Editor’s Note: As we continue to cover cryptocurrencies and blockchain technology, we’ve recently had the opportunity to meet Vladimir Smerkis, who offered to contribute to Wealth Daily. In his article below, he discusses the popular cryptocurrency Bitcoin and how investors can navigate the volatile market that’s associated with it.
Vladimir Smerkis is an acclaimed Russian expert in cryptocurrencies and blockchain technology. He is the founder of the Token Fund, one of the first coin-traded funds on the market. The Token Fund acts as a managed investment fund for cryptocurrency and blockchain projects and offers the service that many investors today are seeking: a painless entry into the crypto-world that comes with a diversified portfolio and does not require constant maneuvering on exchanges.
Vladimir is currently launching a funding round to build the global platform, Tokenbox.io, which will operate as a turnkey solution built on the Ethereum platform and provide portfolio managers and traders with a simple way to adopt a token-based trading system. He was previously the vice president of international development at Mail.Ru, one of Europe’s largest internet holdings.
To your wealth,
How Investors Can Weather the Bitcoin Storm
By Vladimir Smerkis
Most people know that cryptocurrencies are one of the hottest investment topics right now. The media hype surrounding them is unparalleled, and a lot of astute investors have already raked in enormous profits. But it is also well known that the marketplace is extremely volatile.
While cryptocurrencies tend to show appreciation, there have been occasional heart-stopping plunges in value. Even Bitcoin — the poster child of the cryptocurrency revolution — has seen 10 major, albeit brief, plunges in value during its nine years of existence. That is about one a year.
For the long-term investor who buys stocks and seldom resells them, plunges like these are an annoyance. But with drops in value typically followed by upward climbs over and above the previous peak, the losses are hypothetical just as long as there is no need to sell during a dip.
Some investors, though, seek out drops in value as additional profit opportunities and use one of two strategies to profit on such occasions.
The first is to buy up the cryptocurrency as its value falls. The assumption is that the drop is a mere technical adjustment rather than a valid revaluation. In such cases, there is a chance (but never a certainty) that this is a spectacular opportunity to buy the denomination at an unusually low price in its recent trading history, and it will return to positive territory in the near future.
When investors do this, they face the challenge of knowing when the optimum point is to buy — when the value will stop dropping and start rising again. Leave it too long, and the opportunity might be gone as swiftly as it appeared.
Another common strategy is to “average” one’s portfolio by purchasing some cryptocurrencies when values drop by a certain degree, and more when values drop by a further degree, and so on.
This is a conservative rather than aggressive approach. It is also a less risky option.
For instance, let’s imagine a cryptocurrency was skyrocketing in value from $100 to $1,000 per token and its value started to drop when reaching the $1,000 mark to $900, $800, $700, before reversing at $650 only to climb back to $1,000 and beyond. In this case, an investor might buy shares when it lost 10% of its value, more if the value dropped by 20%, and so on.
In such a situation, the investor would have bought shares at $900, $800, and $700, and, if in equal amounts, their average value would be $800 per token. That’s not the same as buying at the bottom ($650), but it is close to impossible to know when the bottom will occur and the recovery begin. At least the investor secured some currency during the brief drop in value.
Of course, there are also more sophisticated ways of setting trigger points and investment amounts for a cryptocurrency’s drop and recovery in value.
One approach is to short-sell a cryptocurrency.
This is essentially the same scenario as with traditional stocks, and it involves selling tokens that you don’t yet own and buying them at an agreed upon future date to match the tokens already sold — hopefully at a lower price. Not all investors appreciate that cryptocurrencies can be short-sold in a manner analogous to short-selling regular shares on traditional exchanges.
Short-selling works when a cryptocurrency’s value is dropping. First, you borrow some tokens from another party. Then you sell them, say at $1,000 each, to an investor who hopes the tokens will rise in value. Then you can pick and choose when you buy tokens to give back to the person who lent them to you.
If during the time between when you sold and bought back the tokens, the value drops and you buy them back at $900, then you have made a profit of $100 per token (lower transaction costs, of course). However, if the price of the tokens rises as opposed to falls, you have lost money.
Only some exchanges allow investors to short-sell cryptocurrencies, as this requires additional functionality and more careful participant regulation. There is a risk that needs to be minimized prudently to prevent the fraudulent selling of tokens that an investor does not have and cannot obtain. This is more of a risk in a traditional market because one of the pleasant side effects of blockchain technology is that the risk of token non-delivery is practically reduced to nil.
Some cryptocurrency exchanges allowing for short-selling include the widely known Poloniex, Bitfinex, and Kraken.
Typically, what happens is that the person you are borrowing the tokens from requires you to have a percentage of the tokens’ value on the account. So, in simple terms, as long as the tokens do not go up in value beyond the amount of funds you have on deposit, the risk is covered.
From your perspective, though, if the lender or broker requires you to simply have a 50% deposit, that means for every $1 you are investing, you can actually buy $2 worth of tokens. This “leverage” can result in much greater returns on your money — but only if things go well.
If they do not go well — in this case, if the tokens rise in value — your losses will also be twice the rate that they would be otherwise.
There is an unkind mathematical element in all this as well. Clearly, in any short scenario, you run the risk of losing every penny of your investment (in theory, even more, but this is usually prevented by cautious brokers urgently closing your position well before you reach this point).
But what is the maximum amount you could earn? While there is no limit on your percentage loss, there is a clear limit on your percentage gain. In the case of tokens, you short at $100 with a $50 deposit margin, and the most you could receive is a $100 return for each $50 of deposit margin — double your money, plus the return of your principal, less the transaction fees.
If the margins are lower — if you only have to keep 40% of the funds on deposit — then your return gets better. Now you could get $100 for every $40 invested, plus the $40 back. And so on.
Oh, about those transaction fees: They are higher than you would expect. When you borrow the tokens for your short sale, the person lending them charges interest. The rates vary depending on the token, the exchange, and various other factors, but generally they seem to be at least 2% per month on the original value of the tokens you borrowed.
So, if you are a classic portfolio investor, buy some cryptocurrency-type tokens and hold onto them for an extended period in the hope that their value increases overall.
If the market is dipping and you expect it to turn around, consider buying tokens during their fall in value using the “averaging” strategy.
Lastly, if you think the market will soon start to drop, short-sell some tokens now and then buy them when you think the market has fallen about as far as it is going to.
For an astute, well-informed, active investor, it is possible to make money no matter which way the market moves.