42…

dont-panic

The title of this blog is, of course, the answer to the “Ultimate question of the life, the universe, and everything” from the classic work, The Hitchhikers guide to the Galaxy by Douglas Adams.

 

Contrary to the hysterical questions on Crypto-Twitter and Crypto message boards, the ultimate question is NOT whether this is “The End” of crypto or when the bottom will be formed.  (editors note – those questions are still more relevant than “wen moon” or “wen lambo” questions we all saw earlier in the year)

 

Premature “victory laps” from ignorant financial traditionalists and panic from crypto opportunists aside, the price action lately in Bitcoin has been significant, but not surprising.   Realization of the true value of most crypto assets is still far in the future, yet prices ramped explosively a year ago, as the unsatisfied demand of retail investors for early stage technology investments drove them upwards.

 

Like many early stage investments, Bitcoin, Ethereum, and other digital, cryptographic assets are essentially long dated options which pay off if the technology pans out.   More traditional technology investments, such as those made by venture capital or private equity firms, however, trade infrequently, without participation by the public, which suppresses price volatility and the impact of emotional swings.  Crypto assets, on the other hand, trade 24 hours, 7 days a week on a variety of disconnected global markets dominated by individual traders.    The result has been large price moves across hundreds of crypto assets, ridiculous hype (and now bust) stories, as well as the participation of opportunists and scammers.

 

That said, I still believe that crypto-assets hold enormous promise to transform the future of money, transaction processing, and securitization of assets on a global scale.  While none of these technologies are particularly close to mainstream adoption, their potential is as significant today as it was a few weeks ago.  Thus, while the noise emanating from the markets is near deafening, those of us building critical infrastructure should not be deterred.  Investors, at the same time, should have a thesis for why they are buying or selling crypto assets, and not rely upon statements such as “going to the moon” from crypto evangelists whose main qualifications might be that they bought Bitcoin at $1.50 many years ago.

 

It is, however, worth putting the crypto bubble of 2018 into context.  While, depending on how one measures the magnitude of the upwards move, the crypto bubble seems historic, it was much smaller than the “Dot Com” bubble, which resulted in a loss of value of roughly $2 trillion in the year of the bust.  (Large cap internet companies were worth roughly $2.9 trillion and fell by over $1.75 trillion in the first year of the bust, while there were hundreds of smaller and OTC traded companies which also lost billions of dollars of value.)   In contrast, the total value of the crypto market at the peak was less than $1 trillion, and, in reality, was less than that as prices were artificially inflated by selective reporting.  (see https://www.youtube.com/watch?v=Edidr2JD6yI for a video explanation)  It is also worth noting that even Amazon suffered more than a 90% fall in value from internet bubble peak to its lowest price in the ensuing bust.  It is worth a lot more today, of course…

 

This context is cold comfort to those investors that piled into Bitcoin on the way up, expecting that they would double their money (or more) quickly.  Many had no intention of making a long-term investment and have been panic selling for the last week or two.

 

For those of you wondering why I am so sanguine about a 90% (or thereabouts) fall in the value of crypto assets, it is probably due to my own experience.  I was on a trading desk in the fall of 87 during the crash and lived through LTCM, the internet bubble and subsequent crash, the “quant quake” of 2007, the financial crisis of 2008 and the longest equity bull market in recent history.   While history doesn’t necessarily repeat, it does usually rhyme, and one lesson that I have learned repeatedly is that markets over-shoot rational targets.  This means that, during a bull run, prices go much farther than the “experts” predict and during market falls, they go much lower than people conceive of as “possible.”

 

In the case of crypto, however, this should be much more severe due to its nature as an option.  For many of these assets it might be years before we learn if it reaches a critical mass necessary to justify its continued existence.  In the case of Bitcoin, people who point to its potential as a “store of value” calling it “digital gold”, the jury is still out.  While it is easy to dismiss Bitcoin due to its price volatility as being a poor candidate for such a use, the fact is that its current price action is much less relevant than the financial ecosystem being built that could increase (or decrease) the likelihood of global acceptance.    There is plenty of time for Bitcoin to stabilize in fiat terms, as the infrastructure continues to evolve.  Of course, it is also possible that other crypto assets could emerge from the rubble in the way that Google & Facebook replaced early front runners in the internet space in the aftermath of the dotcom bubble…

 

Before concluding, I do want to point out one “silver lining” in the crash of crypto assets.  I believe that it could well lead to a better foundation when the market emerges from this.  My reasoning derives from our experience in building CoinRoutes and talking with members of both the crypto community and those that were from more traditional financial backgrounds.  We noticed a huge gulf in market understanding between the two groups, where people in crypto having very limited understanding of market structure and price discovery.  While we built CoinRoutes by blending the most important aspects of financial market data and trading offerings with several of the unique aspects of digital cryptographic assets, we had to spend a lot of time explaining why to people in the crypto community.   Market structure was an afterthought to those who saw their investments rocket by 1000% or more and many business models attracted funding despite making little to no logical sense.  Recently, however, we have seen an increase in financial market expertise migrating to crypto firms and that should lead to better markets in the long run.  This is particularly true as nonsensical business models fail, and smart money gravitates to those that are grounded in sound financial principals.

 

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