Epistemic status: Speculative, obviously
There are three claims I wish to start out with:
1. With an estimated market capitalization of 250 billion Euro, Cryptocurrency as a market is still in bubble territory, a severely overvalued technological phenomenon.
2. The individual cryptocurrencies tend to undergo inflation, as every individual unit of account gradually comes to represents a smaller share of the individual currency.
3. Cryptocurrencies as a collective suffer inflation, as the market for cryptocurrencies becomes increasingly crowded as new cryptocurrencies emerge on the scene.
Based on these three claims, I’m willing to draw the conclusion that on average, a single unit of a random cryptocurrency would likely see a decline in its dollar value over time. I would even be able to draw this conclusion in the hypothetical scenario where the market for cryptocurrencies as a whole would stay stable, based simply on claim two and three.
It’s possible to short sell popular cryptocurrencies, for negligible interest rates. Assuming the platform you use is reliable, it should be profitable to short sell popular cryptocurrencies, based on the previously stated conclusion. But which ones would you wish to short sell? This leads me to the following two assertions:
1. Participants in individual cryptocurrencies overwhelmingly choose to participate in their particular currency in an effort to get rich quick. Other motives that might exist are generally minor.
2. Once an individual cryptocurrency has grown as valuable as some of the largest coins on the market, the potential for growth is lost, as everyone who might be interested is now aware of the phenomenon, but generally realizes they can no longer be early adopters. As the potential for further growth in value is lost, the previous assertion would suggest participants have no genuine reason left to participate.
My suspicion is that short selling popular cryptocurrencies should generally lead to easy profit, as the overall trend once it becomes possible to short sell the currency should generally be downward. The reason it’s possible for these currencies to rise to absurd heights in the first place, is because those who expect the value to go up can participate, while those who expect it to go down find themselves generally faced with an inability to put their money where their mouth is.
As an analogy: Imagine you’re sitting in a boat where you can start throwing coal into the steam engine if you think the boat should move forward, but not if you think it should go backward. Even if 90% of passengers think the boat should move back, the boat will move forward. So it is with cryptocurrencies. Without access to credible, reliable means to short sell, a speculative bubble is inevitable. What we notice with Bitcoin is that it roughly hit its peak once short selling became an option for professional institutes. Short selling might have been possible before, but no sane individual would ever deposit a billion dollar on Bitfinex.
Counter-arguments:
Cryptocurrency isn’t overvalued.
This argument on its own is not sufficient to reject my assertion. However, the idea that cryptocurrency is still undervalued is one I can relatively easily reject. Cryptocurrencies as a whole are worth roughly three times as much as Paypal. Which of these do normal people use more regularly? Which is more user-friendly? Which is more prone to theft and fraud? The idea of cryptocurrency as a store of value is also easy to reject: How can it be a reliable store of value, if a new cryptocurrency could replace yours overnight? How can it be a reliable store of value, if your family has no idea how to handle the currency once you drop dead? How can it be a reliable store of value, if it’s so vulnerable to theft? We use property, stock and bonds as stores of value, because you can’t steal a house or a stock portfolio.
You can’t time a bubble.
“Sure, it will drop to zero, but it might double in the meantime and leave you liquidated.” A critic might argue. Of course, it did exactly that a few months ago. There are different solutions we have to this problem. The first and most important is that we should avoid using high leverage. This is the mistake most people tend to fall victim to. For you to use high leverage is profitable for your trading platform, but not for you. The second important point to remember is to open multiple positions, on multiple cryptocurrencies. The currencies generally do move together of course, but the most popular ones have a particular habit of falling extraordinarily hard.
You can’t reliably beat the market
This is a claim derived from the efficient market hypothesis, a hypothesis that isn’t broadly supported anymore since the great recession. It’s a soothing idea that you can’t consistently outperform an index fund, as it delivers an easy answer to discourage every random fool from throwing his money away on speculative nonsense and ponzi schemes. I believe I can beat the market, because I believe I can recognize market inefficiencies. Prices for many assets simply don’t follow a random walk.
Alright, so which cryptocurrency should I short-sell?
A cryptocurrency derives its value from the promise it holds to one day serve as an effective payment method. The store of value argument simply does not hold up, for reasons pointed out earlier. There are different types of these currencies out there. The oldest currencies however, tend to suffer from a flaw that more recently developed currencies generally don’t have: Proof of work. Proof of work basically means the currency needs people to reliably spend a lot of money on electricity, to keep the currency functional. For this reason, the currency either becomes less safe over time, suffers from eternal inflation or both. Because these currencies are decentralized, it’s not genuinely possible for anyone to implement solutions that would solve these problems and receive broad backing from the community. The solution to the problem endorsed by the developers tends to be a massive increase in use of the currency, to pay the cost of securing the network. Such a massive increase in use however, besides being unrealistic would merely increase the incentive to damage the system. These systems are prone to collapse, according to economists who study them.
The first cryptocurrency Bitcoin, has a relatively sheltered position, as the trade in other currencies depends on the continued proper functioning of Bitcoin. In addition, its enormous size makes it resistant for now to attacks. The other proof of work currencies are more vulnerable. The reason these coins are still valued at hundreds of millions of dollar, is because the market lags behind new insights. New information disseminates slowly and people take time to adjust to new information once exposed to it.
So, my plan is as following: In the weeks ahead, I’m going to use 1,000 Euro to open a short position on LTC:USD, with 2:1 leverage. I’m also going to increase this position, whenever the position of my short has improved. In the scenario where my position were to fall victim to a short squeeze, I would double down on my position. My belief is that this currency is using outdated technology and will be superseded by superior systems that don’t carry its disadvantages. Its value will ultimately approach zero, as it ceases to function as a payment protocol.
Carbon negative investing
Most of our investments are carbon positive, in the sense that the money we invest serves to incentivize activities that are thoroughly polluting to our environment and release vast amounts of carbon dioxide into the atmosphere. My own nest egg, as sad is it is to say, is largely derived from Bitcoin. Bitcoin is of course one of the most carbon-intensive investments known to man per dollar of value produced. Cryptocurrency however, is the market I best understand. The problem with investing is that an investment should be both morally justifiable and profitable. If it’s unprofitable but morally justifiable it’s charity. If it’s profitable but unjustifiable, it’s a form of theft. To make investments that pollute our environment is a form of legally tolerated theft from the global commons.
Carbon negative investments are a rare phenomenon. When it comes to short-selling cryptocurrencies however, I believe I have found a very carbon-negative investment. How carbon-negative exactly? Well, look at it from this perspective: A net inflow of 6 billion dollar into crypto leads to a market cap of 300 billion. A short position of 1000 dollar thus theoretically translates into 50,000 dollar in market capitalization withdrawn from the system. Assuming those 50,000 dollar would otherwise have been devoted to mining new coins and thereby consuming electricity allows us to make an estimate of the negative carbon emissions. 50,000 dollar, at an estimated 0.05 cent per Kwh leads to a nice round 1.000.000 Kwh of electricity. 1 million Kwh of electricity, at 1 kilogram of CO2 per Kwh, leads to 1 million kilo of CO2, or 1000 ton of CO2 emissions avoided. This is roughly 100 times what the average Dutch person emits in a year.
Of course I make a lot of big assumptions here. I assume 100% of a Litecoin produced goes to paying for electricity expenses. A more reasonable estimate might be half of that. More difficult to estimate is how strongly outflow translates into a decline in market capitalization and how a decline in market capitalization translates into a decline in mining. My position nonetheless still stands. I believe that by short-selling proof of work cryptocurrencies, I deliver tremendous value to society by discouraging carbon emissions and addressing a market inefficiency.
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