2023-08-26 13:08:14
The structural risks of trading cryptocurrencies are constantly changing, which also affects the return on investments. The first law of thermodynamics, the principle of conservation of energy, states that energy can neither be created nor destroyed, it only changes form. The same law can be useful for investments, where risk and return are never created or destroyed, only transformed during the investment cycle. The popular cryptocurrency meme may sound familiar: “Everyone buys bitcoin at the price they deserve.” This has the same essence as the thermodynamic theorem, only the wording is different: the various structural risks of trading cryptocurrencies change over time, and therefore the return on investments also changes. Once upon a time, there was once a Bitcoin (BTC), whose path was paved with risks. The first risk is called “existential risk”. In 2014, the viability of bitcoin was still unclear, especially following the Mt. Gox hack. It was still the “funny money” era of bitcoin, when an unsuspecting pizza lover bought two pizzas for 10,000 BTC (which is now worth regarding $300 million). As the level of existential risk in the market has decreased, the value of Bitcoin has increased, creating a new price equilibrium for new investors who no longer have to worry regarding this risk. Then there was the “financial/funding risk”, i.e. whether enough capital would be mobilized into this asset class to be at the vanguard of the envisioned technological revolution. This risk was eventually mitigated by the massive influx of venture capital, which exceeded $50 billion between 2021 and 2022, and the price jumped once more. In 2023, “regulatory risk” appears to be the next domino to fall. Although developments can be unsettling at times, it seems that cryptocurrencies will weather this risk (as we have already seen outside the US) and risk factors will undergo another transformation. Of course, many risks are still present, so investors still have a chance for huge returns – although as each risk decreases, the returns gradually decrease. So if this risk-return energy is not destroyed, what does it turn into? With the focus on regulatory risk, we see a constantly changing landscape unfolding around digital alpha investments. Things to consider: Offshore market makers reduce volume, which affects volume pricing and high-frequency arbitrage trading strategies. Government lawsuits that view altcoins as potentially unregistered securities are affecting the token selection habits of experienced alpha investors. The rules for qualified escrow management affect all on-chain strategies where cutting-edge financial planning and market structure innovation prevail. In other words, while the incremental return potential of crypto beta is always less significant compared to the previous ones, the opposite is true for crypto alpha. Continuously reducing risks paves the way for increased funding and institutional acceptance. However, this transformation creates an “allocator dilemma”. In the case of the largest funds, random investing is not considered to lead to success. Instead, currently investing in smaller funds with limited capacity offers a unique opportunity to outperform. But, of course, this won’t last forever, as the investment thermodynamics of cryptocurrencies are constantly changing. Institutional investors should consider what risks they may face during this transition period.
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#Thermodynamics #cryptocurrencies #risks #turn
