missing Out on bitcoin.
My Personal Bitcoin Story
I first investigated bitcoin a few years ago when the price was in the $100 to $200 range. At the time, I became quite interested in the digital currency. There are massive implications for global commerce if a decentralized currency is able to be established outside of government control. I seriously considered buying some. Not as an investment, but primarily to understand the use case and more as a novelty.
However, I also analyzed whether I wanted to buy any Bitcoin as an investment. I finally decided not to do so. There was no way for me to determine how much one bitcoin (BTC) was truly worth. It was impossible for me to decide what the true intrinsic value of a bitcoin. Basically, if bitcoin was worth less than $200 and I bought at $200, then I was likely to lose money. Meanwhile, if bitcoin was worth more than $200, I would likely earn money by investing.
In the end, I decided that I didn’t have enough money that I could afford to buy an asset that could go to $0 at any moment. It turns out that even today, I still don’t have enough money to purchase something that could go to $0 at any moment. I assume that I’ll likely never have enough money to have the freedom to gamble large amounts of it away on uncertain speculation. Which is basically the story of bitcoin from the perspective of a value investor. If the intrinsic value of an asset cannot be reasonably estimated, then you should assume the intrinsic value is zero. In this case, it’s quite easy to determine that the intrinsic value of bitcoin is equal to zero. No assumptions are required.
Bitcoin’s Intrinsic Value is Zero
Intrinsic value is the net present value of all future cash flows of an asset. Bitcoin is a currency, and as a currency, bitcoin provides zero future cash flows. There is no absolute measure of its value, there is only relative value. Bitcoin’s (BTC) value is determined entirely by what another person will pay. Hence, the large amount of speculation rampant in the bitcoin market. The entire bitcoin market is a mania as people buy into parabolic growth in price. Hoping to participant in investment gains without a backing of intrinsic value can only be described as gambling. For comparison, let’s discuss some other common assets that people own for investments.
Gold has No Intrinsic Value
First, I’ll mention gold. Gold is a physical currency which has been used as a medium of exchange and store of value for thousands of years. However, it’s impossible to define an intrinsic value for gold. Gold doesn’t provide dividends or grant interest payments. With the exception of some industrial uses, the only reason gold has value is the confidence of buyers that they can eventually resell to another buyer. Bitcoin and bitcoin prices function in the same manner.
Real Estate has a Range of possible Intrinsic Values
Second, we can consider a house. A house is a physical asset similar to gold because you can touch it with your hands and feel the materials of construction. You can personally see the asset that you own. However, a house has a definable intrinsic value because the owner can earn future cash flows by renting it out. There might be uncertainty on the magnitude of future rents. However, there is no uncertainty that future rents are possible. In addition, reasonable people can disagree on the true value of the house, but it’s possible to make an estimate of what a valuation range might be. The same holds true for all manner of real estate.
Bonds have a clearly defined Intrinsic Value
Finally, consider owning a bond that pays bi-annual interest payments of $50 on a purchase price of $1000. Bonds are digital like bitcoin but are an investment instead of a currency. Although this bond isn’t something you can put your hands on, you can easily determine the bond’s intrinsic value. All it takes is a required rate of return, and the calculation is very simple. With a bond, if you want a 10% annual rate of return, I can tell you exactly what price you need to pay. I can’t say the same for bitcoin. I have no idea what rate of return someone buying bitcoin at today’s prices can expect.
The ongoing Bitcoin (BTC) Bubble
Back in 2013, you could buy Bitcoin in the $100-$200 range. For the purposes, of demonstration, I’ll use $100 as the purchase price for bitcoin. At the beginning of 2017, bitcoin was priced at approximately $1000 per bitcoin. That means in 3 or 4 years, speculators in bitcoin earned 10x or 1000% returns on their money. That’s an incredible return. This return could not be matched by an investment in the US public stock market at the time.
This enormous growth in bitcoin price and high returns on invested capital increased the market’s awareness bitcoin. In addition, cryptocurrencies as a whole gained broader exposure. As awareness grew, many new speculators flocked to buying bitcoin as an “investment.” I use quotes because no rational person using a value-based discipline could ever call bitcoin an investment.
The large growth in interest in bitcoin combined with the rapidly growing price has created a massive bubble. While speculators were ‘content’ to accept 10x returns over a 3 or 4 year period prior to 2017, that’s no longer true. Since the beginning of 2017, bitcoin’s price has gone parabolic. From approximately $1,000 per bitcoin, we’ve now exceeded $10,000 per bitcoin with no end in sight. It took less than 24 hours from the point that bitcoin prices reached $10,000 for them to exceed $11,000.
The Fear of Missing Out Mental Model (FOMO)
The point of this discussion is neither to attack nor promote bitcoin as an investment or speculation. In addition, this article is neither a primer on bitcoin as a digital currency nor an introduction to cryptographic blockchain technology. Instead, my goal is to use bitcoin as a critical real-time example of the Fear of Missing Out Mental Model. The Fear of Missing Out or FOMO is a critical psychological phenomenon for prudent value investors to understand.
Mental Models are a key aspect of Behavioral Finance
Humans are social animals and we’ve been conditioned since tribal times to be accepted members of a group or community. It was literally life or death to be ostracized from your tribe. The fear of missing out on the benefits of a hunt was very real. If you didn’t receive a portion of the food, you would likely perish. Consequently, it was critical that you didn’t miss out on the bounties experienced by others.
This latent fear of missing out on the good fortune of others continues to this day. It could be a vacation your friends post about on Facebook or from watching scenes of a party you weren’t invited to on Snapchat. Social media creates consistent messaging that you might be missing out on something. This messaging is in addition to the constant barrage of success that the traditional media shows. The fear of missing out can arise whether it’s the newest trendy stock pick, local 20 something who founded a successful startup and made millions, or even the ongoing parabolic rise of bitcoin’s price.
Bitcoin is a prime example of both the allure and dangers of giving in to the Fear of Missing Out. I have seen numerous stories of bitcoin minting millionaires of early adopters. They bought large numbers of bitcoin when prices were low five or more years ago. Just recently, I’ve started to see even mention of new bitcoin billionaires. The publicity that these stories create instills a fear amongst non-participants that they are missing out on the next big thing. Many people would like to get rich someday. Thus, the allure of getting rich quick and without much effort is too much to ignore. Unfortunately, bitcoin has caused millions of people to be caught up in this mania.
Greed disguised as Fear
The Fear of Missing Out is a particularly important mental model for investors because it’s not a normal fear. Typically we associate fear with danger or loss. People are afraid of heights, spiders, or dying. The fear of missing out isn’t like that. How would you feel if you were the only one amongst your peers NOT getting rich from bitcoin? Likely you’d be afraid, but it’s a fear based on greed. This is a particular kind of greed that tends to only come in the late stages of a bull market turned bubble. It is important to recognize that. You know the bubble is nearing the end when the prevailing emotion is the fear of missing out on gains.
Warren Buffett discussed fear and greed in his 2004 Annual Shareholder letter. However, this is not the fear to which he was referring. For reference, here is his quote:
“And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”
As I said, greed normally prevails at the tail end of bull markets. Thus, greed and euphoria in the markets is typically a time for caution. However, the current fear of missing out is simply a special type of greed. This greed comes later but is the most dangerous because fear can lead people to make mistakes that greed alone never would. For instance, I’ve read an article about a family that sold their house and most of their possessions. They took the entire sum and gambled it on bitcoin, planning to live solely off bitcoin from now on.
Conclusion: Be Cautious when the Fear of Missing Out becomes prevalent
The bitcoin bubble should be self-evident to anyone who looks at a price chart of bitcoin. Sadly, the most likely outcome is that it will end badly. The same has happened throughout history as bubbles routinely inflate followed by a pop and crash. Whether we’re discussing tulip bulbs in the 1600s, bank stocks in 1929, beanie babies in the late 1990s, dot.com stocks in 2000, US housing in 2007, or nearly every asset class today including bitcoin, all bubbles eventually crash. The timing and severity of the crash can’t be realistically predicted, but you can prepare.
The Fear of Missing Out Mental Model (FOMO) should be a tool in your toolbox. Use it when analyzing investments, market psychology, and your own emotions. Like all mental models, the value of understanding the fear of missing out will depend on incorporating it as just one tool amongst many in making sound financial decisions. The important thing to remember is that making investment decisions based upon volatile emotions, whether fear or greed, will limit your long-term success. However, if you understand your emotions and your fellow market participants, you can leverage that understanding to improve your performance.
Have you ever felt the fear of missing out? Do you currently feel it with the ongoing rise of bitcoin? Share your experience in the comments below, so we can all learn together.
1 As it turns out, by the time I’m publishing this article Bitcoin not only surpassed $12,000/BTC but broke through $17,000/BTC. In addition, it seems very brief highs broke all the way through $19,000. It just goes to show that you can’t predict how quickly a bubble will inflate.