Select Observations on the State of Crypto Markets

Two important things happened in crypto-land over the past few weeks. The first, which you probably heard about, was yet-another-crash in prices to new cycle lows. The second, which I consider more important, was that while market caps fell apart, the trading infrastructure did not.

It wasn’t that long ago when every major market move resulted in exchanges crashing and wallet services slowing to a crawl. The problem was so pronounced that it made most traditional trading strategies useless, because you couldn’t access the market when you needed to. Anytime a friend asked me if the latest selloff was a good time to get in, I would joke that they shouldn’t buy “until you see the white’s of their CloudFlare errors.”

These problems were understandable, because crypto companies have to commit an extraordinary amount of their resources to security. The New York Stock Exchange doesn’t have to worry about someone penetrating their servers and stealing a bunch of Disney stock, so it can focus on stability and usability. Crypto exchanges on the other hand are the world’s greatest honeypots, so capacity and UI have always taken a backseat.

The lack of major outages during the recent decline shows capacity has caught up with demand and liquidity has improved. We’ve come a long way from traumatic events like this one, and that’s an important accomplishment.

Most people only care about the price of crypto assets, but the reliability of the infrastructure is arguably more important. A good market isn’t one that only ever goes up, it’s one that clears smoothly in both directions. My overarching theory that decentralized platforms will eventually overtake their corporate counterparts requires reliable markets to pan out.

As for the question of why prices have fallen so dramatically in 2018, the simplest answer is “because they went up too much in 2017.” I’m generally skeptical of after-the-fact market explanations, but since it’s fun to speculate, I’d like to consider two possible explanations for why the selloff has accelerated of late.

The first is yet-another-rejection of a Bitcoin ETF by the SEC. To gauge the importance of this news, it helps to quantify the potential demand for such a product. For that we can look at the only other dollar-denominated “equity-like”product that Americans can buy, the Grayscale Bitcoin Investment Trust (GBTC).

This product doesn’t trade on any major exchange, and has not passed nearly as much regulatory scrutiny as more popular investment trusts like the one for gold, so a lot of brokers won’t let individuals buy it and most institutions are not legally allowed to own it. Despite those constraints, GBTC manages to trade at a 40% premium to the Bitcoins it claims to own.

This kind of disparity between the price of the shares of a trust and the value of the asset it owns usually implies that demand for the underlying asset is so strong that investors are willing to overpay to own it. That conclusion is further validated by the fact that back in December, when the price of Bitcoin was really soaring, the premium was over 100%. That it remains as high as 40% despite the current crypto winter tells us that there is still a significant amount of money wanting to find its way into crypto that can’t. A fully regulated ETF would help alleviate that problem.

The second possible reason why crypto has been falling has to do with the biggest crypto traders on the planet. And no, I’m not talking about whales, miners or assorted Bigfoot-cum-Tether-toting boogiemen. I’m talking about project developers.

All of the ICOs that raised billions of dollars last year got paid in Ether, a currency that they could not use to rent office space or pay their staff. This put the leaders of such projects, most of whom probably had little market experience, in the awkward position of having to figure out when to sell, and how much.

The responsible approach, given their cash requirements and the volatility of crypto assets, would have been to sell some of their ETH immediately and to keep selling as ETH went parabolic. But Ether was the best performing asset on the planet in 2017, and nobody wants to sell something that seemingly only goes up.

Until it starts going down. There is a theory floating around that the current bear market is at least partially caused by ICOs panic-selling into the decline. It’s substantiated by the fact that ETH has fallen more than most other coins, and some anecdotal data. I would add a third piece of evidence: human nature. The great bull run of 2017 even fooled experienced traders. We can hardly blame project developers from falling into the same trap.

The volatility of this space continues to be perpetuated by the fact that there are still no widely agreed-upon valuation metrics, no P/E ratios or Net Present Values to help investors make decisions. The only piece of information anyone has is price, and price is a self-perpetuating metric. It makes people want to buy when something is going up and sell when it’s going down.

Investors and project leaders would be well served to remember that the next time the market shoots for the moon.

My book, the Story of the Blockchain: A Beginner’s Guide to the Technology That Nobody Understands, is available on Amazon



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