The Bright Side of Bitcoin’s Downers: Things to Consider for 2019
2018 has seen a spectacular, overly long decline in the value of Bitcoin for investors and onlookers alike. It is because of this that many onlookers and reporters have since decided to back away from Bitcoin, even concluding that investors should write it off along with the vast majority of cryptocurrencies.
While this decline has given these commentators some misplaced validity in the eyes of flighty past buyers of BTC, but in reality, there's more optimism to be seen from this market correction than upon first glance, as the recent downward turn may, in fact, allow for the market to go through a maturing stage, as opposed to seeing it go off into pasture.
Much like any junior market looking to become a senior, respected member of the investing family, maturing is what the cryptocurrency market needs in order to endear itself to a more professional clutch of investors such as institutional buyers.
So what is the plus behind institutional investors coming en masse to the cryptocurrency space? Well, their inclusion will bring a far greater level of liquidity to the market, with the sort of funds that they will bring into space, along with the fact that a more stable, experienced population investing in Bitcoin.
One of the positive indirect impacts that institutional investors will have indicated to other buyers that the market has become an exchange with an increased level of stability and trustworthiness.
The Matter Of Risk
Over the course of 2015 to the late months of 2017, with Bitcoin undergoing a boom stage of its lifespan. One of the more dominant emotions that lie within the cryptocurrency market, there was a climate of bullish excitement and general euphoria at the positive upswing.
It was as a result of this that crypto traders out there were more than happy to rely on exchanges with a far reduced level of security or protection for its users. While these practices carried a very dangerous risk with an incredibly expensive exclamation point. The possible upside to taking that gamble made it worthwhile to consider and even act upon.
There is a unique position that the digital asset market found itself in during the beginning of its life, and it was pretty rare when we compare it to conventional trading and their associated standards – and that was its relationship with operational risk.
This refers to the dangers presented by loss from poor procedures, security, as well as the kind of policies that were used in order to conduct operations within the confines of trading. Higher levels of operational risk within trading were often far higher than the baseline market risks (Referring to the dangers presented by financial loss on account of prevailing conditions of a market that an investor gets involved with).
What made these potential operational and market risks fine to work with were when the ratio was completely disproportionate when compared to the then incredible level of financial return that investors could make off the back of investing in Bitcoin.
It's with this in mind that plenty of new players were willing to run the risk of loss of capital due to a bearish downturn, or even their chosen coin exchange being hacked because it would possibly be dwarfed by the return on investment.
One of the examples we have seen for this is, even as those participants in the market more closely recall the attack on Mt. Gox in 2014, Bitcoin saw its value rocket ever upwards by a total of 460 percent over the stretch of time between July 2017 and January 2018.
While there are plenty out there that would look at people trading on high-risk platforms as a completely foolish act, it can make a certain amount of sense if we use ‘adjusted' measures of ratio. One example is the ‘Sharpe' Ratio which is used to weigh up the degree of risk associated with trading on a platform.
So how does it work? First of all, an Adjusted Sharpe Ratio takes into consideration the sort of return on investment from BTC over a pre-selected span of time, as well as the risk-free rate involved in buying into an otherwise risk-free asset; this can include something like a government bond. From there, the Sharpe Ratio can weigh up the scale of risk associated with your investment portfolio before determining the kind of return you can expect relative to the risk.
If we are to take the previously mentioned example as a model; starting with taking the risk-free rate of 1.5 percent, the portfolios return, which we have previously concluded is at 460 percent (Bitcoin's growth over July 2017-January 2018), and the portfolios associated risk (135 percent if we're considering 35% risk from markets, and 100% from operational). This would end with a Sharpe Ratio-calculated yield of three.
In conclusion, this ratio represents a very attractive level of risk-weighted return as the expected return increases relative to risk by a multiple of three.
While over the span of late 2018 to now, these returns have since lowered or otherwise returned to normal as liquidity has steadily increased across the wider range of coin exchanges. An interesting fact is that if you took on a longer-term strategy would now be undergoing some possible losses due to potentially repeating a strategy used from six months ago.
While employing a directional strategy can provide some positive returns, there are some speculative investors and traders that believe the days of easy returns on investment have since disappeared into the ether.
Examples of these ‘easy' strategies have, in the past, included arbitrage opportunities; this refers to buying the same assets on one exchange, preferably at a low position, to then go and sell it on another exchange within a higher position. It's important to point out that this method can often cause major price fluctuations on exchanges, resulting in many former arbitrage traders having to rotate exchanges on a continual basis.
While traders believe that these strategies are gone, they argue that a level of stability has taken its place, with many of the returns they've seen recently being much more akin to the returns you would generally receive from the more institutional asset classes.
Along with these more commonplace returns, it is believed to coincide with a changing demographic and behavior within cryptos investors. With many of them being far, in a way, more averse to risk than they were during the bullish years. Many of which are less likely to take the ratio of monetary and/or operational risks as they would have in years prior.
To make a summary, there has been a dramatic shift in the people's perceptions of investment when regarding the Risk-reward ratio, along with their being a fundamental change to this ratio in general.
In light of this new approach and aversion to high risk, the pressure has now been put on crypto exchanges to shape up for a more professional, and skeptical investor pool. One that is not going to accept a lax approach towards operations, security, as well as poor regulatory oversight.
One of the examples of this a hardening up and professionalization of the digital wallet side of coin exchanges. In the past, crypto exchanges regardless of their size would use a single wallet that would hold all assets from all users within its ecosystem. This was even the case with a wide range of assets that were held in a cold storage wallet.
While the end user would sometimes be oblivious to this, hackers weren't; and nothing presents a more tempting target than a single, not so well guarded wallet full of a whole communities money. It's because of these easy to hit targets that exchanges are taking on a more robust framework of storage and security for its users. This includes a series of segmented wallets, including the likes of Seed CX, which involves creating a dedicated wallet for every single user within the exchange.
This gradual transition to demanding more from cryptocurrency exchanges means that they will have to dedicate far more attention to providing the kind of security needed in order to prevent perceived risks from becoming very real disasters.
These exchanges will have to create a climate of lower operational risk and, as a result, this will draw in a more professional crowd of institutional investors, who spend far more time weighing up the operational and capital-based pros and cons to any addition to their investment portfolio.
Along with this fact, exchanges will also need to finally get on the ball in terms of domestic regulatory policy with regards to the users it hosts. Many will need to offer more in the way of regulatory oversight, surveillance and countermeasures in place in order to prevent suspicious activity within their exchange: such as trading alerts, order book audits, etc.
The Professionalization Of Exchanges
As was previously mentioned in this article, there have been a great many changes within the cryptocurrency market since the bullish days of 2015-17. The market since has proven that adopting a purely long strategy is not workable as a profit maker and that opportunities to make an ‘easy return' on a Bitcoin investment are harder to capitalize on.
One of the recent examples of this that we have seen was from DeVere Capital, which recently announced that it will be launching an actively managed crypto fund which will have a greater emphasis on arbitrage opportunities that exist between certain cryptocurrency exchanges.
The bottom line for cryptocurrency exchanges is this – in order to continue being profitable in the face of a new, bearish and diversifying market, there need to be new, more professionalized strategies brought in, along with more professional trading strategies for changing investor demography.
In The Shadow Of The Bear
The cryptocurrency market has been profoundly and irrevocably changed as a result of the bearish trend that took place over 2018, and it still provides one of the biggest overhands in its otherwise short history. It is also early 2018 that was marred by cybersecurity vulnerabilities; having the majority of the year indicating the loss of nearly $1 billion in cryptocurrency from exchanges and trading platforms that offered little in the way of security.
While professionalization is steadily coming to a high percentage of cryptocurrency exchanges out there, there will always be those that decide to skimp on or fall short on security measures against hackers out there. While there are those that are recalcitrant in the face of regulatory demands, others are making a great degree of progress towards providing better security.
Along with the greater inclusion of segmented wallets, there is a far higher rate of application for multi-signature security measures within exchanges (Seed CX requiring two keys from any of its users, which are randomly generated by independent parties). This increase in security comes alongside the enforcement of whitelisted withdrawal IPs, which provides an added level of security when users need to withdraw funds from their chosen digital wallet.
One thing that is worth considering in order to put the market into a state of positive contemplation is this: if we were to be told some two years ago that institutional investors will, and are steadily walking into the world of digital assets, we would have thought of that as some kind of unusual joke.
Fast forward to the present day, and we see institutional investors making a concerted effort to make their presence known within the cryptocurrency world, and coin exchanges are steadily changing to accommodate them. Sometimes people, and markets, need to take a step down to climb up the ladder of trading.