Advice To Beginner Investors In Crypto, Part 2

in LeoFinance •  last month  (edited)

Introduction

This is a multi-part series of posts for beginners about how to start your journey as a crypto investor. I do not claim to be any kind of a guru and I will always tell you to do your own research and make all of your financial decisions based on your own personal situation and relying on your own judgment. But I have been around the block and I've picked up a thing or two along the way. I'm writing this for you to express my personal opinions about how a beginner can avoid some of the pitfalls awaiting him or her.

You can check out the first part of this series here.

How to go about acquiring your first cryptocurrencies

So, now you've got your wallet software and your password manager set up. You have copies of your wallet files stored properly. Now you can go shopping for your first cryptocurrencies.

Most people will buy cryptocurrencies from a reputable cryptocurrency provider in their own country. You can buy crypto from many overseas cryptocurrency exchanges with a credit card or you can top up your fiat accounts on an exchange through a bank transfer just as well. I've never wired anything to any exchange in another country, though, because it's slow and because the fees are likely to be higher. I use a cryptocurrency provider that is a licensed payment processor in Finland. That particular provider has a long track record of reliability and it is supervised by the national financial supervisory authority. Lower chance of funny business there.

As I said in the first part, if you're are newbie to the space, you should know that the industry is still a bit of a wild west and immature from a technological perspective to boot. That's why it's a good idea to stick to the well-established large market cap coins at first.

Timing your entry into and your exit from the market

The very first thing you need to understand is that the cryptocurrency market is driven by the Bitcoin mining reward halving that is an event hardcoded into the Bitcoin protocol that takes place roughly every four years. Bitcoin's market cap is currently over a half of the total market cap of all cryptocurrencies, which is why the tokenomics (=token economics) of Bitcoin are crucial to the entire space. What the mining reward halving means is that the reward a Bitcoin miner gets in return for mining a valid Bitcoin block - paid in Bitcoin - is cut in half. Bitcoin mining is computationally very expensive, the purpose of which is to disincentivize a miner from being dishonest and attacking the network by falsifying blocks and thus throwing away all the work gone into mining it. Therefore, Bitcoin miners are forced to sell their mining rewards on the market to cover their costs. This causes constant selling pressure on Bitcoin. When the mining rewards are cut in half, the selling pressure is reduced and if interest in Bitcoin is assumed to stay constant, the halving should create an upward pressure on the price. It has done so twice before and there is every reason to expect the halving to do it again.

How the mining reward halving affects the price isn't this clear cut, of course, because the halving does not affect the balance of supply and demand too much at least immediately. Also, as the new supply of coins that the miners gain access to as they mine becomes a smaller percentage of the whole supply, the least profitable of them are forced sell at a loss of shut down. This phenomenon is called miner capitulation. What it temporarily does is decrease the total computational power the network has. But when the network detects that, it adjusts the mining difficulty upwards. This can cause fluctuations in the price following a halving event. But over time the decreased new supply will restrict the supply relative to demand if demand is assumed to stay constant, thus supporting a higher price. The market expects this and a game theoretical situation is given rise to where a new bull market (rising prices) can be expected to follow.

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Image by Ladislav Mecir CC BY-SA 3.0

This is an exponential Bitcoin price chart from when it was first traded to January 2020. Bitcoin has undergone three mining reward halvings: in November 2012, July 2016 and May 2020. The first two halvings resulted in a wild speculative rally that topped out 12 to 18 months after the halving event. What followed the spikes was a roughly 85% crash in the price of Bitcoin.

Other cryptocurrencies, of which there are over 8000 listed on public cryptocurrency exchanges, tend follow the bull-bear cycles of Bitcoin but with much greater volatility. Even the largest cap cryptocurrencies that naturally crashed after Bitcoin when Bitcoin's December 2017 bubble burst lost over 90% of their value. For example, the second largest cryptocurrency by market cap, Ethereum, crashed from $1,448 per coin to a rock bottom low of $84 on December 16 2018. Ethereum lost over 94% of its value from the peak. Most of the other coins lost 97% to over 99% of their value. Many disappeared altogether.

What I just told you implies that buying any cryptocurrency, any coin other than Bitcoin in particular, anywhere near the top of a speculative rally is a really horrible idea! If the cryptocurrency market is in bubble territory, it is a lot smarter to just wait until the bubble bursts and buy at or nearer the bottom.

Calling the bottoms is naturally a hard thing to do but metrics have been developed to help investors identify when Bitcoin is expensive and when it is cheap. For instance, one metric to look at is the Mayer Multiple for Bitcoin. The Mayer Multiple is simply the multiple of the current spot price of Bitcoin over the 200-day moving average. It's an indication of how expensive Bitcoin is at each moment by historical comparison. (It is not an indication when you should sell, buy or hold. That's for you to decide based on your personal situation.)

The theory that the mining reward halving of Bitcoin is the driver of the appreciation of Bitcoin is based on a measure called stock-to-flow, which simply means the ratio of the existing stock of a commodity to the flow of new stock in a year. The stock-to-flow model of valuation applies to many different assets including precious metals and real estate. It makes a lot of sense. If you can't increase the supply of an asset to keep pace with demand, then the price of that asset will go up. This is why gold can be money in the first place. To double the stock of gold would take 66 years at the current rate of production and due to the scarcity of gold in the Earth's crust, increasing the flow of new supply is very hard. That is why gold is called hard money. Bitcoin's current stock to flow is 55. Because Bitcoin's stock-to-flow ratio doubles every four years, its hardness as money (= its ability to be a store of value from a supply perspective) doubles every four years.

The key takeaways from the above is that cryptocurrencies - even Bitcoin - are extremely volatile compared to all traditional asset classes and that all other cryptocurrencies are much more volatile that Bitcoin. Timing your investment according to the macro trends is much, much more important than thinking too much about any short-term price movements.

Trading cryptocurrencies

My advice to every newbie without extensive professional experience in technical analysis and trading is to steer well clear of the short-term trading of cryptocurrencies. There is no surer way to lose your stack than to engage in short time frame trading. I doubt very much if even seasoned professionals without specific experience in crypto could consistently make profit in crypto. The cryptocurrency market is unregulated and rife with wash trading, spoofing and every other trick in the book market manipulators have. Because of the small market caps there is also a lot of sheer noise. The futures market is even riskier. Bitcoin whales seem to often amuse themselves by causing short and long squeezes by using their massive stacks and cash reserves to move the market in the short term. Just avoid trading altogether. You'll save a ton of money and also get to keep your sanity.

Another issue are the expenses and tax consequences of day trading crypto. By doing a lot of day trading you constantly pay trading fees. You are also liable to pay either capital gains taxes on all profitable trades deemed tax events, which would include all crypto-crypto trades in most countries as well. Your loss-making trades may or may not be deductible from your profits depending on the particular tax rules concerning cryptocurrencies in your country. Your profits might even be considered earned income if you don't hold your coins long enough before selling them. I strongly suggest you carefully study the tax guidance on cryptocurrencies given out by the tax authorities of your country.

The key takeaway from the above paragraphs is this: JUST HOLD!

Conclusion

Multi-year trading is a different matter altogether. If you look at the chart in the previous chapter, you'll see a pattern. Whether the pattern will hold is matter nobody can claim to know. But it is based on the fundamentals of how Bitcoin works on the supply side. Whether the demand side holds is much more complicated. There is the speculative and game theoretical aspect that I alluded to earlier and also macroeconomic factors that are the reason why Bitcoin was created in the aftermath of the financial crisis of 2008 in the first place, namely distrust in the ability of central bankers and politicians to manage the monetary system in the long run without driving it to the ground with continual deficits and runaway money printing. If you distrust central banking and politicians as guardians of the monetary system, then your best bet is a decentralized and hard form of money of the kind Bitcoin is.

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I like this series. Keep it on comin'.
I had desire to do (write) something like this. But I'm even more willing to see somebody is doing this for me. 😃
Maybe I'm to lazy? Once I got retired, somehow I got big wish to do only what I really really enjoy. Writing has never been my hoby...
Keep them on, comin'

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Thank you for your encouraging comment!

What I really believe should be done is create content that is valuable to people searching for information about cryptocurrencies and investing in general. This is the way we can drive traffic to leofinance.io, boost ad revenue, raise the token price and create a virtuous cycle. LEO whales play a decisive role in this. I wish everyone focused on what is likely to be the most valuable content to readers outside the ecosystem.

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wish to do only what I really really enjoy

That's what I wish too, retired or not :) ......life is so much lighter without 'obligations' and self-imposed 'have-to-dos'. When one does [whatever] with enjoyment, the quality and impact is automatically of a higher level IMO. I find blogging and interacting on LEO/Hive facilitates this in many ways not previously available.

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This is well written and very clearly explained, an excellent example of the kind of post that showcases LF as a platform for all levels of experience and interest in crypto.

Bravo 👍

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Thanks.

I must confess that this is one of the amazingly written articles on leofinance for newbies on bitcoin. It is easy to follow, clear to understand and exclusively for newbies. I can attest that as I am only 5 months old with BTC.

Well written.

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Thank you. That was really nice to hear.

Nice work here!

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Very well done. Keep us posted on future additions to the series.

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Just HODL.
the best part is that even if market manipulators with their fat wallets try to mess with the price, the code is law and the quantity of Bitcoin through mining is never affected

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This is why I believe even professional trading experience on mainstream markets may not automatically qualify anyone to be a crypto trading expert.

Thanks! Forgot to do that. :)