Why bad news on cryptocurrencies is good for its future

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This is a follow-up post from our guest author Suyash as the grand saga of ‘cryptocurrency boom’ is unfolding before us. Bitcoin and other similar cryptocurrencies are in lot of news these days due to recent ban from China. Suyash, being a keen follower, has some more insights on the latest developments.

PS: For understanding basics of cryptocurrencies like Bitcoin, please read the earlier article – Understanding Bitcoin bit by bit

Over to Suyash!!

The battle between central banks and cryptocurrencies has begun. China recently banned Initial Coin Offerings (ICOs) from introducing new cryptocurrency tokens in China market. There are also indications that China plans to ban cryptocurrency exchanges. In contrast, other central banks & governments (including RBI) are taking a different line. In this article, we will try to make sense of these moves and how it impacts cryptocurrencies. 

Initial Coin Offering (ICO) Ban

Initial Coin Offerings are akin to IPOs in conventional equities markets. Like IPOs, ICOs are floated in the market by founders for a markup price. However, there is an important difference. IPOs are backed by a business model, has promoters/owners/management and an accounting/audit trail. ICOs, on the other hand, are just ideas with a promise to solve real world problems. There are undoubtedly some exciting ideas, but very few of them are actually going to make it. Buying into ICOs is a bit like funding a startup right now; rate of failure is very high. Also, scams are rife as it is hard to judge the intentions of founders. So, China’s regulators move to protect investor interests seem justified.

The Banks have their say

Proposed China’s ban on cryptocurrency exchanges is an interesting development though. Does it indicate China wants to block all trades in cryptocurrencies? We think it is unlikely as there are also reports of a cryptocurrency framework. RBI seems to be taking a more rational approach, with executive director’s comments last week about Rupee equivalent fiat cryptocurrency. While central banks do not like the idea of de-centralized money, they are interested when a network can act as a clearing house. It is essentially an automation of central bank’s core function, clearing. India joins Canada, Singapore and Uganda in experimenting with centralized cryptocurrencies. 

While central banks finally seem to have woken up to cryptocurrencies, some big financial institutions are making erratic noises. JP Morgan CEO Jamie Dimon has called Bitcoin ‘fraud’, ‘stupid’ and warned employees to stay away from it. He does not exactly explain why he thinks so, neither does he explain its demerits. While JP Morgan was fined for their role in 2008 subprime mortgage crisis, bitcoin was in response to the very fault lines that caused the crisis. 9 years after, the two still being diametrically opposite of each other raise questions about the health of the financial system. Dimon’s comments are missing in content or context, but anger in his comments is hard to miss. In the business world, anger is either a response to marginalization or a response to threat. And it is hard to believe a bank of JP Morgan’s stature feeling marginalized.

Why bad news on cryptos is good news for investors

Investors in cryptocurrencies can be broadly classified into 3 groups:

  • Promoters – In case of cryptocurrencies, these are the programmers and geeks who build the systems. They are the early adopters and ardent believers in their work.
  • Believers – Cryptocurrencies, as an idea, promises a level-playing field on various levels. Bitcoin, for example, offers a potential of financial inclusion for millions of un-banked people all over the world. Ehtereum promises digital democracy with applications like smart contracts as auto-triggering exchange mechanisms between untrusted parties. Believers are investors who understand this megatrend and are aligning themselves to it.
  • Speculators – Be it bonds, equities, commodities or bitcoins, so long as there is a market, there is an inclination to capitalize on short-term trends to make a quick buck. As with any financial asset, speculation is an enemy of stability and cryptocurrencies are no exception.

It is hard to know the amount of holding by each of these groups though. Crypto market is neither mature enough to have secondary level applications that aggregate holding patterns nor is there any obligation to do so. So, for now, we can only draw conclusions by the movements in market capitalization.

Since Sep 1st, bitcoin has lost 22% in market cap (down from $80 Billion to $62 Billion) & 23% in value (down from $4,870 to $3,740 per bitcoin). Ethereum has lost 26% in market cap (down from $36.7 Billion to $27.3 Billion) and 27% in value (down from $389 to $286 per Ether). This has largely been due to news of ICO ban & proposed exchange crackdown by China.

Time to flee or time to buy?

Right now, weather is stormy and winds are strong in the cryptocurrency sea. Speculators are jumping off the ship, believers are staying put and promoters are working hard to keep the ship in shape. The ride ahead will certainly be bumpy and there will be more testing storms. But if history is anything to go by, this ship has not only held itself together but has gotten bigger & stronger after each storm.

We feel this correction is healthy and represents an opportunity for new investors to enter the market. However, it promises to be roller-coaster ride, so approach with caution. Invest small amounts over larger time frames and stay invested for at least 2 years.

“You can’t stop things like Bitcoin. It will be everywhere and the world will have to readjust. World governments will have to readjust” – John McAfee, Founder of McAfee

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