Debut of our regularly published Explainer Series on interesting crypto concepts.

by Edmund Yong

This article was first published by Smart Investor Magazine at the following link: https://www.smartinvestor.com.my/how-does-the-greater-fool-theory-apply-to-crypto-investing/

 

 

How does the Greater Fool Theory apply to Crypto Investing?

You may have heard of crypto investors being labelled as ‘fools’. Business figures such as Jim Cramer, host of CNBC, and Bill Gates, founder of Microsoft have made such comments. Asian regulators such as Felipe Medalla, incoming governor of the Philippine Central Bank, and Raghuram Rajan, former governor of the Reserve Bank of India, have warned the public about it.

What and Who is the Greater Fool?

According to the Greater Fool Theory, investors buy a digital asset not because they believe that it is worth the price, but rather they believe that they are able to sell it later to someone else at a higher price. The original investor is a ‘fool’ and hopes he or she can sell it to a ‘greater fool’ out there. The theory is about investor psychology and not a name-calling insult.

Let’s say you are thinking about buying an NFT (non-fungible token) of a cute animal that costs 1 ETH. You know it’s just a cartoon image on a JPEG file. It doesn’t cost much to produce. You don’t even own the copyright to it and the NFT creator can reproduce other copies for sale. But you want to buy it anyway because you are confident of selling it (or ‘flipping’ as they say) for 2 ETH. You are influenced by Youtubers and TikTokers who claim to have made a lot of money doing so.

What should you do then? Always, always ask this question – Is there a ‘greater fool’ than you out there who will eagerly pay a higher price than you did for the NFT? If none of your immediate circle of families and friends are willing to do so, then you are the ‘only fool’ you know! First, you need to be sure there exists a ‘greater fool’ that will buy the NFT from you – before you buy it yourself. If you are not convinced that there is a ready market out there, then you shouldn’t buy it at all.

To further illustrate this theory, here is a real-life case study close to home. Last year, a Malaysian-based businessman Sina Estavi made headlines around the world after buying an NFT of a tweet for US$2.9 million. In April this year, he put it up for sale via an auction and started the bid at US$48 million. However, as Bloomberg reported, the auction for the NFT closed with only seven offers ranging from US$6 to US$280! You read that correctly, this is close to the cost price – but minus four big zeroes! It is almost a complete write-off. There were just no ‘greater fools’ in the market for this deal.

Are All Crypto Investors Fools?

The Greater Fool Theory has been used to criticise the investment thesis of bitcoin back in its early days, when it was in the sub-US$10K levels. Since then, crypto has become a lot more mainstream. Wall Street is accumulating bitcoins, and even some governments and pension funds are doing the same. Are they all ‘fools’ writ large?

The critique had gone quiet for some time but recently surfaced again due to the NFT mania and ‘degen’ culture. The word ‘degen’ is a shorthand for ‘degenerate’ and refers to crypto investors who go after risky digital assets like NFTs without doing their own research. Crypto ‘degens’ have become the new punching bag in this current bear market with the Greater Fool Theory as its punchline.

For some, the theory is an investment strategy to profit from ‘fools’ – specifically when there is a high degree of price uncertainty and herd mentality in the market. This works for certain assets like art and real estate where there is no objective price reference. The founder of modern macroeconomics, John Maynard Keynes explained this with an example of a beauty pageant, where judges are rewarded for selecting the contestant whom all judges think is the most beautiful, instead of the one they personally find the most attractive.

One can observe similar behaviour in the NFT market. Investors don’t value an NFT based on what they think it’s fundamentally worth, but what everyone else thinks the value of the NFT is. Some investors know how to use this to their advantage, though many fail as well, no doubt. It ends up being a zero-sum game, you either fool others or be fooled yourself.

  

Disclaimer: Contents above shall not be considered financial advice.

 

Edmund Yong is the managing partner of Celebrus Advisory and appointed by MDEC as part of its Talent Expert Network (formerly known as Digital Expert Panel) for blockchain technology. He is also the resident consultant for GLT Law, a multi-award-winning legal practice with specialisation in digital assets.