Throwback Thursday: Market Becoming more Efficient for Crypto?

A day of meetings and travel back home to meet my family for a Valentine Day surprise led me to look back on my blog for a Throwback Thursday post. I found one that while it did not do too well the first time around with only 4 upvotes and $0.10 value of payouts, it continues to be a relevant thought around the markets we find ourselves in today.

As we have learned from the explosion higher in 2017 and the subsequent fall last year, markets can and will be irrational for extended periods of time. This occurs as markets take time to mature and find balance between their intrinsic values driven by speculation, demand, supply and many other factors. However, as asset classes attract more participants and capital, the efficiencies start to gather as more information starts to proliferate related to the factors that determine the value of said markets.

The following post was originally posted in March 2018.

Efficient market and how it impacts asset prices?

An efficient market is when the price of an asset properly reflects all available information. In an efficient market, few investors can truly make money because investors will not sell undervalued assets nor buy overvalued assets. However, we know that markets are not always efficient. Human behavior is the main culprit behind swings in market prices that grant opportunities to profit from deviations in efficient markets. Decisions made by investors with emotions create mispricing that can be taken advantage of. Financial assets have life cycles that start as inefficient markets and as investors learn and market participants increase, they become more efficient.

An example of prior markets that went through these cycles were high yield debt (“junk bonds”) in the 1980s. High yield debt are securities issued by companies that have high risks to their business environment or on in an unhealthy financial position. These risks demand a higher return or yield to their capital. Most institutional investors and individual investors do not invest in the space due to regulations and/or suitability requirements. However, some smart investors and asset managers began pooling capital to invest in these assets as opportunities arose. They would research the Company, their management team and the industry to find mispriced assets worth investing in. As they diversified into the assets, they found that returns could be superior to the risks being taken. This led to an influx of more investors in the space which created more capital and opportunities for the asset class. Ultimately, it has led to the asset class being a $2 trillion market. Now all types of investors participate as mutual funds and ETFs have emerged as an offering to investors that did not have access to these markets in the past. It has also led to lower returns as the market has become more efficient.

I believe that Crypto assets are still in a market with low adoption. This makes it an inefficient market at the moment. While that creates opportunities to find assets at good prices it also has the risk that most assets at this early stage are largely speculative. Given the increase in adoption we are seeing, volatility continues to ramp up as players in the market continue to misprice assets. If we think about it, has the value of Bitcoin really increased from $3,000 to $19,000? If so, why is it at $10,000 now? This is an example of players placing different values on an asset. However, I feel that we are at an interesting point for the market as more investors come into the space. Institutional investors will also start to participate more which will ultimately create additional instruments like ETFs to expand the availability to even more retail investors. Ultimately, this will lead to a larger market, decrease volatility and decreased returns as prices get more efficient.

Although I do not believe we are there yet, we should look at how an efficient market will impact our investing decisions. Ensuring how we assign value to assets is an important part as every participant will have its own view. Particularly for these assets with no cash flows, value is in the eye of the beholder so be careful. Adding risk management approaches from traditional investing techniques will create value to your portfolios. Therefore, always have in mind: (1) diversify your portfolio, (2) look to rebalance when appropriate, (3) always have some fiat available to take advantages of opportunities, (4) do not let emotions control your portfolio, and (5) always do your own homework. In addition, as many people say in this space, only invest an amount you are comfortable with losing. Consider that this should only be a part of your overall assets.

As always, let me know your thoughts as I welcome feedback and enjoy engagement. Your opinions help me define mine so let’s work together as a community to educate ourselves with perspectives.

The amounts of development that has and continues to occur given the amount of capital and transactions seen in the markets over the past year demonstrate how the cryptocurrency market continues to mature and evolve into an asset class. There is still a divide between where the capital is deployed as most continues to go into underlyjng infrastructure projects to support ecosystems and not the underlying cryptocurrencies. I feel that there is promise on what this could mean for the adoption and growth of the protocols going forward.