“Victory has defeated you”- Bane
The Dark Knight Rises
The last few days of human life on earth, will be characterized with the words, “No one saw this coming.” Yet, the few people who do see the darkness on the horizon, are rarely listened too. This is particularly true in finance, where a major bull market tends to numb the collective ear.
A case in point, the 2008 financial crises. If you saw it coming, and tried to warn anyone, you risked a punch in the face. The Author knows this because he was almost punched during an argument with a friend over bearish concerns with the real estate bubble. Participants are often too exuberant to remain critical during boom times. From banker, regulator, to investor, in 2008 we were victims of our own success.
Still, I’ll take a chance again and ring the alarm bell. Ding. Ding. Ding. Duck! We are on the precipice of a third-party scaling debacle. You are seeing it everywhere, from wallets to exchanges. The influx of new investors has tested the system hard, during a relatively modest uptrend.
The total daily transactions is relatively small when you consider that exchanges are dealing with what amounts to something akin to one high cap stock. The total market cap for the entire space doesn’t come close to Apple, for example. I won’t bore you with details, go to coinmarketcap.com and then compare it to Facebook. In the face of these relatively small numbers, exchanges are having problems dealing with the new demand. This is compounded when you consider that most of the altcoins in the top 10 don’t have many on-chain transactions and literally are starting to look like ghost towns. This means that there is little justification for all the off-chain trades going on at exchanges.
Scaling is not an interesting subject for the average Joe. It’s something the new guy isn’t even going to think about. What is more troublesome, many of the so-called experts wont either. The best example is the 1987 Stock Market Crash, more famously called Black Monday. Lets look at Investopedia’s summation of the cause of Black Monday:
The cause of the stock market crash of 1987 was primarily program trading, used by institutions to protect themselves from significant market weakness. Some secondary factors included excessive valuations, illiquid markets and market psychology.
Its a concise explanation and it is easy to see that crypto has these factors in play. Investopedia even explains how the algorithms themselves failed to account for the possible number of orders that could be generated:
Program trading exacerbated market weakness even though it was designed as a hedge. These computer programs automatically began to liquidate stocks as certain loss targets were hit, pushing prices lower. Then, the lower prices fueled more liquidation with stocks dropping 22% on the day. This is an example of behavior that is rational on an individual level – but irrational if everyone adopts the same behavior.
The experts, caught in the exuberance of an historic bull market, never bothered to consider what a severe jolt to the market would mean. That it would send massive orders to an archaic trading floor. A place where almost everything was done by humans, not computers. In short, it was a failure to scale. The end result was catastrophic.
Now consider the average new investor, thinking that the crypto industry’s exchanges are something like the stock market in 2017, not 1987. These players are coming in droves, thinking they can buy or sell with ease, like on Etrade. When their lunch money gets taken, and their exchange is down for days, it won’t be pretty.
Now here is the real kicker! It is not the Bitcoin scaling issue that is even remotely the problem. In fact, Bitcoin’s anti-fragility and its position as the reserve crypto currency, is likely to help prevent a total meltdown. As is typical, everyone is worried about the wrong issue.
Its hard to say when this event might happen, and it is easy to say it can be avoided. My question though is- will anybody pay attention? If you are one of them who is paying attention, its not hard to figure out how at risk your funds are.
Take notice and manage your risks!
Disclaimer: The Author may be long or short assets mentioned above at any time. His opinions are not financial advice.