2020: Bitcoin, reflation, & the rise of Tinkerbell Economics™

…in which our hero (Tinkerbell) gets poisoned, and we (the audience) clap her better with our belief:
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As the year draws to a close we must admit, if nothing else, that it has stumped many market participants.

Shorts got burned, bitcoin is mooning, all while the economic backdrop is probably the worst in our lifetimes.
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So what gives - has the Fed kicked us into a reflationary future? Are we on the precipice of a new monetary paradigm?

Perhaps. But I’d still take the view here that what we are witnessing is a heady brew of fat narratives and thin markets.
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What do we mean by thin markets?

For our purposes, a thin market is one in which the majority of participants (on an ownership basis) are… well… not really ‘participating’ in a meaningful way.
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In the Bitcoin arena, the dominant market behavior is HODLing — an approach to asset ownership which snowballs on itself and creates ultra-thin markets.

Here’s Jack noting how thin the market can become:
5/ https://twitter.com/BTC_JackSparrow/status/1339452405105221632

Many of you are probably familiar with the work of @profplum99 on passive indexation, which has a tendency to create similarly thin markets.

Here’s a graph because people like graphs:
6/ https://twitter.com/ISABELNET_SA/status/1279040734927224834

One way to think about what’s happening here is to imagine some commodity where there are, 1000 units, but only 10 of those units actually trade.

We use the transactions that happen amongst those 10 units as a heuristic for the value of the remaining 9990 units.
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But our entire system of price-setting is markets-based, so we can’t really properly *know* what the other 9990 units are worth until they start transacting.

Markets-based pricing works something like:

<commodity> is worth <value> given <transactional volume of X>
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When people try to intentionally “corner the market” on something (as cartels do), they’re controlling the transactional volume so that price moves in the manner they want.

This can also be done organically via emergent market behaviors like passive investing or HODLing.
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The more that happens, the more the thin transactions that are happening can move price — both up and down.

Thin liquidity acts as a “participant amplifier” as the remaining participants set prices based only on the 10 tradable units.
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So in absence of transactions, what are the other 9990 units worth?

Pricing is a dynamic function we can’t really know until we try to sell them, but note that adding just 2 units of the 9990 in our hypothetical here would increase effective (e.g. transactable) supply by 20%!
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And this is part of why thin markets can be so weird — the thinner they get, the more impact participant decisions have.

HODLing any currently-transactable units significantly reduces supply; and selling any previously-HODL’d units similarly juices supply significantly.
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This is part of the mechanics behind why thin markets can be so whippy and have a reputation for being subject to “butterfly effect” style contagion under these conditions.

@S_Mikhailovich puts it best here:
13/ https://twitter.com/S_Mikhailovich/status/1339713950519336971

It’s been a very weird year, and it’s likely to stay weird so long as these liquidity conditions persist.

In a way, it’s sort of like clapping for Tinkerbell: so long as we keep HODLing (bitcoin, reflationary stocks, whatevs) then it kinda just keeps the whole game going.
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But if, say, a bunch of people were to decide to un-HODL (because they are unemployed and need money, or because they are retiring, or… well there are tons of permutations here…) then we might see some strange side effects.

It’s typically how these things end.
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But for now we appear content to keep clapping and believing that will work.

And you know what? It probably will.

Until it doesn’t.

Now back to clapping - Tink ain’t gonna save herself!
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