Lawrence A. Cunningham’s Quality Investing: Why bitcoin’s bust and the ‘crypto cult’ threaten all investors


Traders who have been coordinating on social media to promote stratospheric prices in meme stocks, such as GameStop
and cryptocurrencies such as bitcoin

and dogecoin

— what exactly are they doing?

They are not day trading, but “holding on for dear life,” (HODL) as the group describes it. They are not indexing, because they view the entire stock market as corrupt. They are certainly not quality investors, as their process defies financial analysis.

While indexers, day traders, and stock pickers each have a distinctive approach, all are conscious and diligent participants in a traditional market. The same is even true of shareholder activists, who may demand changes, from board composition to dividend policy, but accept the corporate setting and related measures of returns. Others use their position as shareholders to advocate social causes, from consumer protection to workforce diversity, but purpose is clearly stated and proposals formally made, often in a target company’s proxy statement.

Most of today’s devotees of meme stocks and crypto operate outside any such familiar forms of market behavior or investing theory. Rather, they protest against Wall Street capitalism, revel in disruptive poisoning of markets, or rejoice at creating the fantasy of an alternate reality. 

The behavior of most of these participants can best be explained by a nascent branch of economics called “identity economics.” Pioneered in a 2010 book of the same name by George Akerlof and Rachel Kranton, the book’s focus is on behaviors at odds with traditional economic models of rationality, such as why people vote against their economic interests or why they stay in jobs making less than they could elsewhere.

Identity economics attributes such choices to our conception of who we are and other social considerations.  People value working with certain colleagues in a particular organization when they share distinctive norms and goals. When employees feel they have a shared mission, their sense of culture compensates for a lighter paycheck. That’s one reason HR departments invest in artifacts of corporate culture, from mission statements to mantras.

Meme-crypto trading culture is like that. Just as employees who think of themselves as insiders work for less, members of this cohort stake their capital on the riskiest possible bets with scant regard for corresponding returns.  Participants share a code and language: they “HODL” or are going to “reach the moon.”

Devotees of dogecoin call themselves “subshibers,” referring to the breed of their Shiba Inu mascot. And just as corporate culture and employee identification can be decisive to a business’s success, that sense of in-group identity is essential to dogecoin’s sustenance.  

The cyrpto cult is a new force all investors must consider. For indexers, their presence injects volatility into the ever-fluctuating market, a jolt greater than ordinary company risks that indexing diversifies away. Short-sellers, focused on shorter-term market pricing, face significant additional risks, as the GameStop price spike earlier this year revealed.       

Even quality investors, who care more about business value than market price, face headwinds from the persistent mispricing of risk. After all, identity economics can influence pricing and investment returns anywhere, without regard to underlying business features or competitive advantages. The strongest business moats — brand strength, economies of scale, network effects — may ward off rivals, upstarts, and disruptions. But not identity economics. 

Traditional investors of every stripe will benefit from learning about this cohort to assess risk. Such cults throughout history eventually unravel, as some members defect, others follow, and the culture collapses on itself.  Using markets to protest markets may prove to be fiendishly dangerous.

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. To get updates on research about quality shareholders, sign up here.

Read: No one will save you from a bear market, so you’ll have to do it yourself

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