Is picking tomorrow’s cryptocurrency winners luck or are there tools that can help?
“I’m a great believer in luck. The harder I work, the more I seem to have of it.”
— Thomas Jefferson
Cryptocurrencies have been described as a solution looking for a problem. Out of the thousands of coins and tokens, how do you pick the future market leaders?
Doing your own research without being influenced by respected market commentator opinions is not easy. Most don’t attempt it, preferring instead to follow someone else.
You could just read someone else’s opinion, and that’s what the 95% do. The 95% represents the group of investors, speculators, and traders who are not consistently profitable. The 95%, have no plan, no risk or money management, and no methodology. Their interaction with cryptocurrencies is haphazard at best.
Yes, you’ll always read about someone who’s made a fortune, but was it blind luck, like playing lotto, or did that person take action with intent, factoring in background conditions and other variables, while simultaneously managing their risk?
Unlike Marty McFly, in Back to the Future, you don’t have the benefit of Biff’s Almanac. You don’t know how tomorrow will turn out. Instead of jumping in and out of the latest coin or token being promoted as the next big thing, the 5% build a framework, a point of reference, to operate from. They use it to make watchlists of potential investment candidates, as well as to manage to the most important variable of all. Risk.
Building your own framework takes hard work. And that’s why most market participants don’t do it. They either enter and exit randomly, driven by FOMO, greed, and fear, or, if they do use a framework, it has usually been provided by someone else.
And this is why it’s difficult for beginners because they don’t know what they don’t know. They don’t trust their own opinions.
Imagine walking into a casino. The electronic melody of the machines and the busy carpets are working together providing perfect conditions for gambling. Maximum confusion — combined with excitement. The floor, the same size as a football pitch, is covered in lane after lane of slot machines. If you had to choose a machine to play, how would you choose? How would you build your framework?
You could just sit randomly and start playing. Or, you could attempt to build yourself an edge.
You’re probably thinking that it’s impossible to build an edge with slot machines, but this is an exercise in thinking. If it was possible, what could you do to increase your chances of a win?
One thing you could start with is the number of people playing the machines. You could ask on what days of the week the slot machine floor is busiest? Let’s say you observed it’s Thursday, Friday, and Saturday night. By finding out the reset level of a machine after a payout has been made, you could look for machines on a Sunday that have not paid out their jackpots.
The framework you use is limited only by your imagination and creativity.
Follow the Money
A casino floor covered in slot machines is not a bad metaphor to use if you had to guess which, out of thousands of coins and tokens competing for the big time, will be the household names of tomorrow.
Instead of blindly following the latest guru, you could do the work yourself. You could read the white papers, and figure out the edge one coin or token has over its competitors. This is an approach taken by Warren Buffett who is the most successful speculator and investor ever.
But this takes time. And if, as Buffett said, “You’re not skipping on the way to work,” you probably won’t have the discipline to be consistent using it.
Another practical and straightforward approach is to follow the money. Out of the thousands of potential choices around 95% of the total volume in the cryptocurrency markets flows into the top 20 coins, by market capitalisation.
One observation, at least in the stock market, is that the stocks that lead the overall market out of a downtrend and into a new bull market tend to out-perform the rest of the market during the new bull run.
The Magic Stick series of articles, podcasts, and videos, discussed how history makes picking winners seem obvious.
Travelling back in time to 1972 would you have spotted the skinny kid with the traffic analysis program? Probably not.
Even if Bill and his Traf-O-Data computer had slipped under your radar, you wouldn’t have had the opportunity to invest in his fledgling company until March 1986. But, if you had, a $1,000 investment would now be worth $1.2 million, not including the ten of thousands you’d receive a year in dividends.
Bill is, of course, Bill Gates, and his startup company is Microsoft. Easy to find using history, not so easy in real time. So, like slot machines on a casino floor, are there any tools you could use to narrow down your search?
One efficient way of finding potential leaders is to use a heat map.
The regions are sized not by market cap, or price gain or loss, but by the volume traded over the previous 30 days.
Bitcoin and Ethereum dominate, as does Tether, but because Tether is a stable coin, whose primary role is to reduce the effect of cryptocurrency volatility, removing Tether helps build a more accurate picture of where the money is flowing.
Without Tether, the picture becomes even more apparent. In mid-December 2018, Bitcoin and Litecoin made new bear market lows. In late March 2019, Bitcoin has gone up 30.8% from its December low, but Litecoin is up over 170%.
Using a heat map is an efficient and effective way to see the big picture from a follow the money price-performance point of view, taking seconds to show that Litecoin is the best performer in terms of volume traded and price performance.
Take a look at a chart of Litecoin, and it’s easy to get bullish. But here’s the thing. Charts can deceive.
If you look at a chart, you’ll be drawn to the December 2018 low and start playing the what-if tape in your mind.
Litecoin, in 2019, is the best performing major cryptocurrency with the comment and quote brigade pointing out Litecoin is up 170% — and that sounds like a lot.
But, it’s all about perspective. Charts have to be squashed to fit onto a computer screen. Try it. Using your favourite charting package, view the LTCUSD symbol and play around with the scale. TradingView.com makes this particularly easy.
If you arrange the chart on your screen with the December 2018 low in the lower left corner, the rally looks impressive. It seems like the new bull market has begun. Let’s do something different. If you measure the movement with a ruler, you’ll get a distance in centimetres. On this monitor, the Litecoin rally from the December 2018 low to the March 2019 high is 15 centimetres high. Without changing the scale, if you scroll up to the all-time high measuring the distance as you go, the distance between the all-time high and the December 2018 low is 1 metre 36 centimetres or 4ft 6 inches in old money.
Yes, the 2019 Litecoin rally looks impressive, but to see the recent Litecoin rally and previous decline from the all-time high in its true scale you’d need a computer monitor 4ft 6 inches tall.
At the December 2018 low, Litecoin had lost 94% of its value, but a 94% loss requires a 1,566% gain to breakeven.
It’s possible to make the 94% drop in Litecoin look like nothing at all. All you have to do is use a log scale.
When using charts, your eyes aren’t as keen as you might think. Your eyes can trick you. It’s useful to remember perspective.
So, what is going on with Litecoin and what’s behind its 170% price move?
Satoshi Nakamoto launched Bitcoin in 2009 as open source software. This means Bitcoin source code can be modified by anyone and used to create something else.
In 2011, Charles Lee did just that. Lee hard-forked the Bitcoin core and created Litecoin.
Lee, a computer engineer who once worked for Google, holds a BS and MS in computer science from the Massachusetts Institute of Technology.
Litecoin is technically similar to Bitcoin, but there are some differences.
One of the issues with Bitcoin is scalability, causing much debate inside the crypto community.
As a digital cryptocurrency Bitcoin’s big problem is transaction speed. The size of Bitcoin’s header limits the number of transactions that can fit inside, and this combined with the decision to use 10 minutes for the time needed to solve the puzzle set by the Bitcoin algorithm hamstrings Bitcoin’s scalability.
Bitcoin uses a proof of work algorithm to compensate miners. You have probably read that the miners have to solve a complex problem, but, actually, it’s quite simple.
Bitcoin’s proof of work is just a guessing game that needs to be solved in a set period. The time decided upon is 10 minutes. There’s nothing magical about 10 minutes, it could be any value, but 10 minutes was chosen because it was the best guesstimate on the time it would take for newly mined blocks to reach other nodes on the network. It was the Goldilocks approach. A little more time and chains would be built that would have to be abandoned, wasting precious network resources, because after a solution is found, you don’t want the network wasting resources trying to solve a puzzle that’s has already been solved.
If two Bitcoin nodes find the solution at almost the same time, one will be the winner, and one will lose. As the solution is broadcast out on the Bitcoin network other nodes randomly pick up on the either of the two chains. Eventually, one chain will be dropped and abandoned. As more blocks are added to the network, consensus on which block won is reached by what many people new to cryptocurrency think is too simplistic. The rule is this: The longest chain wins.
Bitcoin is designed to be both disinflationary, because it has a fixed supply of 21 million coins, and also deflationary because the supply of Bitcoin can only go down once the next block is discovered. But as blocks are discovered the Bitcoin algorithm adjusts the difficulty level. The time element of the difficulty is set at 10 minutes, so the computer power needed to determine future blocks has to be corrected.
And this is what caused the great Bitcoin arms race.
Bitcoin miners get paid for verifying Bitcoin transactions. (Think of them as auditors) Once they have checked a block, they are put into a draw to win 12.5 Bitcoin. But verifying a block is the easy part. The hard part, as far as computer power is concerned, is winning the draw.
The Bitcoin algorithm takes the contents of a block and encodes, or hashes it. Think of the block being forced through an encoding machine, that outputs a hash of the same length, in Bitcoin’s case 256 bits. And this is what Bitcoin mining is — the encoding and decoding of a block.
The Bitcoin network sets a target value of the hash and Bitcoin miners run hashing algorithms trying to guess a number that is equal or less than the target hash. The first miner to do this is the winner.
The output of the hashing algorithm is a set 256 bits in length. It’s deterministic, meaning that if miners used precisely the same input data, they’d output the same hash string value, so miners have to change the input data to change the output data guess, and they do this by generating a random number, called a nonce, a number only used once.
If the output is less than or equal to the target hash, the miner wins. And this is the root cause of the enormous energy costs and investment in Bitcoin mining.
Making guesses faster than your rivals means that Bitcoin mining moved away from the home-brew techie wiring up graphics cards to multi-million dollar investments in mining farms.
The more hashing power on the Bitcoin network, the more difficult it becomes to discover the next block. Bitcoin difficulty is adjusted every 2016 blocks. At 10 minutes per block, this means Bitcoin difficulty is adjusted up or down, depending on the hash power, or guess frequency, every fourteen days.
Litecoin, in contrast, uses 2.5 minutes instead of Bitcoin’s 10 minutes to complete the mining puzzle.
This is Proof of Work mining economics 101: Hash rate = heat = energy = running costs.
If the next batch of 2016 blocks is discovered faster than the previous batch, the level of difficulty is adjusted up. This means the hash rate on the Bitcoin network will go up. As the hash rate goes up, more heat is generated, and the energy costs go up. As the energy costs go up, the mining profitability goes down.
So what is Litecoin? What problem is it trying to solve? If you go to Litecoin’s website, the answer is on the home page.
“Litecoin is a peer-to-peer Internet currency that enables instant, near-zero cost payments to anyone in the world. Litecoin is an open source global payment network that is fully decentralised without any central authorities.”
Clear enough. Litecoin is money. Decentralised money. Like Bitcoin, Litecoin is attempting to democratise your cash, shielding it from the hidden tactics used by the world’s governments and central banks.
Is Litecoin scalable? If Litecoin is replacement money, giving you access to very low fee cross border transactions, what is it competing with?
Currently, the average number of daily Bitcoin transactions per day is around 340,000, while the average number of Litecoin transactions is approximately 22,000 per day.
Litecoin’s maximum number of transactions a day, given a maximum limit of 56 transactions per second and 86,400 seconds per day is 4,838,400. While this number sounds impressive, Visa transactions average around 1,700 per second, and with 86,400 seconds in a day, that’s 146,880,000 transactions per day.
This means Litecoin, operating at 100% capacity has only 3.29% of Visa’s transaction bandwidth.
Yes, Litecoin’s price is going up, and the hash rate is going up, as is the difficulty level, while at the same time transaction costs are stable, indicating a healthy network, that’s easily within the Litecoin network performance envelope.
But, why is Litecoin going up?
This is a question, the 95% spend most of their time searching for. Litecoin’s price performance is attracting attention because it is the best performing top-ranked alt-coin.
Headlines tell the 95% what they want to hear, headlines like this: “Litecoin price predicated to keep rising after posting best Q1 ever through bearish market.”
Litecoin uses a different hashing algorithm to Bitcoin. Litecoin uses Scrypt instead of Bitcoin’s SHA-256 algorithm.
ASIC (Application Specific Integrated Circuit), processors are now available for Litecoin as is the ability to connect up to a Litecoin farm. The network capacity for Litecoin is not under stress, and the Litecoin transaction costs are stable.
The reward paid to Litecoin Miners is due to half around August 2019, and this may be one of the factors behind the increased hash power on the Litecoin network, and one of the drivers of Litecoin’s rally.
In financial markets, if you give anyone an inch, they’ll always take a mile. Any edge, no matter how small, will eventually be arbitraged away. Same with proof of work cryptocurrencies like Litecoin. Conditions may be perfect for the few who know what to look for, but as the news gets out, via bragging rights, and more and more people begin to take advantage, then, in proportion to the neophytes signing up, the edge dissolves.
Leaving the majority with either worthless stock or in this case unwanted Litecoin mining equipment.
Coingate, one of the largest cryptocurrency payment gateways has recently enabled Litecoin access to the lightning network. The lightning network is a technology that is attempting to solve Bitcoin’s scalability problem. The lighting network is an off-chain micropayment processor that aggregates and nets out individual transactions and writes the net figure to the blockchain, resulting in a massive reduction in the number of transactions.
Investors might be front running the news of increased Litecoin scalability.
Another reason behind Litecoin’s rally could be a psychological one. It’s well known in financial markets, that investors are drawn to round numbers and low prices.
For example, if a stock is valued at $700, it is almost always ignored by small investors, because of the high price. Growth stocks, companies at the beginning of their “S” curve growth cycle split their shares regularly. If you own 10 shares of a stock whose price is $700 and the stock splits 10 for 1, you will own 100 shares of a $70 stock after the split. Same dollar value, but in the eyes of new investors, who don’t understand the actual drivers of stock prices, $70 seems cheap.
It’s the same when a stock reaches a round number, say $100 per share. Prices often struggle up to the round number, but once broken, accelerate away.
These on psychological tendencies — not certainties.
Litecoin is often referred to as silver to Bitcoin’s gold. Investors are often drawn to price and not value in the cryptocurrency markets too. That’s not to say Litecoin has no value. The point is Litecoin is much cheaper per coin than Bitcoin, so it is psychologically easier to purchase Litecoin than Bitcoin.
This is why you’ll always read of someone who has made millions buying this or that. Let’s say you picked a coin trading for five cents. Because of the price, you decided to buy 20,000 coins for $1,000. In your mind, the risk is not life-changing, but the rewards, if you got lucky, most definitely would be.
Imagine, a few years later that the five-cent coin was purchased by a mega-company for the patents associated with the currency.
Then, over the next three years, the market reprices your five cent investment and one day, just like that, your five cent coin is selling for $100 per coin, and your $1,000 investment is now worth $2,000,000.
There will always be stories like that. It happened with Bitcoin, and it will happen again. This is what drives the masses into the market — and paradoxically signals the beginning of the end.
The Truth of the Tape
Litecoin is up 170%. Is the bear market over? That’s a 95% question. A better question, and the one the 5% ask is this: What is the risk of entering into the market at this price?
There are many ways to assess risk. In the short term, one method is to use supply and demand, another is to use option prices to calculate abnormal price action. But there are many others.
Longer term, a strategy might entail looking at business cycles or using trilemmas to help ascertain long term background conditions.
Litecoin is the top performing top-ranked alt-coin in 2019. While the comment and quote brigade are praising the 170% rally, the 5% step back and take notice of the 94% decline — a decline what will require a 1,566% move to get back to the all-time high.
So far, Litecoin has regained 11% of that drop. While the majority spend their time on social media following the hype, the 5% build frameworks, both long and short term. For them, it’s not about a bull or bear market but probability, likelihood, and managing risk.