The Labor Day Cybercurrency massacre and the transition to legal asset Tokens


Lots of people I am working with are asking me to comment on the Cybercurrency price crash that occurred over the long weekend. 

So here goes. It is easier to write a post than answer a lot of emails. People know that I give away a lot of free advice on Daily Fintech and so they don’t ask for custom advice for free; I thank you for that. That is why today, Daily Fintech breaks it’s self-imposed rule of only one post per day.

Usual disclaimer: I Am Not A Financial Adviser (IANAFA). Be careful out there folks. 

The people asking me to comment have varying motivations and these motivations lead to many different questions which this post seeks to answer:

  • What caused the crash?
  • Can I make money shorting Bitcoin and Altcoins?
  • What is the next entry point? What should we buy and at what price?
  • Can Wall Street now get back to business as usual and ignore all this disruption?
  • What will trigger the next Crypto Bull Market?
  • How do I trade this stuff?
  • Why does bad stuff like this always happen on weekends?
  • If this is still a game-changer, what are the rules of the next phase of the game?

What caused the crash?

Like any crash there is a proximate cause. In this case it was the move by China to ban ICOs.

That is only the proximate cause. The China move to ban ICOs crashed the market because the market had risen so fast. Markets fluctuate. Bitcoin went up from 1,000 to 5,000 in 2017. Markets don’t go up in a straight line.

The proximate cause does indicate what are good shorting opportunities and what are good fire sale buying opportunities. It also points to the phase transition coming to the Bitcoin Blockchain and Crypto market; more on that at the end.

Can I make money shorting Bitcoin and Altcoins?

I think shorting Bitcoin is a tough game. There are ways to do it. But it is tough. Think about it. The technical analysts who track this market give about equal weight to the odds of a fall to $3,000 and a rise to $6,000. Even $3,000 is 3x gain for the year. The price could easily go to $10,000. The risk of shorting anything is super high as your losses can massively exceed your gains. That is normal shorting rules. It is even more true in Bitcoin where a) shorting is complex b) the long term trend is up, so you have to be super smart and quick on timing.

There is sophisticated technical trading. Then there is KISS technical trading. If Bitcoin falls below $4,000 the next resistance is at $3,000 and so on. You can watch the real time action here. As I write, traders are working out if $4,000 is the resistance point. 

Shorting Bitcoin has more downside risk than upside IMHO. Taking a one week view:

  • You could ride it down to $3,000. Maybe 50% chance of that.
  • It could go up to $6,000. Maybe 50% chance of that.
  • It could crash to $300. Maybe 1% chance of that. See strong hands vs weak hands analysis for why that is only 1%.
  • It could go up to $10,000.  Maybe 1% chance of that. In a few months the odds of $10,000 are much better but short term risk is more on the down side today.

Figure the odds and place your bets. If it stays above $4,000 this week, the bias will be to the upside again.

The long term trend is up. Any chart will show you that. Unless you believe Bitcoin is worth zero; I will come to that.

The proximate cause of the Labor Day Cybercurrency massacre is China banning ICOs. The Chinese government does two things with this action:

  • it saves dumb money in China getting ripped off by scammy ICOs. With exchange controls, Chinese people have fewer investing options so they are prey to scammers. The Chinese government could eliminate exchange controls or jail scammers; the latter is much easier. Fear of jail time does change promoter behaviour – in any jurisdiction. You can run this simple ICO test. Can you identify the promoters and where they live? If you can, then the cops can also find the promoters and the venture may be legit; it can still be a lousy deal but at least it is an honest lousy deal.
  • it prevents smart money using ICOs as a way to evade exchange controls. That money flow will move to dark web coins and other well-established mechanisms; cybercurrency was only one tool in the capital control evasion toolbox, but it got big enough for the Chinese government to take action.

This helps answer the next question.

What is the next entry point? What should we buy and at what price?

The flight to safety from scammy or weak Altcoins will benefit Bitcoin. Think about it. You own some Altcoins. The price action worries you. But you still believe in crypto. Do you go to USD or BTC? Which has more upside/downside?

That is why I reckon Bitcoin price will recover first. It is weird to think of Bitcoin as a flight-to-quality asset but many do. I do.

The long term trend for Bitcoin is up. Dollar cost average is the best advice for mainstream investors. If you want to trade, assume a long term bias to the upside.

Figuring out a price entry point is hard, like it is for any asset, thus why dollar cost averaging is the usual recommendation.

The reason for a long term bias to the upside is the ratio of strong hands to weak hands holding Bitcoin. Strong hands include:

  1. Early investors who have a very low entry point and who have seen many fluctuations and can afford to simply wait out this fluctuation. If you bought Bitcoin for $100 the difference between $5,000 and $4,000 is not too stressing. They have already cashed into Fiat whatever they need to maintain their lifestyle. They can afford to hold and will do so because they are also:
  2. True believers who think this will change the world for the better. Maybe they work in the Bitcoin economy. Maybe they are are libertarian or just don’t like banks. 1&2 are often the same people.
  3. Savvy Wall Street types who see a market that is massively volatile and getting big enough and who want in on the action. They will go short and long – they are not buy and hold believers. But they have strong nerves and the experience to ride out wild fluctuations to shake out weak hands.

Weak hands are all those who bought on the digital equivalent of a tip from a stranger – a YouTube pump and dump video.

I don’t know the ratio of strong hands to weak hands. If anybody has that data please share. Anecdotally I reckon the strong hands control the lion’s share – and that is a deliberately imprecise term.

If you add the Savvy Wall Street types and the weak hands together, is is 10% or 50% of the Bitcoin out there. If it is 50%, expect a 50% drop. Both will sell into a crash. The Savvy Wall Street types will buy in as soon as it dumps enough. The weak hands will lose confidence until it goes back up a lot – they buy high and sell low.

If you want to short, there is plenty of Altcoin opportunity. Short those scammy “shitcoins” all the way to zero. Don’t mistake a 50% price fall in an Altcoin for a good entry price. If it is worth zero, a fall from $1,000 to $500 does not make it a bargain. Don’t catch a falling knife.

Within the Altcoins there are nuggets of gold covered in layers of mud. They will all crash hard before recovering, because it is hard to differentiate them from Altcoins that are really worth zero. It takes a lot of work to uncover the nuggets and for now nobody cares. There will come a point like the summer of 2002 after the Dot Com crash when great companies are available for screaming bargains. But that takes time and work.

Can Wall Street now get back to business as usual and ignore all this disruption?

No. That would be like saying the Internet is dead after the Dot Com bubble burst.

What will trigger the next Crypto Bull Market?

I don’t know. Proximate causes of meltdowns or meltups are always unpredictable. Scares about Fiat may do it, maybe related to Government shutdown in USA? Or just a few days of price uptrend that makes technical traders jump back in? Or something specific to Bitcoin?

How do I trade this stuff?

With difficulty. Entrepreneurs are figuring out how to make it easier and many professional traders have it figured out, but there are lots of traps for the unwary:

  • Bitcoins can be stolen from exchanges and wallets
  • Huge difference between prices on exchanges. This is an opportunity for risk free arbitrage – for example buy on Poloniex, sell on GDAX. What is the price is a surprisingly hard question to answer.
  • Big fees and spreads – which can kill profits if you trade a lot.
  • No transparency or regulation; it is like Wolf of Wall Street but worse.

Why does bad stuff like this always happen on weekends?

Equities traders are used to enjoying trade-free weekends and evenings. FX traders are used to 24/7 and now so are Bitcoin/Altcoin traders. The difference is that FX markets have great depth and wild swings are rare (with the exception of Francogedon of course).

It is no coincidence that the Chinese Government made their move over a long weekend in America. Maximum damage gets done when trading volume is light. Most people like having a life aka weekends free of work and nobody can work 24/7. So until we get FX like depth and liquidity, expect more volatility than normal at weekends. If you want to be an active trader, figure out how much time you want to dedicate at weekends and evenings. Or work in a trading shop with a team that passes the book around the world.

If this is still a game-changer, what are the rules of the next phase of the game?

Betting against Bitcoin is like betting against the Internet. Betting against scammy Altcoins is like betting against type stocks in 1999. But don’t bet agains the Internet or Bitcoin.

There are long term scaling things that need to be fixed so that Bitcoin can go mainstream. That is happening and is the subject of another post due on Saturday (hint: check out Lightning Network).

So yes, I believe that price movements are noise on the line and that Bitcoin is still a game-changer.

To understand the phase transition that is coming, look at the two regulatory crackdowns – in USA and China.

  • In USA the crackdown is on Securities via SEC. The ICO market hardly blinked. ICO promoters said “it’s a coin/currency not a security”. Just in case, lawyers advised blocking US Internet addresses – as if this actually stops a US resident!
  • In China the crackdown is on coins/currency. The market tanked.

Now ICO promoters are in a bind. They cannot offer either securities or coins/currencies. There will probably now be regulatory crackdown on coins/currencies in the USA as well. This won’t be via the SEC as they do securities not currencies. 

That is why the transition will be to Tokenised assets. We will stop referring to ICOs and talk about ITOs. The Tokens will represent real assets – securities, gold, property, whatever. They will be Beneficial Interest Tokens (BITs) with an asset value. They will be regulated and work as per current rules.

It is only one word difference from Coins to Tokens but it is a phase change. This is like going from the Napster era to the iTunes/Spotify/Pandora era – from free and piratical to legal and cheap/convenient.

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Bernard Lunn is a Fintech deal-maker, author, investor and thought-leader.

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