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The Cryptocurrency Credibility Gap

Selling dreams are as old as time and the future of cryptocurrencies are as ethereal as those that dreamed of untold riches during the technology bubble in 2000. As it was then, so it is now with cryptocurrencies: the practicality of implementation delayed a future that looks certain to alter the very foundations of how the world conducted business. Fortunately, where there is uncertainty, there is opportunity and cryptocurrencies provide a material one, particularly with the blockchain. Near-term cryptocurencies are a trading opportunity, despite their current perilous position.

Crypto Credibility

Cryptocurrencies and their sibling, the blockchain, will alter the nature of exchange with no less force than electronic payments transformed banking 50 years ago: the old methods will be washed away in the deluge. That time will not happen for Cryptocurrencies until the closing of the credibility gap between the two fundamental principles of currencies: a store of value and a medium of exchange.

The world has increasingly adopted cryptocurrencies as a medium of exchange for many products as countries moved to legitimize the currency. The challenge is that it is ineffective as an everyday medium of exchange and is most notorious as the exchange mechanism for illegal business. The adoption by nefarious actors has slowed its ascent to acceptability even as cryptocurrency exchanges have proliferated.

The lack of credibility as a medium of exchange has resulted in extraordinary volatility in the price of the currencies. This uncertainty not only reduces its value as a medium of exchange but also reduces the ability of cryptocurrencies to meet the other fundamental principle of exchange: a store of value. Without a credible link to value, the cryptocurrencies are a product of speculation only.

Supply Seducing Demand

Speculating on the future is the action of all investors and cryptocurrencies offer one of the most enticing stories of all time: a finite number that takes an extraordinary amount of energy to produce. As economics 101 tells us, limited supply is the bellwether of higher prices. Hence, the rush to be first into cryptocurrencies is a seductive serenade for the adventurous investor.

The intersection of a compelling story with a limited supply undoubtedly delivers demand. As the recent price activity has shown, Cryptocurrencies have had an intermittent affair with demand. Without the ability to act as a credible store of value and the depth that a medium of exchange brings, the price swings will continue for Cryptocurrencies as value remains at the whim of the last trade. In this environment, there is only one strategy to adopt: day trading using the tools of technical analysis.

Technically Trending

There are two underlying principles for trading trends: let profits run and cut your losses. These actions effectively make all positions resemble a long option: a small premium when the direction goes against your position and significant gains when it goes with your position. While all traders have their own risk to reward profile, a standard ratio is three to one, which provides a fair reward even if you’re only correct half the time.

There are many standard trend-following technical indicators; however, the most widely followed are the simple moving averages. Differing time frames provide a slower longer-term trend (e.g., 200 days) and a faster shorter-term trend (e.g., 50 days), where you stay in the position when the shorter crosses over the longer-term. Recently, this technical indicator has received frequent coverage because a bearish cross-over is called a “Death Cross.” This indicator is very bearish for Bitcoin over a short horizon.

Alternately, moving average envelopes can be used to indicate shorter-term, and faster, breakout periods (e.g., 20 days). AS the price action moves outside the envelope, the trader takes a position in the same direction and holds in, usually, until the position breaks out on the other side of the envelope. The current price action of bitcoin remains bearish on this shorter-time horizon.

A hybrid model that capture both trends and momentum is the Moving Average Convergence Divergence (MACD) oscillator. Utilizing two simple moving averages (e.g., 26 and 12 days) the model tries to keep the trader with the price flow and has performed well over the last year. Currently, the model indicates a bearish trend and weak momentum, which aligns with the two prior indicators.

The conclusion from the trend indicators is that Bitcoin is in a bearish pattern. The challenge is from the “Death Cross” mentioned above: it could trigger significant selling that could lead to further substantial jumps. In this volatile environment, monitor positions carefully and focus principally on the discipline to cut losses as required, regardless of the direction of your position.

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