Over the course of 2017, speculation that cryptocurrencies were in a bubble grew as fast as prices rose. Now, with most crypto asset prices down 50 to 70% from their peaks, it appears certain that we were in a bubble.
But, does that mean the bubble has now burst, and has now deflated, or are we still in a bubble? The fact that opinions are divided, means there is opportunity ahead. Asset prices move when large numbers of traders find themselves on the wrong side of the market. So, let’s have a look at how the market is positioned.
Are We in a Cryptocurrency Bubble?
It’s almost certain that by the end of 2017 crypto prices were in a bubble. There is little consensus over the way digital currencies should be valued, but in 2017 very few people were asking about valuations.
Retail investors bought Bitcoin and other digital coins because prices were rising, and prices rose because investors bought them. This created a reflexive feedback loop, and valuations became irrelevant. There was also a large amount of FOMO (fear of missing out), driving prices. Predictions were being made of Bitcoin ultimately reaching prices of $50,000, $100,000 and even $1 million, and speculators were afraid they would miss out on the greatest investment opportunity in history.
This type of mania is characteristic of all bubbles. Two of the most famous bubble in history, the Tulip Bubble in the 16th century, and the Dot-Com Bubble in the late 1990s were very similar. There was no relationship between prices and reality, and markets were driven by emotion more than anything else.
After reaching a peak of close to $20,000, Bitcoin has fallen as much as 70%. Ethereum, the second most valuable cryptocurrency reached close to $1,400 and has since fallen to below $400, a 72% decline. Does this mean they are now fairly priced? No one really knows, but a lot more attention is now being placed on valuation. It turns out that for a cryptocurrency to act as a medium of exchange it doesn’t really need much value.
There are two other big problems for those with much higher price targets. Firstly, one of Bitcoins primary uses cases is as an SOV, or store of value. But that argument falls apart when it falls 70% in 6 months. Secondly, the big value underpins for Bitcoin is the fact that the ultimate number of coins in issue will be limited to 21 million. That may be true, but there is also an unlimited number of other coins that can be introduced.
Bitcoin Weekly chart 2016- 2018 (Source: Tradingview.com)
However, valuation alone is not what drives markets. If investors believe in the future of the asset class, prices may rise regardless of the challenges. The question is, who is going to invest now?
Over the course of 2018, there has been growing speculation that institutional investors are going to begin investing large amounts of capital in the market. This hasn’t happened yet, and it’s difficult to tell if it will – but if it does, prices are sure to rise.
On the other hand, if institutional investors don’t come to the party, it’s very likely that it will turn out prices are still too high for the size of the market. In this case, prices could easily fall another 50%.
It’s likely that a Bitcoin ETF will be approved and launched in the next six months. This will give us a good indication of the institutional demand and will set up the next big move.
The Importance of Having an Open Mind
The world’s best traders are open to all possibilities. Those who only believe an asset will go in one direction will miss out on countless opportunities. Permabulls and permabears require so much evidence to change their minds, that by the time they do they have missed the opportunity.
If your primary means of trading cryptocurrencies is owning the actual asset, you are only in a position to buy them. That immediately puts you at a disadvantage, as you will only be looking for opportunities to go long, and will likely overlook evidence suggesting you should sell, or be short.
If you are in a position to take both long and short positions, you will be able to keep an open mind and trade the most likely direction at any given time. Being able to trade in both directions doubles the amount of opportunity available to you.
How to Short Cryptocurrencies?
So, if you want to short crypto assets, how do you do it? There are really only three options available.
The first is to short sell actual cryptocurrencies. This is very complex and involves borrowing the coins from another investor and then selling them. This is how hedge funds short stocks, bonds, and other assets, but is beyond the reach of most retail traders.
The second is by selling futures. Both the CME and CBOE have liquid futures markets. Trading futures requires opening a trading account with a broker that trades on one of these exchanges, but the catch for retail traders is that the contract size is quite large. On the CME, each contract is equal to one Bitcoin, while the CBOE has a contract size of 5 Bitcoins. At the moment, these future contracts are only available for Bitcoin, which in itself is limiting.
The third option, and by far the easiest, is CFDs. A CFD, or contract for difference, is an agreement between a broker and a client, which is very much like a future. You don’t own the underlying asset, but you are exposed to the price movements of that asset. Like futures, CFDs also allow you to use leverage, and more importantly, you can open long and short positions.
Cryptocurrency CFDs are becoming quite common, and are offered by several FX brokers. One of the most prominent is IMMFX, an online FX broker that offers CFDs on forex, indices, metals and now cryptocurrencies too.
IMMFX offers CFDs on Bitcoin, Ethereum, and Litecoin, the three most popular cryptocurrencies amongst traders. You can open long and short positions on all three currencies, which means you can also trade one against the other. The minimum trade value is also much lower than it is for futures, and you can start with as little as $50 in your account.
It is certainly possible that the market is still in a bubble, though it’s also possible that a new bull trend will begin in the next six months. Rather than speculating on which way the market will move, you can remain open to both possibilities.
If you have a trading account that allows you to take long or short positions as the price action and fundamentals dictate, you will be able to profit in both scenarios.