💥DUMP YOUR CRYPTO💥
Breakdown of crypto within a pre and post-covid historical context.
In this post we will try to break down intellectually the current bull cycle in crypto. For historical context we will analyse the crypto markets pre-covid and post-covid.
For simplicity’s sake we won’t comment much on crypto before 2017. For more simplicity we won’t do a separate analysis on Bitcoin, Ethereum and the general crypto markets but rather alternate between the three.
Most of the world got into crypto during the massive rally that started in 2017, and ended around January 2018. That rally took Ethereum from ~$10 to a peak of $1,400 (140X) within the span of a year. It was a time of innovation and early adopters, it kind of felt like the internet back in the 1990s. It was also a time of rampant speculation, misinformation and raw profiteering.
If 100 people were in crypto, 99 of them were out to make a quick buck with complete disregard for all the rest (“the profit motive”). That of course is the perfect recipe for disaster. And disaster came fast.
From January 2018 to the end of that year, Ethereum went back down to ~$100 (-90%). Let’s call that boom/bust process, Cycle #1.
The first cycle was supported by the invention and mass adoption of the ICO (Initial Coin Offering) as a means to raise financing on the blockchain, as well as the notion (true or false) that cryptocurrencies will one day be recognised and used as money. Let’s call this the “money belief”. But not just that, Bitcoin and cryptocurrencies were touted and seen as something more than just money, they were seen as “internet money”. And that’s better than just money.
News flow was positive as companies started to accept crypto payments or even put some of their cash reserves in crypto. Any news was seen as wildly positive, further propelling the market higher.
Let’s take a pause here and lay out the 3 functions of money, as taught in high school economics:
Medium of Exchange. You can transact in goods and services with money.
Unit of Account. Prices for goods and services are listed in terms of money.
Store of Value. You can save x amount of value in money and expect to get roughly that value back.
The ICO cycle and the money belief were the major cryptofundamentals for the massive rally in Cycle #1. The profit motive was also high as people furiously jumped on the crypto bandwagon, as FOMO and envy set in.
There are of course other ideas that can fall in the cryptofundamentals bucket like the mistakes/flaws of global central banking, the need for a major overhaul of the global monetary system, the centralized control of currency and the inflation it causes etc., but that is too long a subject to discuss for our purposes.
Enter COVID-19
After the bust of Cycle #1, Ethereum was hovering for years between $100 and $350 until March 2020 when Covid struck the financial markets, swiftly crashing 70%, to $90 per ETH.
Crypto hit a hard floor (or should I say trampoline), and has been in a 19 month uptrend since. To be fair, the equity markets have also been rallying since. But let’s take a hard look at what has been driving this crypto uptrend.
The NFT (non-fungible token) existed years ago but is gaining a lot of steam. NFT Explainer on TheVerge.com
The area of Decentralized Finance (DeFi) has gained a lot of traction recently and together with NFT are the two buzz terms buzzing our heads and pushing crypto higher and higher.
I can understand that decentralization is a positive for some use cases, but I can’t see why everything is better if made decentralized. Some things are just made to be centralized. In any case, cryptofundamentalists have the motivation to take everything online and make it decentralized. Internet and Programmable Money is the future for them, and this is a strong trend in the space.
Crypto Cooperatives!
Yield Farming is the name of the game in DeFi, and it’s when holders of crypto “stake” or lock up their crypto in liquidity pools. What is Yield Farming?
That liquidity is used to fuel DeFi applications like decentralized exchanges and stablecoins, generating a return (yield) for the liquidity providers contributing to the pool.
Binance enabled DeFi (yield farming) staking on its exchange in August 2020, and this threw gasoline on the DeFi crypto fire. Total Value (TVL) staked in DeFi projects has exploded in the past 12 months.
There is another very important layer in this crypto uptrend, and that is inflation. Speculators seem to believe that Bitcoin (and crypto in general) is an inflation hedge. What makes Bitcoin a natural inflation hedge I don’t know. But I can tell you that narrative follows price, and not the other way around.
In the same way that analysts revise their price targets upwards when the market is rallying, and revise them down when the market is crashing; the narrative around crypto will change as the market changes direction. Analysts, talking-heads and the narrative around a market moves pro-cyclically with the price of said market.
Inflation Spiked in May 2021 rattling financial markets.
Bubble anyone?
First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it's quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, I refer to them as “far from equilibrium” conditions.
I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, 'As long as the music is playing, you've got to get up and dance. We are still dancing.' Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.
Now I didn’t say this, but Uncle Soros did, and he’s right. Markets do have a way of influencing the fundamentals that they are supposed to passively reflect.
Take NFTs for example. Which artist or owner of possible-to-be digitized property won’t move to an NFT to increase the value of their art/property? When they do move to NFT, together with many others, the NFT space blows up in a positive way. That explosion attracts more ambitious artists, and so on...
example of stupidity: https://www.theverge.com/2021/3/11/22325054/beeple-christies-nft-sale-cost-everydays-69-million
In DeFi for starters, the TVL of dollars locked into DeFi projects (important number that everyone follows as a cryptofundamental) goes up as the general crypto market goes up. Then that number is touted as a positive, attracting even more money in the space.
Gone are the days where crypto was an outsider’s game and you were the early adopter, making a lot of money in the process. Now everyone is in on it, from the average Joe betting his U.S. stimulus checks to major corporates to the Soros family office (Caveat: Soros is famous for betting on bubbles).
It seems that the crypto story keeps changing. At first they told us that real-world payments would move on the Bitcoin network. Then when transactions on the Bitcoin blockchain were too slow and too expensive, they promised us the Lightning Network; heard of it? Then Bitcoin was touted as a “reserve currency”, and that major corporates and central banks would move their reserves on Bitcoin.
The typical calculation a startup uses to prop up their offering goes something like this.
The Total Available Market of the space is $1 trillion, if only 1% becomes our client then we have $10 billion in sales.
And so the International Bitcoin Advisory Corporation (IBAC) states:
There exists approximately $30 trillion of assets under management in the world’s central banks, and an additional $8 trillion in sovereign wealth funds. If not more than 1.5% of assets under management were allocated to digital assets, the total market size for the end-to-end servicing of sovereign wealth investment into digital assets is estimated to be greater than $50 billion.
Note: Newt Gingrich, the former U.S presidential election hopeful has joined the IBAC as an advisor. Article on the FT about Newt Gingrich's foray into Crypto
Now DeFi and NFTs are the new poster boys of crypto-related adoption and apparently some people believe they will take us to the moon.
Know what game you’re playing
You bought crypto in the early days or after the bust, and you’re making quite a bit of money on your investment. You are proud of your financial success and it feels good to get back at all the others that were mocking you when you got into crypto. Now, you are committed. You don’t want to miss the rally, you have FOMO. You are a crypto guy, you will never sell.
However, the chances for a price rally after a crash are much higher than after a rally, naturally. Cryptofundamentals or not, prices move by A LOT. Refer to the Frank Underwood/House of Cards GIF above. Prices have a tendency to move like a rubber band, but now the band has expanded.
Crypto Cycle #1
The boom was followed by a sharp bust. The bust resulted in a retracement on Ethereum of ~95% and it took 26 months for the next bull market to start (Crypto Cycle #2).
The positive sentiment was there, so were the fundamentals. There were projects being built, good projects, just like today. The space had attracted the best of the best developing projects on the best platforms. Venture Capitalists were throwing money to seed projects and times were good.
Demand for a Bitcoin futures contract was growing and so the CME started working on it, finally announcing on the 30th of November, 2017 that it would launch 3 weeks later.
In three months times, both Bitcoin and Ethereum tripled in price until they both peaked in January of 2018. That was the start of the bust of Crypto Cycle #1.
https://www.cnbc.com/2018/05/07/launch-of-bitcoin-futures-dragged-down-prices-fed-paper-shows.html
It seems traders were buying both Bitcoin and Ethereum in an attempt to profit as the two main crypto assets were adopted by Wall Street and became more mainstream. However, that is only first-level thinking. Second-level thinking in this case would ask you, “And who doesn’t know that?”.
Crypto Cycle #2
This is where we are now. Crypto has been rallying for 19 months and took Ethereum from below $100 to $4,100 currently (41X).
As mentioned above, the main drivers of this run are the ascent of DeFi and NFTs, as well as the view that Crypto is an inflation hedge. We won’t delve too deeply into this “inflation hedge” notion but we will say a couple of things.
1) Brandolini’s Law
Brandolini's law, also known as the bullshit asymmetry principle, is an internet adage that emphasizes the difficulty of debunking false, fictitious, or otherwise misleading information.
The amount of energy needed to refute bullshit is an order of magnitude larger than to produce it.
2) This is dangerous
Financial markets are all about themes. They tend to adopt and unadopt these themes and valuations adjust to reflect that.
The belief that an asset is an inflation hedge amidst fears of inflation, will increase the price of said asset. But by how much should it increase? Should it increase proportionately by the rate of inflation?
Are there fundamentals that will guide you as to how much you should pay for that asset to allow it to act as an inflation hedge?
For example, in the case of real estate, the expectation of increased rents in the future due to inflation, ceteris paribus, means you will get more cash out of the asset over time.
This increases the present value of the asset, allowing you to pay more money for it today than you would have if inflation was not that high.
But in the case of crypto, value is very hard to pin down. So what do market participants do? They wing it.
How do you know if ETH is worth $4,000, $14,000 or $500?
Cryptofundamentalists will tell you that it’s about utility and this that and the other. Well it’s not really about “utility” (an elusive concept), because when speculators decide to HODL the asset, the price goes up. And when the price goes up more people want to HODL, and the inverse.
And on top of that, you overlay the theory that crypto is an inflation hedge.
In the case of real estate above, we were able to devise a rough method to value the asset’s inflation hedge-ness. We can’t do the same with crypto.
So what does everyone do? They wing it again. And if they wing it, you should too.
It’s all risk/reward
Crypto Cycle #2 gave ETH a 41X return trough to peak. We know from Crypto Cycle #1 that volatility is huge in crypto and when the cycle turns, it can kill you.
What return are you looking for at these levels? A double? A triple?
It doesn’t make sense to HODL here because the risk/reward sucks. Go to cash and wait for a better opportunity, it doesn’t have to be crypto. It’s up to you.
Today’s Revision
Dump your crypto.
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