With Bitcoin 33% higher, did technical analysis cause the move or are background forces at work?


Aphorisms. Financial markets are awash with pithy sayings meant to impart wisdom. Gems like,

“Sell in May, and go away,” and, “So goes January, so goes the year.”

While it’s true, in the United States, that if you purchased a stock market tracker in the first week of November every year and sold it in the last week of April, your results would be spectacularly more impressive than doing the reverse. Most of the time the financial pearls of wisdom dished out to the masses won’t be much use, but there is one whose track record is better than most.

Bad news, good action.

Bitcoin Shrugged

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On Tuesday May 7th, 2019, Binance suffered the 6th worst cryptocurrency hack in history with around $40 million in Bitcoin stolen from the exchange.

In a statement, Binance CEO Changpeng Zhao calmed the market. The hack only affected Binance’s BTC hot wallet, and no other wallets were impacted. Around 2% of Binance’s total BTC holdings were stolen.

Acting quickly and stopping all withdrawals, Binance issued a statement:

Binance will use the #SAFU fund to cover this incident in full. No user funds will be affected.

In July 2018, Binance setup a secure asset fund (SAFU) for users, allocating 10% of their received trading fees into the fund designed to act as an emergency insurance policy to protect users against losses in the event of a malicious attack.

With the news Binance is covering 100% of exchange user losses from their SAFU fund, for Bitcoin, it was back to business as usual.

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The Bitcoin market shrugged. Within seventeen hours Bitcoin’s rally had recovered to the pre-hack high. That’s bad news, good action. Over the next four days, Bitcoin rallied 32.4%.

Yes, it will take Binance a few weeks to recover the losses, but by acting quickly and transparently, Binance managed to control the situation.

On the surface, the decision to pay out losses from the SAFU fund seemed the only course of action. After all, the May 7th hack is why Binance set up the fund in the first place.

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But, around 10:30pm on May 7th, several hours after the hack had taken place, Zhao tweeted out that after speaking with third parties Binance decided not to pursue a reorg approach.

Presupposition: Noun

Presuppositions belong to a branch of linguistics called pragmatics. A presupposition is an inferred assumption based on a belief that is taken as truth in a statement.

Jim stopped running presupposes Jim used to run. They wish they can go on holiday now presupposes they can’t go on holiday now.

After speaking with third parties, Binance decided not to pursue a reorg approach presupposes a reorg approach exists, that it was discussed with other parties, and it presupposes a reorg approach is possible.

And that is a problem. Why?

Because it implies, it’s possible to rewind Bitcoin’s blockchain and undo the transactions.

While blocks on the Bitcoin blockchain are reorganised during regular mining, as mining nodes in Bitcoin follow the simple rule of following the blockchain with the maximum work done, the tweet sent out by Zhao implies Binance were considering a coordinated 51% attack on the Bitcoin blockchain. This is not like the normal reorganising that occurs after a new block is completed; instead, it entails going much further back in time and temporarily forking the chain to orphan the blocks containing the stolen coins.

In the tweet on May 7th, Zhao mentioned that Binance had decided against a reorg, but then briefly pro-conned the situation.

On the pro side, by implementing a reorg, Binance could punish the hackers by moving the fees onto them. This would also act as a deterrent against future attacks, and would also test the reaction of the Bitcoin network to a reorg event.

On the con side, Zhao acknowledged that a reorg event might damage Bitcoin’s credibility, as well as potentially causing a permanent split in not only the Bitcoin blockchain but in the cryptocurrency community too.

The comments replying to Zhao’s remarks made the community’s opinion on a reorg clear, causing Zhao to tweet it’s not possible to implement a reorg of this magnitude and calling for everyone to move on. But the damage was done.

It’s highly unlikely that Binance could have pulled off a reorg. But the fact that they considered it, and the implications of them being successful is the news the market is ignoring.

Bitcoin’s strategy to prevent a 51% attack is to make cheating more expensive than being honest. On the Bitcoin network, it’s more costly to attempt to control 51% of the hash power than it is to mine Bitcoin itself.

Binance probably only considered the option for about 30 seconds as a knee-jerk reaction to the hack, but the possibility of a group of miners working together on purpose to change the Bitcoin blockchain goes against the underlying philosophy of Bitcoin itself. A reorg on this magnitude would set a precedent.

And, arguably, it could render Bitcoin worthless. Why?

Because it takes away Bitcoin’s reason for being. If Binance had attempted the reorg and been successful, it would have shown a decentralised system can be controlled at will by a centralised authority — and that could mean game over for Bitcoin.

CEO comments have ended businesses in the past. In 1991, the CEO of a FTSE100 company, when asked about why his company was so successful at selling products for such a low price, replied, “Because it is total #@!.”

In just a few days 80% of the company’s share price was wiped out, losing over $1.8 billion in today’s money. Over the next twelve months, 330 high street stores were closed, and 2,500 people lost their jobs because of five words the CEO blurted out in a speech.

And this isn’t an isolated incident. You could begin your research with the CEO of Tesla.

Wall of Worry

Another phrase used in financial markets describes how markets move in trends. When trending down, the market is sliding down the slope of hope, and, when trending up, the market is climbing up the wall of worry.

At first glance, sliding down the slope of hope and climbing up the wall of worry don’t seem to impart too much wisdom, but, under the surface, these phrases describe not only crowd behaviour but also one of the biggest causes of the crowd’s losses.

As markets move down, news that has the potential to stop the rout gains more attention. And, as markets move up, news that could end the rally becomes the focus.

The process of sliding down the slope of hope and climbing up the wall of worry is continuous. Even in the sideways accumulation and distribution phases of the price cycle.

The 5% use this process as one of the checks before they take a position because paradoxically all liquid markets, including cryptocurrencies, exhibit the worst news typically portraying a near hopeless situation at major lows, and vice versa, when markets are soaring, and the news is good, when everything looks fantastic, and the thought of a market selling off looks highly unlikely, it’s then that markets typically print major highs.

The catalyst could be exogenous, external to the market, like a natural disaster, a geopolitical shock event, or a cryptocurrency exchange collapse. Or, it could be endogenous, something internal; a shock report exposing corruption within an organisation, an earnings miss or a profit warning.

The tendency for the worst news to coincide with the end of a down move and the best news to coincide with the end of an up move has, like the slope of hope and the wall of worry, been turned into a handy aphorism.

It shows up in the stock market, the forex market, the bond market, in fact, all liquid financial markets, including cryptocurrencies exhibit this behaviour - even real estate markets: When the only way is up, the only way is down, and when the only way is down, the only way is up.

In financial markets, including the cryptocurrency market, there’s always someone willing to stand in front of an oncoming train.

As markets move through the stages of the price cycle, moving from downtrends into sideways accumulation, and from sideways accumulation into uptrends, eventually cycling into sideways distribution and finally new downtrend, there is always some genius who thinks that the bottom is in or the high has been made.

Occasionally they are right, but even then, they get out too early and rarely exploit the true potential of their position, typically exiting without any understanding of return on risk.

As Bitcoin continues its accent, the bullish articles continue unabated with one article (in a respected high circulation publication) claiming the cause of the rally was Bitcoin’s RSI, relative strength indicator, reading.

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The RSI indicator is a momentum indicator. It works by dividing the initial percentage gain by percentage loss over the period used by the indicator, typically fourteen days, and then smoothing the results. The point is, the RSI, like all the other momentum based indicators, is based on the price of the underlying market and a moving average to smooth the results.

What’s more likely to act as a catalyst for a market — an RSI reading or a real-world exogenous or endogenous event?

As discussed in the Disruptive Force series of articles, podcasts, and videos, the 5%, the most consistent speculators and investors, focus their attention not on other people’s opinions, but on points of reference where they can quantify their risk.

The 5% wait patiently for a market to set up. As cryptocurrencies trade through time, prices are driven above and below zones where entry can not only provide a quantified amount of risk but also market feedback if the position is unprofitable.

In contrast the 95%, the inconsistent majority, buy highs and sell lows. Yes, sometimes this can work, and yes, it is a strategy at one specific point during the price cycle, that allows good risk management and market feedback, but most of the time buying the high and selling the low is highest risk lowest reward strategy a speculator can deploy.

Bitcoin is climbing a wall of worry without mass public participation. While news of Bitcoin’s rise might be making headlines in Australia, in other countries, like the UK, cryptocurrency rarely makes the news. In May 2019 the general public is still not invested in crypto. (As a test, ask around next time you’re out socialising)

What is behind this week’s 32.4% move up in Bitcoin? An indicator reading or are there background forces a work?

Carrot and Stick

Of all its trading partners the United States largest trade deficit, the net balance of exports to imports, is with China.

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For ten years, between 1995 and 2005, China maintained a fixed peg at over eight yuan to the US dollar.

Moving in 2005 from a fixed peg to a narrow trading band, where if the yuan breached the boundaries, the Chinese Central Bank would intervene, selling or buying the yuan to keep the exchange rate within the limits of the band.

The problem? From the United States perspective, the Chinese maintained the band at an uncompetitive rate, undervaluing the yuan against the USD, allowing China a competitive edge exporting its goods into the United States.

In 2015, China removed the fixed peg to the US dollar and allowed the yuan to float freely — with a twist. The twist being the Chinese central bank use a managed floating currency approach. Based on the previous days close, a trading band of plus or minus two percent is maintained.

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Cheap goods into the United States exports deflation into the US economy, and at a time when the US has record-breaking amounts of debt, deflation is a bad thing because you have to print more debt just to maintain the level of debt you have, never mind pay it down.

Ironically, the biggest currency manipulator in the world isn’t China; it is the United States.

When the US cranked up the printing presses in the wake of the 2008 financial crisis, China, having its currency pegged to the US dollar, was importing inflation from the United States. This is because the yuan was pegged to the US dollar at a fixed rate, and as money was coming into China via current account surpluses, portfolio investment, and short term profits due to hot money inflows, the Chinese Central Bank had to print more yuan to match the number of dollars flowing into the country. For example, a Chinese exporter earning US dollars has to swap those dollars into yuan.

Historically, inflation has created politically dangerous situations in China, so instead of a fixed peg, the Chinese central bank moved to a trading band, and then finally a managed floating rate.

But now, with the QE program at an end, the US needs another mechanism to control the relationship between the two largest trading partners in the world.

Maybe the Trump trade war is designed to persuade the Chinese to see the wisdom of a higher yuan valuation against the US dollar. This is because, with a weaker dollar, goods coming into the United States from China will cost more to the US consumer, and this is inflationary.

Inflation decreases the percentage of overall government income needed to repay the holders of the debt. And, with $22 trillion of debt, higher inflation will reduce the stresses on the US economy.

The levels of slack in the US economy are the lowest since 2000. When slack is low, the greater the influence inflationary pressure will have, because unemployment in the US is at nearly twenty-year lows, and low unemployment reduces the economy’s ability to absorb inflationary pressures.

The background conditions for increasing inflation in the United States are in place. Of course, it’s a balancing act. A little too much inflation is problematic too.

A trade war forces the increase in prices on US consumers and this, because of the current background conditions, is the favourable environment for an increase in inflation.

The Chinese could react by an aggressive devaluation of the yuan, neutralising the effect of the tariffs imposed by the US.

In 2016, the Chinese yuan was added to the basket of currencies, along with the US dollar, the Euro, the British pound, and the Japanese yen, that make up the International Monetary Fund special drawing right asset, or SDR.

As China’s economy transitions from the exporting of goods to the consumption of goods, and as this will require a stable currency and exchange rate, the Chinese are unlikely to counter-attack the US trade tariffs by devaluing the yuan.

What has all this got to do with cryptocurrencies?

Bitcoin shrugged off the bad news this week. Less than twenty-four hours after news of Binance’s $40 million hack, Bitcoin was back at new highs for the move and added nearly one third of its value over the next four days.

As tensions increase, it could prompt new demand in cryptocurrencies. One reason for new demand could be Bitcoin arbitrage, buying in one location where prices are stable and selling in another region where geopolitical events are causing surges in demand.

For those who doubt the effectiveness of arbitrage techniques, researching how the Rothschild family used its family connections between London and Paris during the Napoleonic war might persuade you otherwise.

All liquid markets, including cryptocurrencies, move between price levels, searching out levels of liquidity.

Over the short term, it’s possible to use technical analysis successfully as a trigger into and out of a market; however, if you want to increase your field of vision, an RSI indicator might get you across one lane on the freeway, but you’re unlikely to make it to the other side without an understanding of background conditions.

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