In the alternative investment industry, there is an unpublished list of all-time excellent risk management trades. There is Balyasny Asset Management logically modeling in 2015 that the US Federal Reserve withdrawing quantitative stimulus might lead to a crash and adjusting its risk management overlay accordingly. There is Jim Chanos and Kynikos Associates calling out fraud at Enron, identifying little underlying value amid the market hype. And there are the likes of Ray Dalio and Bridgewater Associates looking at the consensus hype before the 2008 financial crisis and likewise identifying fundamental concerns that were being ignored.
Is the same true of bitcoin?
What will mark the top in the cryptocurrency market – and who will make this legendary call? And could a recent Morgan Stanley analysis of how value is established in bitcoin reveal the problem with calling a top?
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Those who got into cryptocurrencies early are saying enough
“How much is enough?” Bud Fox famously asked Gordon Gekko in the movie Wall Street. “How many yachts can you water ski behind?”
For Litecoin creator Charlie Lee, “enough” might be when an investment you hold is up near 7,200%.
Lee’s reason for selling a cryptocurrency he created was that he had become too influential in moving the price.
"Some people even think I short LTC (litecoin)!" he wrote in a Reddit post. "So in a sense, it is conflict of interest for me to hold LTC and tweet about it because I have so much influence."
Is Lee getting out near the top or just at a point where he wants to book his paper gains? The same could be said of the Winklevoss twins, dubbed “the Winklevii.” They are mainly using near the same excuse to lighten up on their bitcoin holdings as they seek to launch an ETF or even potentially an exchange. They have quickly parlayed their Facebook-begotten fortune many multiples with their bitcoin investment, raising the ire of former Harvard University President Larry Summers in the process.
But does a Morgan Stanley report point to a more logical process in understanding where a top in cryptocurrencies may or may not be called?
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Recognize how bitcoin is valued before calling a top
The question of how to assess bitcoin has rankled many in the trading community. Often algorithmic trading programs are built based on a framework that includes relative value analysis. Given a static set of economic circumstances, the correlation between two economically related assets can trade in a band, where a deviation from the historical correlation means leads to selling.
This is the cornerstone of some algorithm development mechanisms, but they are having trouble adapting them to bitcoin, a point that the Morgan Stanley report notes.
Often currencies are correlated with economic indicators such as sovereign interest rates. But this common value correlation isn’t applicable with bitcoin because “there is no interest rate associated with bitcoin,” Morgan Stanley’s James Faucette and his team wrote in a December 18 report “Bitcoin Decrypted.”
Can bitcoin be valued similarly to gold? “Maybe,” says Morgan Stanley. They point to gold’s value in electronics – a small amount of gold is used in computers and cell phones, while dentists use it in fillings, for instance. Gold's use in electronics is less than its use as an investment or a store of value, which is near $2.8 trillion of the interest in the metal. The majority of gold’s purpose is for adornment, including use in jewelry. This is where gold and bitcoin might share a common factor: their value is largely dependent on an arbitrary value humans place on it.
But where bitcoin shines is in its role as a payment network. But this, too, is based on a network effect. “If nobody accepts the technology for payment then the value would be 0,” the report noted, predicting that cryptocurrencies would not “replace every fiat currency payment made today.” In the document, they did not speculate on it replacing a percentage of fiat currency functionality, however.
The problem with calling a top in bitcoin might be found in fact its value is largely based on perception and a network effect. Which makes the feat even more noteworthy.
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