Crypto-currencies are back in the news these days. We are certain that some people were getting frustrated and emotionally distraught about the recent and brutal selloff that occurred across the board in crypto-land. When you think about it, the volatility in crypto prices is truly off the charts. We have mentioned on these pages in the past that the runup in the price of Bitcoin surpasses every bubble known to man. The South Sea Bubble and the Tulip Bulb Mania do not hold a candle to what Bitcoin achieved. (By the way, we discussed the Tulip Bulb Mania in our best-selling book The Options Edge. We explain why a change in government regulations created the opportunity for free call options fueling speculation with minimal risk. This, in our view, is an institutional factor that made this market disaster possible.)
Let’s start by doing a recap of the longer-term picture in crypto-and by focusing on Bitcoin. It is hard to believe, but just 1 year ago, the price of Bitcoin was about $1,310. Given the gyration in prices over the last year, it sure seems a lot longer. In Q4 of last year, people let the mania separate them from reality. Speculators around the world ran the price up to $20,000 in a matter of just a few months. Prices went parabolic and we have never seen a parabolic move that did not end in a crash.
Price moves from dollars to thousands of dollars to create the hope of enormous wealth. That wealth accrues however only to those few people who get in early. The latecomers usually get left holding the bag. That is certainly what happened to people who bought Bitcoin or any other crypto-currency in November or December 2018. So what’s next?
It is important to remember that anyone with the technological knowledge can create a crypto-currency or token. Here is a link to a website that lists most of the currencies and tokens currently in existence. As of today, they list 897 different coins and another 701 tokens. All the crypto coins out there have a market cap of $342 billion, while the tokens have a market cap of $57 billion, for a grand total value of $399 billion. More coins and tokens are being created every day. There are few things in life we are sure of. But we are sure that at least 90% of these cryptos will go the way of the dodo bird and become worthless. So when playing in the crypto space, it is buyer beware to the max.
Before going further, let’s take a look at the difference between a coin and a token.
A Coin is where it all began and it began with Bitcoin. A cryptocurrency (digital currency) uses its own platform and operates independently from any other platform or network. We like to think of coins as running on a peer-to-peer network much like the old music sharing networks as Limewire and Napster did. But instead of moving around mp3 files, they move around value. To keep track of ownership and transfer of values, a ledger (commonly referred to as a blockchain) is created that tracks every transaction on the network. That ledger is “decentralized.” That means everyone on the network has a copy of the ledger. This makes the system robust because if someone’s computer crashes, there are thousands of other computers keeping the network going. What Satoshi Nakamoto did in his white paper is present a method that requires all the ledgers on the network to agree on who owns what before a transaction takes place. It solved the double spend problem. To be clear, every coin has its own blockchain and the coin is the native currency. Bitcoin, Litecoin, and Etherium are examples of crypto coins. Litecoin and Ethereum are often referred to as altcoins, which means they are Bitcoin alternatives in some ways. There are two common types of altcoins:
- Some altcoins are built using the original source code of the Bitcoin derived Blockchain. They are simply modified in some way to create a new independent coin. Dogecoin and Litecoin are examples.
- Some altcoins are built with design improvements. They attempt to address some of the shortcomings of the Bitcoin network such as speed, capacity, and transaction cost, or add an additional feature or capability. Some examples are Ethereum, Icon, and AION.
A Token is a cryptocurrency that is built on top of an existing Blockchain. We like to think of a token as an asset or utility that exists within a defined ecosystem. Since tokens are created on top of an existing Blockchain, they are easier to create and most of the tokens we see today are based on the Ethereum blockchain:
- Utility Token – These tokens are not designed as investments, (but we find they are often sold as such). Tokens are designed to be used to transact, exchange, and access products or services, essentially providing a ‘utility’ of some sort. Tokens are not designed to be an investment. It is this feature that allows tokens exemption from regulatory scrutiny under the law.
- Security Token is considered investable assets and therefore they are subject to securities regulations. The SEC (Securities Exchange Commission) uses the Howey Test to verify if a token represents a security (ie. stock or bond) or not. Some believe that if a firm meets all the regulatory requirements, this token has the most potential for widespread use. It is possible for companies to issue tokens that represent ownership in a company or asset, just like stocks.
Coins provide the foundation for tokens. However, tokens have the potential for greater functionality than just being used as a native currency within a defined ecosystem. One can use tokens to represent ownership in a company or real estate, provide voting rights, etc. At the same time, if a use case for a token does not materialize, it will become worthless. The same could happen with a coin.
What’s Next for the Price of Cryptos?
The price of cryptos took off once again during the month of April. Bitcoin cash was the big winner as it was up an astounding 48.4%, which Etherium came in second rising 38.5%. Bitcoins grabbed peoples attention as it rose $930 a coin, but this was just an 11.7% move. Litecoin came in last with just a 4.3% increase.
We listen to podcasts regularly about cryptocurrencies to learn not only what people are thinking about price, but more importantly, how people intend to use it in the years ahead. If we can figure out how cryptos will be used in the future, we should be able to better choose the coins and tokens to focus on for fun and profit.
One thing we noticed in listening to all the self-appointed experts discussing cryptos on websites and youtube is that they are steadfast bullish. Ever time the price fell, they said: “it was time to buy.” When the price fell more, they said: “this was the time to buy.” When the price fell, even more, it was due to “manipulation” or “tax selling.” Does everyone on the planet have file income tax form in April? Once the price of cryptos found a bottom earlier this month, they said now is a good time to buy because the bottom is in and prices are rising.
But the rally does not seem to be lasting. Prices have fallen sharply, in the last week giving back about 25% of the gains. From a market sentiment point of view, the conditions for a lasting bottom are not in place. There are 2 memes that are common right now. The first is FOMO (Fear Of Missing Out). These folks own cryptos because they do not want to be left behind. This is leading to something called HODL (Hold On For Dear LIfe). This is an emotion of desperation. These folks believe that the price of cryptos will eventually be much higher, so they buy and hold no matter what. They are willing to suffer brutal losses in the near term to make big gains in the long term.
We have seen this before. This is what people were doing during the dotcom and NASDAQ tech stock crash. Most internet stocks went out of business and the Tech Stock Averages line the NASDAQ fell over 80%. This emotional condition suggests to us that the bottom is not in. We think the ultimate bottom will come when we read about systemic fraud and many of the coin issuers going out of business. This will shake out the bad actors. At the same time, those who bought Bitcoin at prices over $10,000 will be emotionally worn out and many will sell. Confusion or treats of regulation or outright outlawing cryptos may be the catalyst. We do not know, but there will be fear in the minds of people who got in too late. At the same time, those who keep a cool head may discover greater clarity on how cryptos can/should be used. This will set the stage where cryptos will have a real impact on the economy. Cryptos will thus be transformed from a speculative instrument to a real asset with real uses. This is what we are waiting for before we commit to buying.
We could be wrong of course. We remind ourselves that price can do whatever it wants. Cryptos are part of a brand new world. Events in countries that have traditionally had currency problems, access to banking problems such as in Latin America, Eastern Europe, Africa or South East Asia that might cause a quick change in the landscape.
Image Source | David McBee, Pexels.com
