"When the tide goes out, we get to see who has been swimming naked." Warren Buffet
A bull market will camouflage market vulnerabilities. As capital flows into stocks, the rising tide tends to lift all boats, so to speak, even those that couldn't survive a storm. Even a leaky tire will get hard if you pump enough air into it. It's only when the pumping stops that the leak becomes obvious. So too, is it in the investment world. During a bull market both good ideas and bad tend to rally alongside each other. The inflow of cash is like the rush of air into a tire. The overwhelming force of it glosses over mistakes and faulty business models. Only when the pumping stops, do we hear the hiss, and watch as the tire immediately begins to deflate.
As we can see on the weekly chart of ETH in the chart below, cryptocurrencies peaked out in a bubble top one year ago. On the way up, countless coins and NFT's were bid higher, regardless of their underlying business model. A bull market in an asset class carries coattails. Not only does the underlying asset rise in price, but the infrastructure that surrounds it also benefits from increased activity. When cryptocurrencies were all the rage, exchanges to buy and sell them sprouted much like a town does near a gold deposit.
During the heat of the bull market, exchanges flourished. Capital continued to flow into the exchanges, regardless of how solidly constructed they were. In the late stages of a bull market, little attention is paid to risk, as the dizzying rally overwhelms faulty business models.
But when a financial bubble bursts, it leaves a lot of collateral damage. Frankly, things tend to break. When the 2000 internet bubble burst, newly listed stocks disappeared seemingly overnight. For them, something permanently broke, and their failures became obvious once the flow of money reversed.
In ’08, huge financial firms that had been around for over a century buckled, and then collapsed with alarming speed. Think Bear Stearns and Lehman Brothers. While those two firms captured the headlines, many smaller banks and firms also folded and disappeared, seemingly overnight. That brings us to today.
As we all know by now, when covid struck, the Fed went into overdrive and pumped $90 billion per month, EVERY month into the economy. The stimulus had its intended affect and assets shot to the moon. Anyone who had stocks or owned a home couldn't be happier. However, the stimulus had a dark side as well. It wasn't only asset prices that rose. Prices on EVERYTHING began to rise. Not cool. Finally, inflation became a bigger problem than a slow economy, and the Fed began to hike rates and end its quantitative easing program. Now we get to see who is naked. We’ve been predicting that something will break, but we didn’t know exactly what.
Enter FTX. According to Wikipedia -
FTX is a Bahamas-based cryptocurrency exchange. The exchange was founded in 2019 and, at its peak in 2021, had over one million users and was the third largest crypto exchange by volume. Since 11 November 2022, FTX has been in bankruptcy proceedings in the US court system following a liquidity crisis.
During the bubble years, the founder and CEO of FTX, Samuel Bankman-Fried, could do no wrong. He knew that the game he was playing was basically one of trust. Even though it was a bull market, there was competition, and Sam was anywhere and everywhere promoting his exchange. If trust is measured in money, Sam earned a lot of it. So much so, that even people who are conditioned NOT to trust authorities with their hard-earned wealth, were willing to submit their savings to a young man whom they'd never met.
Many people only got involved in crypto as a speculative trade and don't care about the fundamentals. They were just following the price action. But cryptocurrencies also appeal to the libertarian crowd for their ability to operate outside of central command, and for privacy protection. It's rather ironic that some of these people who wanted total freedom from government regulation, are now embracing the bankruptcy court in hopes the government will be able to recover some of their lost funds—the money is gone.
We wish nobody got hurt from the FTX implosion, but financially, it was a painful crash. Now, investors in bitcoin are accustomed to risk. They have held through countless surges and purges—enough to know that it isn’t for the faint of heart. But this time, they didn’t only lose because of the decline in the value of bitcoin. They lost because the exchange where they keep their funds imploded. FTX took customer funds and used them to trade other cryptocurrencies for its own benefit. A great idea in a bull market, maybe, but not so much when the market turns.
Now that FTX imploded overnight, investors are on edge and looking around for who is next. In a game of confidence, crypto exchanges cannot withstand a deterioration of confidence. If investors decide to pull their assets like they did in FTX, we'll quickly see which exchanges are over-leveraged.
Cautious investors can protect themselves by purchasing cryptocurrencies and storing them offline. Doing so is akin to burying gold in your back yard or sleeping with it under your mattress. Both methods protect you from risk in the event that your brokerage firm goes bankrupt and your hard-earned wealth evaporates.
Without a doubt, removing your assets from a brokerage or exchange will shield you from risk in the event that the firm goes bankrupt. With that additional level of security, you'd think everyone would store their bitcoin in cold storage, but they don't. Why? convenience. Sending your money to a broker gives you the freedom to enter and exit different cryptocurrencies with the mere touch of a button and a minor processing fee.
I've been trading and traveling my entire adult life. I'm currently trading from my boat in the Caribbean. Over the years this has gotten easier and easier to do. Drop the anchor, tether your phone to your laptop, browse some charts, and trade. At Wanderer we first began investing in Bitcoin in 2017 when it was worth $2,500. Fortunately, we recognized its potential, unfortunately, we didn't realize it even earlier. Today it is worth about $15,000, and despite the turbulence, we believe it is here to stay. Bitcoin will have its ups and downs along the way, and we'll still be bopping around in the islands.
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