Opinion The Upside of the Crypto Bear Market

The Upside of the Crypto Bear Market

January 26, 2019

2018 brought about a fall of bitcoin prices, as well as many additional cryptocurrencies and digital assets. The sell-off was so big that many simply wrote off the concept of digital assets as a passing fad that finally found its end phase. However, some analysts believe that the same sell-off will be able to actually help the entire market find a way to mature and advance beyond its current point. Right now, the level of maturity is precisely what the same space needs to attract long-term investors.

Their mass arrival would be able to improve the state of the markets for everyone involved through the process of liquidity increase which would go in two ways. First would include the funds they invest in the market and the second would come from the fact that they are an adopter. The entry of the same investors would finally send a message to other capital-owners that the domain is stable and offers a level of trustworthiness.

The Seriousness of Risk

Between the years 2015 and late 2017, the price of bitcoin was rising steadily and there was plenty of euphoria from the bull traders. The market was mostly willing to rely on unregulated or little-know exchanges to do the trading, even though the risks were evident. However, the chance for profits clearly made it worth it for so many people and even companies. In the early crypto days, digital assets offered a unique scenario thanks to their difference to regular trading standards.

With bitcoin, in particular, the operational risk in trading, or the risk of loss through bad procedures, policies or securities was much greater from the risk market provided – this is the risk of losing money because of the prevailing conditions in a market that is being used for trading. This meant that there was a loss of digital assets and money because of hacking, but a chance for an astronomical return made it all worthy of the risk. What made it even more appealing was the fact that the returns could appear in a very short period. For example, bitcoin rose by 460 percent in just six months between July 2017 and January 2018 when it went from about $2,599 to well over $14,000.

On the other hand, the trading platforms that had high operational risks could also make sense using the logic of adjusting the Sharpe Ratio, which is a risk-assessment measure. The adjusted Sharpe Ratio considers the return on investment in BTC for a period of time and leverages this against risk-free assets like the US Treasury bond. This is then used to determine a particular portfolio risk (both in the operational and market term) which is then used to figure out the risk-adjusted return.

The potential for an earning with a – relatively – low-risk estimate meant that people were willing to bet on crypto. The adjusted Sharpe Ratio presented a very attractive risk-weighted potential that, in the case of bitcoin rising 460 percent, sees the benefit exceeding the risk by three times.

A Rise in Risk

Today, the investment returns have normalized because of the drop in prices. If anyone tried to employ a long trading strategy that gave such exponential returns would experience constant losses in the previous six months. Besides, the problem is that the arbitrage opportunities, which present the ability to buy a digital asset at one exchange and then sell it at a different one using a much higher sum have vanished. In layman terms, the digital asset opportunities are slowly coming closer to traditional asset classes.

When this occurs, the traders are less willing to accept the risks or losses that could come from hacking attacks. This, in turn, means that unlike before, digital exchanges cannot argue that the huge possibility of profit will compensate for lack of security, troubling instances of conflict of interest, poor operation standards or a lack of oversight.

This includes the instances of cryptocurrency exchanges holding all of the participants’ assets using a single wallet. With a bulk of their assets placed inside of a single location, the possibilities for hackers are huge and the incentive great. Today, because of the issue in security, exchanges are employing fragmented wallet structures but this is only one right step in a journey of many miles. Yet, this also shows that the crunch has forced many digital exchanges to rethink their long-standing problems.

A higher level of security will attract more institutional investors who are, unlike the day traders, interested in their reputation and the risks it might face when trading digital assets. As the cycle continues, the exchanges will begin introducing an additional element of account-keeping and surveillance infrastructure. They might not necessarily hamper the users who wish to keep the anonymity features of digital currencies, but they will surely make life harder for those who planning malicious activities.

Increasing Level of Sophistication

The growing sophistication of the exchanges is a process that has been evident in many digital ventures. Esports are a good example, which started off as really non-government LAN parties where people use to play competitively but over less than 20 years managed to grow into a one billion USD industry.

Here as well, the complexity means more safety and more assurances that a particular venture is a long-term project that will not just vanish one day – many investors tend to fear this possibility even when it is leveraged against very high returns. As the sophistication of the infrastructure grows, the offer of trading possibilities will include options, derivatives and much more.

Bear Market Legacy

The legacy of the bear market will definitely be the changes in security principles that are still in development in many digital exchange companies. In the first three quarters of the previous year, almost a billion USD worth of cryptocurrencies had been stolen from exchanges and other platforms dedicated to trading.

The setup for this possibility is slowly going away and it is thanks to the external pressure that this is made possible. Today, because of the falling prices, the institutional investors are keeping their distance from the crypto market, but once the infrastructure is beefed-up, they will come looking for investment opportunities.