Legendary futures trader Ed Seykota used to tell me the three most important rules of investing:
1. Risk management
2. Risk management
3. Risk management
Certainly in the metaverse, one must utilise sound risk taking principles in all pursuits, especially when it comes to investing.
In the world of cryptocurrencies, volatility is nearly off the charts. The only thing that could compare is the futures markets since a huge amount of leverage can be employed.
Long-time traders such as Seykota typically only risk a maximum of two per cent of their whole portfolio on any one position. With CME futures, one can get locked into a position especially should a ‘black swan’ type event occur.
During the Asian Contagion market crash in 1997, it wiped out the nine-figure fund run by market wizard Victor Niederhoffer as his position went locked-limit down for days, so he could not exit.
Fortunately, in the world of cryptocurrency futures, exchanges have insurance policies so you can only lose what you bet. Still, according to the largest centralised exchange, Binance where there are more than 25 million futures traders, more than 80 per cent of futures traders leverage above 20x. When Bitcoin has even a minor 15-25 per cent correction, liquidations spike as most traders are overleveraged thus get taken down.
Bitcoin has already had 3 such corrections this year.
What causes the minor corrections in Bitcoin in a bull market? Numerous factors abound but for this piece, I will focus on market risk.
Major market risks including but not limited to the following:
1) Strong dollar. Since 2013, a strong dollar has put pressure on Bitcoin and cryptocurrencies as investors are more likely to buy the dollar thus reducing buying pressure on cryptocurrencies. Major price bottoms in Bitcoin came shortly after a big spike in the strength of the US dollar.
2) Rising bond yields make bonds more attractive to investors which can negatively affect the price of stocks and cryptocurrencies.
3) Persistent COVID-19 lockdowns. The multiple order effects have deeply affected rates of employment, economic growth, bankruptcies, and loss of lives and livelihoods.
Massive stimulus programs around the world have been launched. The question remains whether the current round of vaccines will be sufficient to lift the lockdowns in areas still locked down. Further, there may be additional new strains of COVID that could create further lockdowns. Ultimately, more stimulus is good for Bitcoin and bad for fiat.
The meteoric rise in price in Bitcoin since it was created in 2009 is in answer to the debasement of fiat which began with quantitative easing in late 2008 in answer to the financial collapse of 2008. Bitcoin was created in answer to this as well. QE has since accelerated as a deterrent to COVID-19.
4) Inflation from too much stimulus could arise once lockdown restrictions start to lift by and large. An effective vaccine that creates herd immunity would help boost consumer confidence. The Federal Reserve and other central banks around the world could be caught on their back foot if history is any guide.
In 1920s Germany, Germans hoarded cash causing a depression. But once the economy improved, Germans started to spend. This spending resulting in the hyperinflation of the 1920s that is well chronicled in history books. Something similar could occur in the world of today. While this is ultimately bullish for Bitcoin, it could easily create a brief, FUD-induced correction in Bitcoin as the Federal Reserve would have to appear hawkish thus threaten to take away the QE punchbowl once again, despite knowing this would cause a crash in markets.
5) Profit-taking risk. Sometimes without warning during Bitcoin bull markets, we can have sharp, short corrections, of as much as roughly 1/3 off peak. What starts as a smaller correction is often made worse due to exchanges unable to handle the order flow. Nevertheless, such a correction typically takes several days or less before Bitcoin finds a floor and heads higher once again.
Should any of the above occur, it could have a domino effect on the other pieces. A black swan event can also crash almost all investment instruments. For example, in late 2008 during the financial collapse, most everything crashed from stocks to bonds to precious metals to real estate. Nothing was safe except for cash. Bitcoin did not exist at that time.
In March 2020, most everything crashed once again including Bitcoin, though most everything staged meaningful bounces due to record levels of stimulus in consequence of the COVID-19 pandemic.
Other risks to be discussed in future pieces include regulatory risk, security/counterparty risk, protocol risk, and liquidity risk. That said, market risk tends to cause many of the minor corrections in bitcoin.
Remember that profits beget profits. The power of compounding can work brilliantly especially when returns can easily exceed triple digit percentages during bull markets. The key is to then move to cash or go short when the bear market begins.
The sad reality is that most failed to hold onto their steep gains in 2017. By the end of 2018, most had not just given it all back but went bankrupt. The same rinse-and-repeat cycle has been part of every bubble that ever blew apart including the dot-com bubble of the early 2000s.
My metrics remain ever-vigilant in keeping a close eye on potential major market tops in cryptocurrencies. So far, they have managed to bring me to the safety of cash in every major bear market within weeks or less of the absolute peak. But change is the only constant when it comes to markets so daily vigilance is key. There is no such thing as a black box.
Dr. Chris Kacher, nuclear physicist PhD turned stock+crypto trading wizard / bestselling author / blockchain fintech specialist / top 40 charted musician. Co-founder of Virtue of Selfish Investing and Hanse Digital Access.
Dr. Kacher bought his first bitcoin just over $10 in January-2013. His metrics have called every major top & bottom in bitcoin since 2011. He was up in 2018 vs the median performing crypto hedge fund at -46% (PwC) and is up quadruple digit percentages since 2019 as capital is force fed into the top performing alt coins while weaker ones are sold.