Cryptocurrency’s liquidity problem


It was only a week ago I wrote How do I know which cryptocurrencies will go up in value. It's not easy, and is a lot of work.

My personal view of cryptocurrency and blockchains that their social value lies in their utility - what problems do they solve, and how effectively do they it? At the moment, a lot of cryptocurrencies' main proposition is speculation - the promise of you buying something and then praying it goes up in value so you can cash out. But the speculative part is part of blockchain's value proposition, if it truly is revolutionary, then it should accrue value to its inventors and developers.

Yet I, as a developer, only have so much time to devote to any particular platform. I spend most of my professional time fighting spam, malware, and phishing. And even though I have a primitive method of researching cryptocurrencies, I still consider it inadequate.

For example, on Dec 20, 2017, I published a screenshot of the top 12 cryptocurrencies on CoinMarketCap. Here's what they are today along with ones that have moved up highlighted in blue:

If I were to speculate in cryptocurrency, then only looking at the top 12 is insufficient. Because while four of the top 12 moved up in value since Dec 20, six moved down significantly in value (the other two also moved down but too little to constitute a movement).

I've read somewhere that there are ~1300 cryptocurrencies today, and 95% will fail. That means that 65 of them will succeed. How can I identify which of those 65 will stick around? Are they currently in the top 10? Top 25? Top 100? Are the ones in the Top 25 today going to be around for the long-term?

It's hard to know.

What I've discovered in my research is that it's hard to diversify your holdings if you want to speculate in cryptocurrency. For example, the most popular cryptocurrency exchange in the US is Coinbase, and you can only trade four currencies on it - BitCoin, Ethereum, LiteCoin, and BitCoin Cash. Yet from CoinMarketCap, you can see that there are far more cryptocurrencies than just those four, and the majority of them are far more interesting (and more risky and speculative) than either of the four on Coinbase.

So if you want to diversify your holdings, you have to diversify how you acquire them, and that means going through different exchanges.

Whenever I want to buy stocks or bonds or ETFs, I can do it through my retail brokerage account. I can buy almost anything I want to buy in the US stock market, and many times I can get foreign stocks as well if they are part of a fund, or have a US-exchange equivalent. Cryptocurrency exchanges are not quite that user-friendly, no doubt because it is so new.

There are some exchanges that let you deposit US dollars, and then use that to buy cryptocurrencies. But there's tons of exchanges out there, how do I know which ones are legitimate, and which ones are scammy or are prone to getting hacked?

The US-dollar method is the most intuitive way for a noob like me to speculate in cryptocurrency. Unfortunately, not every cryptocurrency lets you purchase with US dollars. Many of them only allow you to do exchanges, that is, exchange one cryptocurrency for another, usually Bitcoin or Ethereum. For example, if I wanted to get into Cardano, I'd have to first buy some Bitcoin and pay a fee, and then exchange Bitcoin for Cardano (and pay another fee? I'm not sure because I haven't done that yet but I assume I would). The fees on Bitcoin purchases using USD are high, and one of the things you need to do when speculating is minimize friction (fees, bid/ask spreads, slippage between the order price and execution prices, and taxes).

Or, if I wanted to stick to US dollar purchases [1], I'd have to find an exchange that trades the cryptocurrency that I want, and then find another exchange that trades a second cryptocurrency that I want. Depending on how many I want to hold onto, I'd have a lot of research to do in order to minimize the number of cryptocurrency exchanges I have to maintain. This the opposite of how I buy stocks (that is, I only need a single brokerage to purchase traditional securities).

What a pain.

Thus, at the moment, the lack of liquidity for alt-coins is a problem waiting to be solved.


[1] I've recently become aware of a cryptocurrency called Tether which tries to address the liquidity problem. Basically, Tether is a company that lets you convert fiat currency like US dollars or Euros to Tether, and then convert Tether to another cryptocurrency. The Tether cryptocurrency is backed by actual US dollars and Euro reserves. Thus, some cryptocurrencies list USDT (US dollars backed by Tether) as an acceptable form of payment.

This sure sounds great because it lets people get into and out of alt-coins more easily, but I don't know how much on the up-and-up this all is. Are they running ahead of financial regulation? Will my money be safe there? Does it alleviate my need to hold cryptocurrency in a wallet?

I don't know.

But it seems to me like this is the "picks-and-shovels" approach to cryptocurrency. During the 1840's  and 1850's gold rush in California, most of the money was made not by the miners (other than the initial ones at the very start of the gold rush) but by the people selling tools to the miners who were trying to cash in on the gold.

 

 

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