Navigating through crypto hype-waves
Universal thoughts on cryptocurrency investing
In this post I share a few fundamental learnings, conservative projections and nontechnical investment guidelines. They may stimulate experienced investors to reflect on their decisions and protect new-comers from forming bad investment habits within the cryptocurrency space.
Hype hits larger communities
Cryptocurrencies are likely to become the hottest topic of the year. The crypto hype reached new heights as it ploughs through larger less-technical communities. At astonishing pace, cryptocurrencies became a frequent talking point within previously untouched business communities, academic networks and even friends and family circles. For the time being it may even surpass AI as the ultra-hype topic of today (see figure 1). As the hype slowly moves from blockchain developers through technical affluent and educated communities towards the broader public, the individual depth of understanding is likely to diminish over time. In the absence of regulations, it is the responsibility of blockchain communities to simplify understanding, protect new-comers from bad investments and to let as many as possible benefit from the value creation that is imminent in the expansion of blockchain solutions.
The current wave was propelled by mind-blowing returns and crypto-millionaire headlines, which triggered considerable interest beyond the previously more exclusive technical blockchain communities. As a new emerging asset class, cryptocurrencies challenge industries (perhaps most pressingly Venture Capital), reshape business plans, puzzle long-time investors, and attract a whole new clientele of non-accredited investors who have since been barred from investing through minimum asset requirements. New-comers are pouring vast amounts of hot money into the markets and are alongside sound fundamental progress accountable for an approximately eightfold increase of market capitalization since the beginning of the year (as of September 2017).
Are we in a bubble?
Probably. When will it burst? No one knows, but a correction is likely to happen in yet unpredictable form.
Perhaps the largest risk being that regulators crack down hard on the core of cryptocurrencies, casting severe shadows over the optimistic decentralized future scenario (read Token Economy’s post on recent regulations for more). Similarly, a large coin may tumble due to internal issues and spark large scale panic that may cause market participants to rethink the value of their investments. Or, a series of negative events may seemingly coincidently occur at the same time and in combination set-off chain reactions (also read interesting comparison of dot-com bubble and cryptocurrency bull markets).
At the very least, with prevailing fundamental uncertainty we will likely continue to observe heavy drawdowns even among the largest coins. Coming up with an educated and satisfying prediction of the timing, intensity and shape of a ‘correction’ event, seems factually impossible. Clearly though, the existence of such a scenario can hardly be neglected, such that every investor should assign his own educated probability estimate and adjust any crypto investment decision accordingly.
Remember the basics
In wild times like these it is easy to get carried away and take more risk than one would usually do. I have met many new-comer crypto investors, who managed carefully researched low-risk stock portfolios but suddenly made quick moves on high-risk crypto assets, which now dominate their portfolio. Even more conflicting, I met others who have kept their wealth in cash and gold as they deemed even equities too risky and time consuming, but have now acted quick on crypto assets. In terms of portfolio risk management, the hype around cryptocurrencies appears to be testing the rational mind of many. However, more risk is not necessarily alerting, if it is the product of careful research and deliberate assessment that leads to a change of strategy. Whether still undervalued or not, crypto assets come with fundamental risks that are very different and arguably more technically complex than traditional commodities or fiat currencies.
Many people recognize their lack of understanding and therefore proactively decide to stay away. A quite reasonable decision, since it takes substantial time investment and an intrinsically interested mind to understand and navigate through the multitude of blockchain projects. Perhaps more concerning are those, who have been fully swallowed by the crypto hype but do not invest in necessary research and therefore may tend to slide into irrational behavior and imprudent risk taking that is more similar to gambling than anything else. As the crypto hype wave is expected to capture one community after the other, gradually moving from educated to uneducated, the pool of these gamblers is likely to increase over time (unless regulated).
Fundamental projections
Cryptocurrencies are one of the most risky and volatile assets around. To navigate through this turbulent market, it makes sense to search for few steady aspects from which any investment can depart. There are two fundamental projections for which I would assign high probability.
1. In 5 years from now cryptocurrency market capitalization will be higher than it is today.
Firstly, it is very important to distinguish between cryptocurrencies and the blockchain technology that lies underneath. There is large agreement that the blockchain itself is here to stay. It remains unclear however, how the ecosystem will fall into shape and especially which decentralized applications (dApps) will come out on top. Considering the rapidly increasing attention by developers, the space seems well-set for continuous exponential innovation as we have seen for other disruptive technologies. Assuming this improvement of the blockchain technology and its applications, the fundamental value of cryptocurrencies is likely to rise with it over time. At the same time, the ecosystem is likely to slowly mature and develop more best-practices for setting-up and investing in ICOs. Unless further regulated, a lot of junk will emerge, however a few value-creating projects are likely to tear down status-quo obstacles and soften the path for following decentralized solutions bit by bit. Given the aggregate expected progress, the projection should even tolerate most future regulation scenarios.
Secondly, as cryptocurrencies gain popularity among the public on its way to general adoption, more people will be convinced by the fundamental value that can be unlocked by the blockchain. More capital that enters the market stands to put additional upwards pressure on prices. The 50–100 cryptofunds that are currently in the making are likely to accelerate the process as the funds provide a steppingstone for off-topic HNWI and pioneering institutional investors.
Without doubt the next years will be a roller-coaster ride, however it is probable that market capitalization will be higher in 5 years than it is today, unrelated of whether we are currently in a bubble or not (great article by Christopher Burniske on a crypto J-curve).
2. Cryptocurrency markets will remain highly volatile for the next 5 years.
Firstly, the crypto hype encourages increasingly less technical affluent/investment experienced people as it captures the masses. Active cryptocurrency trading requires both to make informed investment decisions. Accordingly, unless regulated, the share of uninformed traders is likely to grow. This could contribute to even more pump and dump schemes, buying high/selling low behavior, as well as questionable scam coins surfacing among the top 30 coins.
Secondly, cryptocurrencies are not yet used as currencies per se, which you would use to pay your mortgage, college tuitions or everyday retail transactions. And quite logically so, since it is counterintuitive to use it, when the asset may increase in value by 50% within the next 24 hours. Instead, most investors trade crypto assets as they would traditional high volatility commodities, such as natural gas, nickel or crude oil. They hold and trade with the mere purpose to make a return. When speculators dominate the markets, cryptocurrencies will remain volatile and as long as the currencies remain this volatile, they are unfit for the use of most everyday ‘currency’ applications. Obviously, increasing exchange security, trading volume and most of all regulatory infrastructure is likely to diminish volatility over time. In the meantime, promising blockchain projects, such as BaseCoin, are already taking aim to become a low volatility cryptographic store of value alternative.
Conditional investment approaches
Under the assumption of our growing market cap prediction, a rational investor who can afford to carve-out and lock-in a small risk-adjusted portion of his/her wealth for the next 5 years may be well-advised to invest. This could be 1% or 50% of total assets, depending on the actual 5-year return estimate, risk aversion preferences and opportunity investment costs.
The baseline may be to invest in a rather distributed portfolio among the currently largest coins or singular investments in the more ‘established’ coins that hold an evidently leading position for the time being, such as Bitcoin and Ethereum. Readiness for an increasingly specified value investing approach should be a function of how much the person understands. Buffett’s famous quote remains a pillar of truth, especially during times of hype.
Never invest in a business you don’t understand — Warren Buffett
Depending on the individual willingness to spend time on the space, we can distinguish between three investment approaches.
1. Low Effort
If you do not want to properly spend time on the space, there is no reason why you should trust your own judgement on any investment decision. Instead you may let other people, who take full effort, make the decisions for you. With a new, risky and complicated asset like cryptocurrencies this is more important than ever. Unless you have a fully-committed and trusted investor friend in your network, the best option would be turning to crypto brainhubs. The currently emerging crypto hedgefunds offer their full commitment, to make it easier for everybody to participate in this (more here for a very critical but interesting assessment of cryptofunds). Reportedly some, such as Metastable, managed to massively outperform over time. Arguably most convenient are those funds offering asset-backed token with broad and smart exposure to the market at high liquidity, such as Protos Cryptocurrency Asset Management.
2. Medium Effort
If you would like to manage your own funds and willing to invest some of your time to research and follow the markets, then a simple long/hold would be advisable. Any technical trading strategies that somehow involve playing with the volatility should be avoided. Under the assumption of our first projection, you would want to seek those assets which play a fundamental role in the most likely decentralized future scenario that you can imagine — and HODL.
The timing of purchase might be ‘wrong’, such that shortly after your investment you lose 50% of your portfolio value. Remember to not care. Close the book, continue to read the news on whether fundamental regulations or other macro events may change your estimate of the most likely decentralized future scenario and wait. Remain strong to your strategy, do not sell when markets take another surprising nose-dive, and do not shrug away from rewarding yourself once in a while, by taking some money out during the sunny days.
In case you prefer a little more risk distribution, you may hedge against yourself by trusting a part of your crypto dedicated money to someone else. Managing 50% yourself and 50% by a high effort cryptofund, may at least be worth exploring.
3. High Effort
Analyze each of your investment in maximum depth, read all the news you can get your eyes on, mingle in the crypto communities as much as possible to get maximum in-bound of information and monitor the actual market movements closely. Conduct careful analysis of new coin offerings and screen existing coins to find hidden value gems. This is rapidly equivalent to a full-time job.
Once sufficient knowledge about the individual currencies has been acquired, one may try any out of the book trading strategies that exploit market imperfections, insider knowledge or general volatility, such as arbitrage, news based, momentum or advanced quantitative trading strategies. Philipp Kallerhoff just recently posted about how a traditional trend-following strategy could replicate a call-option payoff on bitcoins.
Previously discussed irrational investor behavior may be another profitable source for a strategy. Vinay Gupta puts it well in his post, when he argues that those who fully understand irrational behavior are benefiting from asymmetric information and therefore could potentially game it.
What works for one may not work for another.
Some suggestions on introductory articles for new-comers: the blockchain, ICOs/Token, its history and the capital market landscape.
Happy to discuss anything cryptocurrency related, feel free to reach out!
