For cryptocurrencies to replace cash does anything have to change?
“If you build it, they will come.”
— Field of Dreams
Click. Your best serious face and a clutching your passport, this is how most people start their cryptocurrency journey.
Setting up a cryptocurrency exchange account for buying and selling alt-coins is much more complicated than opening an account with a stock or forex broker — especially if you’re new.
The new cryptocurrency investor and speculator will need to set up accounts on multiple exchanges, and depending on where you live, you’ll be subjected to know your customer (KYC) requirements and anti-money laundering (AML) checks.
If you want to buy an alt-coin — say, Cardano, you’ll quickly find that, more often than not, the alt-coin you want isn’t available. Generally, the exchanges where you can deposit your fiat currency are not the exchanges where you can trade. Fiat currency deposit exchanges have few, if any, fancy tools and flashing lights. Just a plain vanilla selection of Bitcoin and a handful of the top alt-coins, and the usual account management information.
Not only do new users need to get their heads around setting up multiple exchanges, at least one for depositing fiat currency and at least one for trading, they also have to understand how to keep their investments safe. And it’s around now that they realise they are going to need a wallet. Hardware, software, paper, or cold storage on the exchange…and it’s then that the real fun begins.
How do you use the tools? What’s a maker, a taker? What are order types? What’s buying on limit? Public keys, private keys, fees… The list goes on and on… And on.
Innovator and early majority types might be rolling their eyes, thinking that investing in cryptocurrencies is easy, but if you take the time to ask, next time your socialising with friends, you’ll find that cryptocurrencies, for the majority of people, seems confusing and complicated.
As cryptocurrencies and blockchain technologies travel along the hype curve, between the initial trigger and mass adoption, the 5%, the group of consistent investors and speculators, ask if cryptocurrencies are going to be used as replacement cash by the masses, does anything have to change?
In late 2018, the cryptocurrency markets are still predominately male. How male? The answer is 91.22%.
In Smart Dust, we talked about the Gartner curve. A system that tracks the journey technological innovations take from a stage one initial trigger to a stage five plateau; where, if reached, the technology will be established and used by almost everyone.
The lack of female engagement in 2017, signalled Bitcoin and cryptocurrencies as a niche product.
It’s one of many clues that signalled the cryptocurrency markets, being driven to parabolic highs in late 2017, were most likely entering stage two of the Gartner hype curve — the peak of inflated expectations.
Nearly a year after the all-time high, only 8.78% of cryptocurrency investors and speculators are female. And that’s a problem.
If Bitcoin and the cryptocurrency markets did peak out at stage two of the Gartner curve in late 2017, then the entire crypto universe is sliding down into the trough of disillusionment as 2018 comes to a close.
New technology, like Bitcoin, is typically driven by the enthusiast. Think of Bitcoin’s early years with geeks in basements stringing together graphics cards, and you’ll get the picture. These technical innovators drive the new idea to a trigger point, and it’s here the early adopters start entering the market.
Bitcoin has had four price bubbles. The third ended in December 2013. Bitcoin prices dropped 86.89% during 2014, but in January 2015, cryptocurrencies began to go up. And it’s during this time that the early adopters started driving prices higher. The public began to pile in during the summer of 2017, but the ratio of males to females during the huge price run-up was almost entirely one-sided, setting Bitcoin and the rest of the cryptocurrencies up for a descent into the chasm of the Gartner curve.
As the cryptocurrency markets lose billions of dollars of market capitalisation and continue the descent down into the chasm of the trough of disillusionment is this the end of the line for the mass usage of cryptocurrency as a replacement for cash?
You might be thinking this doesn't matter, but for any product to be accepted and used by everyone in society, either directly, or indirectly, the demographics are going to change, and one easily understood (and non-technical) metric will a be balancing of gender engagement.
Over time as leaders in blockchain and cryptocurrencies emerge, the ratio of female to male users will be a significant clue a long-term low is in place and the next stage of the journey, up the slope of enlightenment, to the mass adoption plateau has begun.
We are moving towards a cashless society. When was the last time you used an ATM? In Sweden, it’s estimated that around 20% no longer use cash machines. If you sample the 18 to 24 year age group in Sweden about 19 out of 20 or 95% of them, use either smartphone apps or debit cards for payments. Sweden is one of the leading countries when it comes to phasing out cash, but it’s not alone.
Bank statements are becoming multi-page affairs, instead of one or maybe two pages per month. Buy a coffee — Beep. Lunch — Beep — it adds up. Electronic payments are being made for items costing just a few dollars and pennies.
Instead of withdrawing enough cash for the week ahead, the majority now just hold out their hand. Beep.
And this leads to cryptocurrency’s future role in replacing traditional fiat currency for making payments. The Bitcoin community is split between Bitcoin being a store of value, or an everyday currency. Clearly, as an everyday currency, the transaction speeds of Bitcoin are completely inadequate, but bolt-on technologies have and are being developed to scale Bitcoin into a viable everyday currency.
For cryptocurrencies to be accepted as a convenient way to pay for goods and services, the path needs to be made as confusion-free as using a debit card. Beep.
In times of local financial stress, money flows into the US dollar, but in times of global economic stress, cash flows into the Swiss franc.
It’s all about trust. Switzerland’s reputation for stability and sound fiscal policy means it’s a haven of relative strength when a crisis hits.
Bitcoin launched as an alternative to central bank manipulation, has suffered from a reputation for being unsafe. With the collapse of the Mt. Gox exchange, the public saw how easy it is to lose your investment. Unlike a bank crash, where investors funds, up to a certain amount are covered by insurance schemes, if you store your crypto assets on an exchange, then you’re exposed to exchange failure and being hacked. Not to mention transfer errors.
Then there’s the issue of crime and money laundering. The most publicised story being the rise and fall of the Silk Road website, whose transaction currency of choice was Bitcoin.
To the early users of cryptocurrencies, these issues are obvious and easily avoidable by using secure storage solutions, like Ledger or Trezor, and by controlling the private keys of the account, but to the new entrant into cryptocurrencies, it’s a minefield.
If new users are going to start trusting their funds to cryptocurrencies, trust in the counterparty needs to be improved.
Innovators and early adopters, the experienced old hands of the crypto space, who understand completely how to transfer from fiat currency into crypto and back, have a problem even their aptitude at moving funds around between multiple exchanges and wallets can’t solve. And this problem is volatility.
The cryptocurrency markets are having another bad week. At the time of writing Bitcoin hit $3,500 on BitStamp. From the November high of $6,544, that’s a loss of 47%.
Traditionally most investors only take positions on the long side of a market. They look to buy at $100 to open the transaction and sell at some higher price, say $120, sometime later to close the position.
Financial markets are much more sophisticated. The majority of people are used to the concept of buying something first and selling it later for a profit or a loss.
Few realise with Bitcoin, (and most asset classes) it’s possible to open the transaction by selling something you don’t yet own. This is called going short or shorting.
If you sell (something you don’t own) at $100, and buy it back at $80 to close the position, you’ve made $20 profit.
Financial traders use futures contracts and option contracts to enter into short positions. Options contracts have a limited lifespan, and they are derivative instruments that allow speculators to take leveraged positions. To take leveraged positions to the short side, you buy puts, to the long side you buy calls.
But options, like all markets, have a counter-party. If you buy a put, expecting the market to go down, someone is going to have to sell the put to you.
Logically, if you buy a put expecting a market to go down, then in selling a put to the option buyer you are taking the opposite view that the market is not going to go down.
By taking a long put position, you can gain exposure to downside moves with fixed limited risk. The worst that can happen is your put can expire worthless if you’re wrong about the direction of the move. But options are a depreciating asset. One of the main depreciators of long option prices is time. The advantage of buying a put or a call is your risk is fixed to what you pay for the option, but your timing has to be near perfect because of the time decay as the options ticks towards its expiry, and that's a huge disadvantage.
Conversely, option sellers can be exposed to unlimited or nearly unlimited losses if the seller has not included a protective loss protection strategy. (Selling options without loss protection is called “naked” selling, and can lead to catastrophic losses if you don’t know what you’re doing.)
So why would anyone want to sell an option?
Here’s the TL;DR version.
When using options in directional speculation, called going long, you have to get not only the direction, but the timing right too, because the appreciation of the long option price, either put or call, has to out accelerate the time decay of the long option.
When speculators take a directional long option position, they only make a profit if the price moves in the intended direction, down for long puts and up for long calls, and the move is greater than the time decay of the option.
But in selling an option, the converse is true. Option sellers make profits if the price settles, at expiry, anywhere above what is called the ‘strike’ price.
As an example, if an option seller sells the $100 strike puts to the option buyer, the buyer, to make a profit, needs prices to go down below $100. Not just below $100 — prices have to move through time faster than the option decay rate.
For the seller, all prices have to do is stay above $100. Actually, they can even go down a little too.
Think of a clock face. The option strike price is 3pm. For the option seller, they get paid if the price ends anywhere between midday and 4pm. For the buyer of the put, they get paid only if the option ends between 4pm and 6pm.
In selling an option, you get paid immediately for taking the position, but the payment comes with an obligation to the option buyer. If the seller of a put is wrong and the market goes down, the seller will have to deliver the obligation for a loss.
Why does this matter?
Option prices can be in the money, meaning they have some intrinsic value, or they can be out of the money, and in this case, their price can be made up entirely of time premium.
The cost of the time premium (the non-intrinsic portion of the option) is priced depending on something called implied volatility.
Options were not invented for pure speculation. They were created to smooth out financial returns. Let’s say a company makes wheat-based breakfast cereal. To more accurately forecast future earnings, the company has to figure out what it’s going to pay for its raw materials in this case wheat.
If the price of wheat rises, they won’t make as much profit, so the company uses options to protect against extreme price moves, both up and down.
This way, more accurate and stable forecasts can be given to investors.
As risk enters into a market, one ‘tell’ is the rise in implied volatility. As prices become more unstable, there’s competition to insure positions against losses. As more and more investors scramble to control risk, the cost of risk goes up because of supply and demand.
The 5%, the most consistent and successful speculators and investors, use spikes in implied volatility along with emotion bars, a wide range bar, closing in the top half of the range on very high volume, ideally 300%+ greater than average.
The Vix index is the most well-known indicator of risk. It’s based on the implied volatility of options on the SP500 index.
Bitcoin doesn’t have a Vix index, but it does have options, and the implied volatility of those options has gone from around 50-60% to over 170% in the last few days, indicating a huge level of fear has entered the market.
If an investor in a traditional asset, like stocks, bonds, forex, gold, crude oil futures, or grains like wheat, needs to get out, they sell, and their profit or loss is swept back into US dollars.
But what happens to cryptocurrency investors? What happens to someone who’s made a profit trading an alt-coin but who now needs to protect those profits?
If you’re on a cryptocurrency trading exchange and want to protect your profits, or even if you’ve made losses and just want to get out, where can you put your funds to protect them?
Bitcoin is losing billions of dollars of its market cap, and so is Ethereum, so if you sweep your profits into either of these, then your profit will be at greater risk.
Swap two letters in historical and you arrive at hysterical.
Hedge funds and investment banks use a metric called VaR (Value at Risk) to assess the level of risk in a portfolio, and one component of the VaR metric is historical volatility.
Historical volatility uses standard deviation as a dispersion measure. A rise in volatility is direct market feedback that the level of risk in the asset in question is about to rise. Why? Because the likelihood of the asset fluctuating more in the future has increased.
This is the historical 30-day daily volatility of the Euro/USD exchange rate. It’s measured using the standard deviation of daily returns. Do you notice anything unusual about this chart?
If you thought the peaks and troughs seem to be moving in some kind of cyclical rhythm, you’d be correct.
The Euro/USD has an average 30-day volatility cycle of 105 calendar days (around 75 trading days)and if this behaviour is still active in the market, then the Euro/USD volatility cycle bottomed around the 8th of November.
If this cycle is still active, the daily fluctuations of the Euro/USD should increase over the near term and this increases risk.
This is Bitcoin’s historical volatility. Notice the cyclicality of the peaks and troughs. Bitcoin has a 30-day volatility cycle of 78 calendar days. If the cycle is still active, it bottomed on the 10th of November 2018.
Academic studies have shown strong evidence of volatility cycles in financial markets. Of course, hedge funds and investment banks are fully aware of this phenomena, and they deploy different positioning tactics to maximise current market conditions — and so do the 5%.
The majority, the 95%, think the only way to view a market is from the ‘long’ side. They think profits are made buying low and selling high, they think you have to buy first and sell at a higher price later to make profits. Nothing is further from the truth.
Market professionals use tactics depending on the levels of volatility, the persistence of trend, and the levels of fear.
The 95% only think of trading for directional profit. The 5% observe specific market feedback and use different tactics depending on market conditions.
Financial markets, including cryptocurrencies, have a 4th dimension, a layer unknown to the 95%. That layer is volatility, and it is important direct market feedback for market professionals. It is a signal of future increased risk, and a signal to change trading tactics because volatility in an asset can be bought and sold too.
This week the cryptocurrency markets have had a bad week, if you're long, losing billions in market cap, but for anyone who is short directionally, the opposite is true.
You’ve seen the levels of volatility in the Euro/USD exchange rate and Bitcoin.
Take a look at them together on the same scale.
The green line is the Euro/USD, and the red line is Bitcoin. On the same scale, the Euro/USD looks almost like a straight line with a few little ripples.
Once you see Bitcoin’s volatility compared to other assets, you’ll realise why Bitcoin’s volatility could easily be renamed from historical to hysterical.
The higher the volatility, the higher the risk. And risk, if the masses are going to adopt cryptocurrencies as a replacement for cash is going to have to go down.
By What Measure
So far, we’ve been discussing some of the issues facing cryptocurrencies before it’s accepted by the masses as an alternative form of cash.
One market ‘tell,’ that highlights cryptocurrencies as a niche product is the polarity between males and females, and the balancing of this market metric in the future could be used as a factor to determine the likelihood of long-term rallies in cryptocurrencies continuing.
Another is the confusion and perceived complexity of setting up and using cryptocurrency in place of traditional cash.
Of course, not everyone wants to trade or invest. Wallets in the form of mobile apps for iOS and Android are most likely going to be the vehicle to onboard the masses.
As the retail sector undergoes a massive change and mobile devices become the new malls, one logical step is retail groups offering mall coins, incentivising shoppers with discounts for using cryptocurrencies, or bonuses for inviting friends.
But the process needs to be convenient, quick and simple. Converting fiat currency into Bitcoin and then converting Bitcoin into the payment crypto coin, isn’t going to do it. The process needs to be, install the app, enter the debit card, transfer fiat to a crypto coin. Done.
Anything else is a hurdle.
Early Adopters who are technically proficient might think this isn’t important, but there’s always a weak spot.
Technically adapt cryptocurrency users might scoff at the confusion and overwhelm of the new cryptocurrency user, but think about how many technically minded tech people have even the slightest understanding of the financial markets?
We’ve discussed cryptocurrency volatility, meat and bread for experienced financial market participants, but probably not so for your average computer technician.
You take a position and make a profit or a loss, but how do you measure your performance? In terms of what?
Throughout history, gold has been used as both a store of value and currency of exchange. Today, society has placed its trust in centralised authorities. We measure our wealth, or net worth, in dollars, euro, pounds, yen, or other local fiat currency.
Today investors and speculators don’t measure their net worth in Satoshi’s or Ether, ADA, or Stellar, the biggest change will come when this is no longer true, but for now, net worth is measured in fiat currency.
Port in a Storm
Let’s say you’ve completed a successful trade. If you can’t transfer your remaining funds into a fiat currency, because fiat currencies are not available on the exchange, the solution is to use a stable coin.
And the exchange stable coin of choice is Tether.
Tether is a stable coin pegged to the US dollar. Tether claims that for every Tether they create, they will do so only when they have a dollar in the bank. The current outstanding supply of Tether, according to CoinMarketCap.com is 1,856,421,736. This means that there should be a bank account somewhere with $1.856 billion in it.
So far no audit has proved this is the case.
Tether is a cryptocurrency pegged to the US dollar. In theory, one Tether will always be worth one USD, but this is not always the case.
Bitfinex is the only exchange where you can buy and sell US dollars in exchange for Tether. Other exchanges, such as Bittrex, Poloniex, and Binance allow Tether tokens to be transferred to them.
As supply and demand for Tether increases and decreases on exchanges like Binance, the price of Tether fluctuates in response. Owners of Tether, on the Binance exchange, trust Bitfinex will receive the Tether being sent back to them and allow account holders to sell their Tether holdings at a parity rate to the US dollar.
If you think this means Bitfinex is acting as a single point of failure for Tether because it’s acting as a gateway, then you’d be correct.
So, trust in Tether is maintained because a single exchange promises to convert Tether back to US dollars at a one to one rate.
The fact that Tether fluctuates as little as it does on other exchanges is not just based on trust. It’s based on arbitrage.
If you can buy Tether on say Bittrex for 98 cents, you can transfer the Tether to Bitfinex and sell it for 100 cents, or one dollar.
Ask yourself, if you had profited from successful speculation in cryptocurrencies, would you be comfortable moving your account balance into Tether? The majority of exchange users don’t realise how Tether works or the bottlenecks and single point of failures in the system.
Another potential danger in trusting Tether was exposed in the Paradise papers. On the 5th November 2017, 13.4 million confidential documents on offshore investment activities were released to the public by a consortium of international investigative journalists.
It turns out that Tether and Bitfinex share the same management team.
Think about how many cryptocurrency users, thinking they are using a decentralised system, are instead, when they’re using Tether, exposed to a single point of failure.
An easy to use point and click system, with the ability to sweep cryptocurrencies into a verified and trusted stable coin, based not just not the US dollar, but other individual currencies like the Euro or Australian dollar will be a boon for alt-coins, providing a trusted port in a storm, holding the hands of new users as they begin their journey into using cryptocurrencies.