Update on Cryptocurrencies: August 15th 2022 By, Nolan Loxton

Nolan HeadshotIf you would like to read this article in a downloadable pdf format, click here.

In May 2018, Bloomberg announced that they had formed a cryptocurrency index called The Bloomberg Galaxy Crypto Index. Since Bloomberg only caters to institutional clients, an index of this nature was one of the first steps toward widespread institutional involvement. The index composition changes regularly but we will just show the graph because so many institutional investors follow it.

This is the 5-year chart for the index –

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The index started in May 2018 at 1,000, reached a peak in May 2021 of 3,504, and then dropped significantly until June 2021. It set a new high on November 12th of 3,715 and has been sliding down until recently. After dipping below 1,000 in June and July, it has bounced up to 1,292.13 with a minor series of higher highs and higher lows. You can see the recent price action below in the six-month chart –

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Market Summary

a) Market type:

Bitcoin (BTC) hit a new all-time high of $68,789.63 on November 10th, 2021 but has had a sharp downturn erasing all the gains back to November 2020.

With the recent upturn, we have now moved from a “Strong Bear Normal” market type in July to “Bear Normal” in August.

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The following table shows the BTC change per year since January 2010. It’s had three losing years so far although the jury is still out on 2022.

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b) Super Trader Bitcoin System

The objective of the system is to outperform a bitcoin buy-to-hold while sleeping easy.

The system entered a new BTC position on July 28th at $23,844 with a trailing stop now at $21,240. Let’s see how it unfolds.

The Super Trader system doesn’t track ETH but if it did, it also would have flagged a long ETH entry on July 24th at $1,599 with a trailing stop now at $1,442.

c) Ad hoc News Discussion: Proof of Work vs Proof of Stake

In the latest month, Ethereum has been on a tear. The popular belief for the price move is the agreed timeline (September) for Ethereum to transition from Proof of Work to Proof of Stake (subject to various technical disclaimers).

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The ETH below chart puts the current 53.98% increase in perspective. This may just be a bear market rally.

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So, what is the difference between Proof of Work (PoW) and Proof of Stake (PoS)?

Let me use my Boston Terrier, Lucy, to explain the difference between the two consensus mechanisms to verify transactions on a coin’s blockchain.

Pretty early on, Lucy found her life’s purpose of chasing down a red frisbee and ever since has been passionately dedicated to the task. Her red frisbee now has thousands of her teeth marks embedded in it. You could say her teeth marks are an immutable record illustrating the entire frisbee throwing history for anyone who dares to inspect it close enough. Sounds a bit like a blockchain ledger, doesn’t it?

The Proof of Work (PoW) Dog

Lucy provides a prime example of a Proof of Work dog – running around with her red blockchain. In her ecosystem, family members and friends provide a lot of viable competition who are willing to take the frisbee from her. But competitors for her frisbee must attempt guessing formulas to take the frisbee. She won’t just hand over the beloved blockchain, she requires an ever-evolving combination of guessing which might involve scratching behind the ears, belly rubs, comforting words and enthusiastic hand gestures.

The more people who simultaneously vie for the frisbee the greater the complexity of her requirements. So much so that she is willing to hang on to the frisbee in a gravity-defying act to secure her blockchain. At some point, someone guesses correctly and pampers her enough to satisfy her canine mind. As a reward for this successful dog mind mining process, she lays down the frisbee at someone’s feet – usually mine.

I have the benefit of some specialized equipment. That would be my throwing arm which can make the frisbee fade around a big bush which adds to the thrill of Lucy’s chase.

My son is quick to point out that it’s unfair I get the frisbee so often, however, I benefit in part because of the specialization I have after investing time and capital to improve my throwing arm. Time and capital are always motivated by the satisfying returns of the frisbee and, as a result, I am committed to the game I chose. At the same time, Lucy’s current preference for my throws does not stop my son from investing time and energy into his throwing arm. The competition is never-ending.

All of this leads to one very satisfied Boston Terrier and one very secure frisbee. Is she ever going to fork over to tennis balls? Highly unlikely.

The most important question of all – will anyone ever sneak past Lucy a malicious block, say a yellow frisbee? Only if someone could control 51% of everyone willing and able to throw a frisbee. Until then, there is but only one beloved red frisbee and it’s secure with the Proof of Work dog.

What Would the Proof of Stake (PoS) Dog World Look Like?

In a Proof of Stake world, everyone that wanted to play would simply need to put up a bone as security (or 32 ETH coins). An algorithm randomly determines the winner in this game — there’s no competition. The dog no longer gets to choose the highly specialized throwing arm because a standard server-grade device is sufficient. And hence, a specialized throwing arm provides no advantage – it’s out of business. It’s a world that aims for minimum standards rather than maximum standards. In dog speak, this means the randomly selected winner might elect to throw the frisbee with their toes because toes are good enough.

There are numerous benefits though in the Proof of Stake world. First, the game of frisbee consumes a lot less energy as there is no specific level of skill, no guessing, and no specialization required—just the initial capital for security. So, we throw the same frisbee, a lot quicker, with a lot lower fees.

Will this dog fork into other games? There doesn’t seem like much of a barrier holding her back.

Again, the most important question of all: Will you ever sneak a malicious block past her? In this world, controlling 33% of all frisbees on the network would mean yes, someone could sneak a yellow frisbee past her.

Enough With Dog Frisbees – What Would it Take to Introduce a Malicious Block?

Proof of Stake networks are indisputably less reliable and less secure than Proof of Work. It’s a mathematical fact.

The question is basically, should we be concerned? After all, a malicious block could compromise your assets in the blockchain.

To answer that, let’s look at the commitment required to launch a successful attack on the two largest networks – the hardest to attack and compromise. The smaller the network the higher the probability of a successful attack.

Attack Scenario 1: On the Proof of Work Bitcoin, you would need to control 51% of the mining computing power to launch a successful attack. If you could fork out an estimated $8.6bn for the ASIC miners, have the space to rack your hardware and then pay the $20m per day in electricity costs you may have a shot at an attack. The effort to buy that kind of mining power will attract tremendous attention in the semiconductor and BTC mining space and your 51% attack would not be a stealthy operation. One of the biggest safeguards against such an attack is the existing miners with capital and skin in the game. They have a significant economic incentive to protect their investment in the BTC network and will likely continue to add to their mining hardware.

The most likely outcome of Attack 1: A balance of computing power is retained and the network integrity survives.

Attack Scenario 2: On the Proof of Stake Ethereum 2.0, you would need to control tokens—specifically, 33% of all tokens in circulation. You could either buy tokens outright or (often overlooked) gain control of enough coins and their votes by providing staking services. For a 4-7% staking rate, this would be a pretty economical way to get the votes on the coins added to your agenda.

The ETH market cap is around $230bn at the moment and an attacker would require 33% – or $76bn of ETH to take control. Sounds too big and impossible? Apple, Alphabet, Microsoft and Amazon each have enough cash to buy that much ETH outright even before we talk about governments. China is sitting on about $989B in US Treasuries. (Might they be interested in a nice 8% diversification out of a USD position with a considerable portfolio heat problem?)

In terms of processing power, all you would need would be one old laptop with a solid-state drive.

The most likely outcome of a PoS attack attempt on Ethereum: A rapid rise in ETH price as accumulation gets underway. Then, a tipping point panic long before the 33% threshold, resulting in some form of mass selling and/or a change in voting protocol in order to sideline the attacker. But also, average voters would likely be sidelined in favor of the guardians of the network. Who will guard the guardians?

Are these Black Swan Events or More Likely to be Day to Day Events?

Looking at the two biggest networks, a serious attempt to attack BTC or ETH would clearly be a Black Swan event.

But it’s important to note that there have been successful attacks on both sides of PoW and PoS. Some notable PoW examples include Ethereum Classic and Bitcoin Gold.

The smaller the chain and the lower the economic incentive for the miners the higher the probability of a successful attack in the PoW world. This is before we even enter the PoS world with over 20,000 coins and no miner incentives.

BTW – Once a year in England there is a peculiar event, the Swan Upping. During this event, all of the Queen of England’s swans get counted. Know thy Swans, black and white.

d) News Map:

Context is all important and to add some context around recent news events we will focus our attention on the five main types of players and the games they play in the crypto space.

We are leaning on a key Tharp Think principle here: “The map is not the territory. The better my map represents the territory, the better I will function in the world.”

We are not trying to explain the extremely complex non-linear open crypto system but rather we are looking for a useful lens to identify what may be important changes affecting the ecosystem and, ultimately, supply and demand.

What is “useful” for a trader? Tools that help make money.

On our map the main players and games are:

The HODLers:

These are mostly retail speculators with no trading systems or buy-and-holds with no stoploss. The early adopter HODLers have done quite well and with many who are still whales today. Many whales pivoted into other categories. The late adopters haven’t fared quite so well, they may be whales but their average BTC cost is underwater. For HODLers, 1 unit of risk (1R) represents their total capital committed—it’s basically an all-in bet. HODLers have no cash flow day to day without selling/staking the holdings.

The Traders:

These are large speculators such as hedge funds as well as the systematized disciplined retail traders. Their cash flow is dependent on the gains/losses in the underlying positions on positive expectancy systems. The common denominator amongst traders is a position sizing approach to capital allocation as well as a risk to reward approach at a trading strategy level (usually a minimum of 2:1 risk reward). For this reason, private equity and venture capital is also included in the Trader category as they have definite entries and exits as well as strict position sizing rules.

Business, Big and Small:

This includes the major commercial players who design blockchain infrastructure, have already adopted blockchain or are actively in the process of integrating blockchain and its related products and opportunities into their business models. Their cash flow originates from their usual business activity. Blockchain offers operational efficiencies improving cash flow and customer experiences.

For the small business, blockchain offers the opportunity to level the playing field (or should we say “paying” field) to unlock cash flow.

The Market & Makers:

This represents the market makers, brokers & exchanges (both traditional and DeFi), banks and asset managers. Cash flow is ongoing from volume in its various shapes of trading, spreads, commissions, assets under management and even order flow payments.

The Sheriff & Co.

This represents governments as well as any free market interventions in its various shapes, sizes and forms. The profit of all other players is their tax base and therefore cash flow plus or minus the impact a couple of trillion depending on the state of the printing presses.

Now that we have our main players categorized, let’s look at some noteworthy news items by category:

HODLers:

  • Fairfax County Retirement Systems, a US pension Fund with US $6.8Bn of assets, is venturing into crypto lending markets to ramp up returns.
  • Michael Saylor “stepped down” as CEO of MicroStrategy as the company posted a $1bn+ BTC-related loss. He will stay on as executive chairman.

Traders:

  • A report by international consultancy PwC indicates that, despite crypto volatility, a rising number of US hedge funds invest in crypto assets. Of traditional hedge funds surveyed, some 38% were investing in digital assets, compared to 21% a year earlier.
  • The custom-made super yacht Much Wow is for sale following the Three Arrows Capital implosion.
  • 21Shares launches BTC and ETH exchange-traded products in SIX Swiss Exchange.

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The Much Wow yacht is now much for sale. From www.reddit.com

Market Makers:

  • MakerDAO has linked up with a US bank, Huntington Valley Bank, as DeFi and traditional finance move ever closer.
  • Coinbase financial results included a record $1.1bn loss, a revenue decline of 60% to $808.3m and declining monthly transacting users.
  • Coinbase and BlackRock have partnered making custody, crypto trading, prime brokerage and reporting available to BlackRock institutional investors.
  • Exchanges continue to feel the bear market pressure. Nuri (Germany’s largest crypto exchange) filed for insolvency and numerous other exchanges are restructuring.

Business, Big and Small:

  • Tesla offloaded 75% of its BTC holdings to strengthen its cash position.
  • World famous auctioneers, Christie’s, entered the Web3 world with an investment fund focusing on the intersection of Finance and Art. In the Acronym3 world there’s a hidden pun.
  • NFT platform PREMINT was hacked, losing 300+ NFTs.
  • NOMAD bridge protocol was hacked for $200m.
  • Disney picks Polygon (MATIC) in its Accelerator program which focuses on developing augmented reality (AR), non-fungible tokens (NFT) and artificial intelligence (AI).
  • Polygon also partnered with South Korea Games published Neowiz to create a Web3 gaming platform.
  • Virtual land prices and sales volumes have crashed, especially, at three of the largest projects: Decentraland, The Sandbox and NFT Worlds. Mark Twain famously said, “Buy land, they are not making it anymore”.
  • Reddit and FTX Pay entered into a partnership enabling Reddit users to buy ETH directly on the site to cover the gas costs for their Community Points.

The Sheriff & Co:

  • The SEC sent a voluntary request to Coinbase for information around listings and listing processes. The “securities” conversation may be back on the table.
  • Tornado Cash (A crypto anonymizer service) was sanctioned and banned by the US Treasury Department after alleging $7bn had been laundered by North Korean hackers and other entities.
  • A UK court gave permission for an anonymous individual to be served via a NFT airdrop to their wallet as NFTs make their way into everyday processes.
  • Iran made its first official import order paid with crypto. The crypto used wasn’t named but the transaction raises fears that Iran could bypass sanctions using cryptos.
  • Crypto exchange BitMEX’s former head of business development pled guilty and was fined $150,000 by the US Department of Justice for “willfully failing to establish, implement, and maintain an anti-money laundering program at BitMEX”.

e) Market in Numbers

The table below tracks the price of five major crypto assets across three generations of the technology, now, along with Bloomberg’s Index:

  • Bitcoin, a 1st generation crypto asset,
  • ETH and NEO, 2nd generation cryptos,
  • Iota, a 3rd generation crypto,
  • Holo (HOT), and
  • BGCI Index.

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Date of the All-Time High Closes

*Nov 10th, 2021 ** Nov 10th, 2021 ***Feb 12, 2021 **** Jan 15, 2017 ***** Apr 5, 2021 # Nov 12, 2021

All five cryptos rallied during the month. Is this the start of a larger rally or simply a bounce in the bear market?

The following table tracks the amount of money in stablecoins in the top 100 which have a market cap of over $100 million. Their percentage of the total crypto market cap indicates one measure of health for the crypto market.

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At the moment, about 13% of the total market cap is in stable coins, down from 15.9% last month as cash moved from stable coins into risk coins. Also note that the number of coins with market caps over $100M went up 43% from last month which suggests a broadening recovery in more established coins.

The following table includes the total crypto market cap, along with the percentage of the market cap that belongs to Bitcoin, as well as the percent market cap of the top five cryptos. The percentage of total market cap for Bitcoin and the top five can give an indication of the overall health of the crypto market.

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The rally in ETH in the last 30 days has decreased BTC’s dominance to 40% and increased the top 5 concentration to 67.9%. The more the market enters “risk on” mode the lower the BTC dominance becomes as money flows into altcoins. Also notice the number of coins above $25m has increased by only 6% contrasted to the 43% increase in coins over $100m. Traders and investors are focused on the more established coins at the moment.

The table below shows the best and worst cryptos in terms of Market SQN. Of the 100 that we track, 58 are bearish, 23 are very bearish and 15 are neutral. This is a positive shift as last month the majority was very bearish. Notice out of the top 15 only 4 are positive while the rest are neutral. Interestingly also is: despite the strong rally in ETH it’s only at a Market SQN score of -0.3. Very early days of a bull or just a bear market rally?

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On a 12-month rolling basis we are seeing three coins in the Top 10 Market Cap turning positive, some individual strength in two Metaverse coins, two DeFi coins and one NFT coin. For the most part I still see red.

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Overall Commentary

This is a free newsletter to the VTI community. It’s not about making any recommendations for what to buy or sell. Instead, it’s about understanding how money can be made in crypto assets.

Until next time,

Enjoy your own game!

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