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Can you dramatically reduce overwhelm in the cryptocurrency markets?
Until we evolve into something else, one thing will remain the same. The behaviour patterns of the masses. This week as Bitcoin moves higher, the majority look back and ask themselves why they didn't buy, playing the shoulda, woulda, coulda tape in their heads.
Like Damocles flattering King Dionysius, articles, following the direction of price, are bullishly reporting Bitcoin's resurgence.
Dionysius, fed up with Damocles' constant flattery, invited him to a banquet. To show Damocles the real precariousness of his situation, the king had Damocles dine with him while sitting directly under a sword supported only by a horse hair.
While the majority might think they've missed their chance, the 5%, the most consistent speculators and investors, know it's not about calling the trend, it's about entering with a reference point and their keeping losses small compared to their profits.
In the Disruptive Force series of articles, podcasts, and videos, we talked about some of the tools used to gauge the big picture, and, if the bear market in crypto is over, what could drive the market higher, leading to the mass adoption of blockchain technology.
The 95% use a purely technical approach to speculation and investing, relying on articles written by their favourite crypto guru for their analysis. Bitcoin has been leading the crypto market higher over the last month, and as prices move higher so will the expectations of Bitcoin's future.
Most find speculation and investing hard. It's because we are just not wired to be good at it. Almost everything we think we should do will hurt, and almost everything we believe will harm us won't.
This behaviour retells the same old story, over and over again. The majority, get caught up in the hype and excitement and buy, always late to the party, without any long term understanding of the actual risks they are taking, bouncing between exhilaration and despair, checking for tweets, posts, and updates from their trusted guru.
But it does not have to be this way. Learning how to speculate is a skill, like any other, that requires effort to learn. It's alluring to assume that something as easy as technical analysis can turn you into a confident and successful speculator, because the potential rewards if you can master the art of speculation, are enormous.
First, it will give you, arguably, that most desirable of commodities — Freedom. Second, it can also provide, after freedom, great wealth. If you research into how fortunes have been made, most are through investing in ideas, land, and financial markets.
In Disruptive Force, using George Soros as an example, his £1 billion profit speculating on the British pound was made by understanding background conditions — not by a moving average crossover, MACD, or RSI indicator.
While learning how to interpret background conditions is not easy, there are tools you can use to help you gain confidence in your own ideas.
The China Crisis series asked if simple heuristics could be used to answer complex questions, randomly asking how many piano tuners there are in the Chicago metro area and using four questions to accurately guesstimate the answer.
The Thinking in Threes series discussed the simple technique of asking questions about a market and trusting the answers. Of course, knowing the exact conditions is impossible, but by overlapping guesstimations, it is possible to arrive at an answer. Exact? No, but accurate enough.
Overwhelm. Computer programmers and tech nerds have their own unique way of talking. The problem is, for anyone outside of the tech realm, their language and assumptions make trying to understand how the pieces of the puzzle fit together extremely difficult — especially so in our time-starved world.
Listening to an announcer on financial TV this week, it's clear that tech speak is leaking out into mainstream use. Backed with a high beat per minute soundtrack, the presenter talked of getting the latest news from TicToc on Twitter with up to the minute tweets. Imagine going back thirty years and listening to a presenter say that. The audience would assume the presenter was suffering cerebral hypoxia.
Recent scientific studies have shown, you can make reasonably accurate inferences by asking simple questions.
How long did it take you to build your understanding of the cryptocurrency market? Maybe, you're an engineer, or perhaps you're a programmer, but if not you probably spent periods of weeks or months picking up bits of information here and there until the lights came on and everything clicked into place.
Maybe, you just intuitively understand how important cryptocurrencies and blockchains will be in the future, but in the absence of engineering or tech skills, and if you're not a futurist savant, where do you start?
In general, tech people suffer from the curse of knowledge, even sometimes deliberately assuming the necessary prerequisites to understanding their point.
If you've ever tried to understand an explanation of how a specific blockchain actually works and found yourself cross-referencing through dozens of sites to pick up the gist of the explanation you'll know how time-consuming and frustrating it is.
Imagine being given one minute to explain cryptocurrencies to someone you know who suffers from technophobia. Where would you start? Would you try and explain distributed ledgers or smart contracts?
Keeping it simple you could begin by narrowing down the cryptocurrency space to a manageable size. CoinMarketCap.com lists thousands of coins and tokens, but out of this list which cryptocurrencies would you focus on?
One fast and frugal method is to use Weiss ratings. Since 1971 this rating agency provides unbiased ratings of investment products. According to their website, unlike Standard and Poors, Moody's or Fitch who use an issuer-pay model, they do not accept any financial compensation of any kind for their ratings.
Weiss provides ratings on US stocks, mutual funds, and ETFs, and also publishes safety ratings on US banks, credit unions, and insurance companies. They provide ratings on cryptocurrencies too, including factors like technology, adoption rate, and risk/reward.
Weiss publishes an overall rating for cryptocurrencies. The coins and tokens listed represent the best blend of four categories: coin adoption, underlying technology, investment reward, and investment risk.
They also publish rating tables for each of four subcategories too.
Here are the top five coins by overall rating.
Then by adoption.
And underlying technology.
Then investment reward.
And finally investment risk.
Another place to start is to use the cryptocurrency rating screener. Weiss rates cryptocurrency coins and tokens on a scale from A+ to U.
If you need a fast and frugal way to begin your cryptocurrency journey, adjusting the screener to filter out only those coins and tokens with a rating of grade C+ and above, you will narrow down your crypto universe from thousands to just ten coins.
Yes, it's an advantage to have some technical knowledge, but it's not essential. Tools like the Weiss crypto screener are a great help, especially if you're just starting out.
Weights and Measures
The White Noise series of articles, podcasts, and videos discussed cryptocurrency taxonomies.
If you want a heads up on the future direction of the overall US market, check the financials ETF. Why the financial ETF? It's because stock markets usually don't rally too far without financial stocks. And, why ETFs? 25-40% of the overall daily volume in the US stock market is driven by the buying and selling of ETF products.
If you want to know the strength of the US dollar, use the EURUSD exchange rate. It's 57% of the US dollar index — a basket of currencies traded against the USD.
The QQQ is an ETF that tracks the Nasdaq 100 stocks. If you had to attempt to figure out the directional bias of the Nasdaq, where would you start? You could begin by analysing the fundamentals of the undying stocks, but which stocks? All of them is going to take you a while.
The fast and frugal method is to use just five.
Apple, Microsoft, Amazon, Facebook, and Google make up 45% of the QQQ index. The Nasdaq isn't going too far without this group, and the weightings of all ETFs can be found online in seconds — for free.
Can you apply a similar method to the cryptocurrency markets?
As the old saw goes — If you don't have the expertise, hire someone who does. While Weiss uses a proprietary rating method to rank cryptocurrencies, these rankings can be used to narrow down your search criteria and as a gauge of the strength of the underlying cryptocurrency market.
To be clear the ratings are not buy and sell signals, nor are they perfect, but they are an efficient and effective method to find the leading coins and tokens. Weiss uses its own in-house team to assess and rank cryptocurrencies, but they also have indexes that track, like ETFs, different sectors of the cryptocurrency markets.
Slice and Dice
As discussed in the White Noise series, cryptocurrency taxonomies are not yet anywhere near as defined as stock market ETFs and sectors. Some have grouped cryptocurrencies using a periodic table like structure to differentiate between function, using groupings like Payments and Currency, Platforms, Fintech, Data Management, Gaming, Media and Social, Protocols, Exchanges, Interoperability, Business and Enterprise, and Privacy.
But this is beginning to change.
The Weiss 50 Crypto Index contains the top 50 ranked coins and tokens using a blend of their four ranking criteria, adoption, underlying technology, investment reward, and investment risk.
Like the Nasdaq QQQ index, the Weiss 50 Crypto index tracks the entire cryptocurrency market, and like the QQQ, the Crypto 50 index is top heavy, with five coins representing 67.82% of the whole index. The top five coins are Bitcoin, Ethereum, Ripple, EOS, and Litecoin.
There is a critical difference in the weightings between the Crypto 50 index and the QQQ. The QQQ uses market capitalisation as the weighting criteria while Weiss uses its proprietary rating system to weight the coins and tokens in the index. This means, over time, the coins and tokens are more likely to change more often than the top five in the QQQ, but, if you want to keep it simple, it's a fast and frugal way to form an opinion of the entire cryptocurrency market.
The correlation coefficient between the Weiss Index and Bitcoin shows a strong positive relationship. The Weiss index is the blue line rebased to 1, Bitcoin is the yellow line, with the red line being CCi30's cryptocurrency top 30 index.
The correlation isn't perfect, but it's close enough to be useable. Instead of overwhelm, instead of searching for the opinions of others, you can form your own. Using a fast and frugal technique, you can follow a handful of coins and tokens and gauge the underlying strength of the cryptocurrency market.
Protocols and Algorithms
Bitcoin is important because it solved one of the oldest problems in computing. It's called the Byzantine generals problem, Bitcoin's blockchain, using a proof of work algorithm, gives a workable solution in providing consensus between nodes in a decentralised system.
But providing consensus has an overhead. In Bitcoin's case, it's the computational power and associated energy costs. It takes a lot of energy to maintain Bitcoin's consensus mechanism. It's expensive and difficult to scale.
Proof of work algorithms has another problem too. Her name was Sybil Dorsett. Sybil suffered from multiple personality disorder, and computer hackers gave her name to a security threat where a single entity uses multiple identities in an attempt to take over the network.
Using a Sybil attack strategy, hackers attempt to control the majority of the underlying blockchain network. Controlling the majority of the network allows the attackers to carry out a 51% attack, which would enable them to tamper with the blockchain transactions, changing the order, preventing confirmation, or even reversing completed transactions.
To create a block on the Bitcoin blockchain miners have to prove they own the computing power, so Bitcoin's Sybil defence strategy is to make the cost of a Sybil attack more expensive than mining a block.
Sybil attacks are only one type of threat, but there are others.
At this point, it's helpful to differentiate between protocols and algorithms. A protocol is a set of rules, and an algorithm is a procedure that carries out those rules. Bitcoin is a protocol, and Proof of Work is the algorithm by which the rules of the Bitcoin protocol are followed.
In the same way, Cardano is a protocol, and Ouroboros is the algorithm by which the rules of the Cardano protocol are followed.
Likewise, Ethereum is a protocol, and the Ethereum protocol uses a Proof of Work algorithm called ethash. Ethereum is changing its algorithm from Proof of Work to Proof of Stake to improve scalability and security. The Ethereum protocol will use a new Proof of Stake algorithm called Casper.
Always mindful of not tripping and falling headfirst into the rabbit hole that is technobabble, there are many types of algorithms including Proof of
Work, Proof of Stake, Delegated Proof of Stake, Leased Proof of Stake, Proof of Elapsed Time, Practical Byzantine Fault Tolerance, Simplified Byzantine Fault Tolerance, Delegated Byzantine Fault Tolerance, Directed Acyclic Graphs, Proof of Activity, Proof of Importance, Proof of Capacity, Proof of Burn, and Proof of Weight.
The two most common are Proof of Work and Proof of Stake.
The algorithms that enforce the rules of the protocols are commonly called consensus algorithms, but that is not strictly correct. A more accurate description is Sybil attack preventer.
When researching cryptocurrencies, it helps, especially if you lack the technical background, to begin by asking simple non-technical questions like what problem is the coin or token attempting to solve?
Using search terms like, "What problem does X solve?", "How does X do Y?", "How is X scalable?", and "How is X secure?", will get you started.
Another fast and frugal non-technical method is to follow the developers, asking who is behind the coin or token.
Another method is to follow the money. Weiss provides other indexes as well as the Weiss Crypto 50. They also compile a Proof of Work Index and a Non-Proof of Work Index, allowing you to compare the most two most common cryptocurrency Sybil attack prevention systems.
Blockchains have to find a balance between three main issues. Security, decentralisation, and scalability. Using third-party coin ratings, cryptocurrency indexes and their constituent weightings, and knowing the fundamental difference between a protocol and an algorithm, as well as the three most important functions of a cryptocurrency — security, decentralisation, and scalability, you'll be on your way to building a solid understanding of the cryptocurrency market. No in-depth technical knowledge required.