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As Wikipedia states, complex system is a system composed of many components which may interact with each other. In many cases it is useful to represent such a system as a network where the nodes represent the components and the links their interactions.
With that definition in mind the crypto-market with interconnected decentralised networks can be see as a highly complex system. These complex systems’ behavior is intrinsically difficult to model due to the dependencies, relationships, or interactions between their parts or between a given system and its environment.
The traditional approach to dealing with complexity is to reduce or constrain it. Typically, this involves compartmentalisation: breaking a large system down into separate components.
Components of the crypto-market
Crypto-asset market can be divided in many ways, whether it is from technology perspective, to market capitalisation, use cases, etc. In this article we take a high-level view and divide the crypto-market into five components:
🔋 Base — Bitcoin and Ethereum.
🚀 Long-Term value — Projects that are building technology and business models that aim to be the key building blocks for future businesses.
🎢 Short-Term speculation — Evolving projects whose long-term viability and value potential is uncertain and the market value is driven mainly with speculation.
🕳 Scams and Ponzi Schemes — Non-legitimate projects that are raising funds with questionable technological promises that often the team is not even trying to execute.
⚖️ Safety Nets and Stability — Projects that promise low-volatility or stability by various means like having assets to back the crypto value.
Is there a bubble in the crypto market? And in which time horizon?
One of the common questions about the crypto market is about whether there is a bubble and when it will pop. The question about bubbles, especially concerning future technologies, is partially about the time horizon you view the market. American researcher, scientist, and futurist Roy Amara coined Amara’s law on the effect of technology:
“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run”
When you look at the crypto market in the short-term, there is limited value creation compared to capital inflow, outside of and the main value creators are crypto exchanges and value storages.
We believe that the technologies behind the crypto-assets will be significant value creators in the long-term as they are the key building blocks for future businesses, and thus will receive part of the value these future businesses can capture. However, even with the acceleration provided by potential network effects and other exponential technologies it will take time for the future business take shape and find the paying customers.
The long-term view of value creation
It’s always challenging to predict how quickly the changes will play out but it’s easier to think about the phases the business evolution will go through. In reality these phases are not sequential but more overlapping and happening in parallel:
⚙️ Development of building blocks — The first long-term value creating projects are the building blocks (protocols, middleware, etc.) that enable the future businesses. They can thought to be for decentralised organisations what AWS is for startups.
🌐 Emergence of new businesses — As the building blocks are developed the new organisations start to emerge as people figure out hypotheses on how to create and capture value by leveraging the new building blocks.
🚀 Value creation and value capture by new businesses — As the new business start to create and capture value from end-customers the building blocks get their share, which is expected to be significant part in blockchain ecosystem (thin protocols vs. fat protocols vs. layers of thin protocols)
To make it a bit less abstract, we can use Colony as an example and think about what type of businesses it can enable. In their whitepaper, Colony describes themselves “the people layer of the decentralised protocol stack”. In practice Colony enables creation of Colonies, new type of open organisations.
“Colonies exist to enable collaboration between their members, and direct collective efforts towards some common goal(s). Facilitating effective division of labour is therefore, one of the most important functions of the Colony protocol.”
To give you a sense of Colony’s timeline:
- October 2015, Colony started their public journey by publishing ‘The Future of Work’ where they laid out their vision of the future.
- February 2017, in the Colony Beta Overview they announced private beta to test their assumptions and learn from the users.
- January 2018, in the Colony Q1 2018 Update they announced the plan for to launch a fully decentralised with an Ethereum mainnet launch targeted for Q3 2018.
- Q3 2018, expected Ethereum mainnet launch.
To forecast the potential adoption rate for Colony after its launch you could use Slack as a benchmark. Launched in 2013, Slack has grown active users to over 6 million in four years and raised in summer 2017 a $250 million round at $5 billion valuation. The growth in Slack’s daily active users can be seen from an infogram by Techcrunch and it can be thought to be still in early phases after four and half years in the market.
If Colony is to achieve a similar product-market fit as Slack then the broader early-adoption can be expected around 2020 to 2021, which would mean that these early-adopter Colony-powered organisations would reach growth stages around 2025.
Cryptocurrency entrepreneur and investor Teemu Päivinen thinks the Future Of Work is almost here, but it might still take some time for the future to capture the value it will.
Similar to Colony, there are several long-term value projects (🚀) being developed or launched. These long-term value projects are tackling complex topics that haven’t been solved before, so it will take time for these projects the fulfil the potential expected from them by the crypto-markets.
As it always is with ambitious projects some of them will fail, but likely some of them will succeed and they are the ones that enable new economic models in 2020s.
What will cause the short-term crash?
As described above it will take time for the crypto-market reach its full potential and be viable through actual value creation. Before the crypto-market can create significant actual value, the only significant flow of fiat money into the crypto-system comes from various types of investors.
One can of course argue that the crypto-system can be self reliant where different services can be paid also with crypto-assets, but the closer we are to the “real” world more there is need for fiat flow out of the crypto-system. For example, food and accommodation costs of crypto-employees, electricity for blockchain miners, Lambos for crypto-traders, and taxes for the government still need to be paid mainly in fiat money.
It feels that many of current investors are in the market looking for short-term profits (🎢) instead of funding the long-term value projects (🚀). This irrational exuberance, unclear regulation, and technical barriers have kept the investor base still relatively limited and especially has kept the institutional investors out of the asset class.
Similar to a Ponzi scheme the crypto-market price increases in short-term are driven by the new investor money, pouring into the market — until it doesn’t.
What might cause the slow-down of new investors (and sow the seeds for the crash)? We believe the slowdown will be a compound effect of several elements:
👩⚖️ Increased regulation for TGEs / ICOs — The increased regulatory focus towards Token Generating Events (or ICOs), which is good for the long-term viability of the ecosystem. This slows down the number of project launches as there is need to do more upfront investments and it takes time go through the legal details.
👨⚖️ Increased regulatory scrutiny towards Exchanges — There is also increased scrutiny towards crypto-exchanges, what type of coins and tokens they are trading and how they are seen to adhere to securities and financial services regulation, which again is good for the long-term viability of the ecosystem. The increased regulatory scrutiny slows down the number of new projects listed to exchanges and how aggressively the exchanges are trying to acquire new customers.
🕳 Revalation of scams and unethical behaviour— With increased scrutiny and time some outright scams will be exposed. One potential candidate for a large scale exposure is Tether and its link to Bitfinex, who both were served subpoenas in December 2017 by the The U.S. Commodity Futures Trading Commission (CFTC). Tether has long been a target of skepticism in the community, with critics speculating that Tether doesn’t actually hold enough dollar reserves to back up the claim that the cryptocurrency’s value is tied to the dollar. The broader publicity of the scams and when the stories emerge of people who have lost their money will make the new investors more sceptic towards the crypto-market.
👾 Hacking of Exchanges or Token projects—Over the time there have been several hacks stealing significant amounts from various Exchanges and Token projects. In Japan, for example, there was a $530 mln Exchange hack in January 2018. After the hack the country’s Financial Services Agency (FSA) have ordered all cryptocurrency exchanges in the country to submit a report on their risk management systems. The broader the publicity of these security concerns and the more complex the solutions seem, the more hesitant new investors will be about whether it is safe to enter the crypto-market and whether they have the technical capability to keep themselves safe.
🙅♂️ Public warnings from the Status Quo — The Status Quo across the world has repeatedly warned publicly about the risks and speculative nature of crypto- market. The broader the publicity of these warnings is, more it will slow down the uneducated masses from entering the crypto-market. For the long-term health of the market this is good because it will also lead to more people educating themselves about the crypto-markets, instead of approaching them as a casino.
If one were to believe the arguments…
- that the crypto-market needs new investor money to drive the prices up (in the short-term), and
- that growth of new investor money (both from existing investors and new investors) will slow down
…the question arises what will happen then?
How the short-term crash will play out
As the tide starts to turn and the money flows start to change these are elements you will most likely see.
📉 Shorting of the market — The “smart” money of crypto hedge funds and other financial players will find different ways to short the crypto-market, the most straightforward being Bitcoin futures at CME or CBOE.
🙅 TGEs not able to raise capital — The canary in the coal mine will be when public failures of projects to raise capital with TGEs increases. This will be countered by TGE / ICO organisers raising the bar for projects that they promote, to avoid failures.
🎢 Collapse of faith in speculative projects— Many of the crypto-assets can be seen as faith towards a specific community and mission. This faith will be tested when the market starts move downwards. If most of the community’s faith is based on the potential to get rich quick instead of the long-term mission, then these same people most likely want to avoid getting poor quick.
🔋 Crypto flight towards Base — As the faith in speculative projects is collapsing the crypto-traders will look for ways to preserve value inside the crypto-markets by moving to Bitcoin or Ethereum.
⚖️ Capital flight towards stability — The emerging ways to preserve your value are the different types stable tokens that promise stable price or low-volatility. These stable assets can be seen as a hedge towards crypto-market volatility, especially if the stability mechanism doesn’t rely on crypto-markets itself. To be noted is that if the stability mechanism converts crypto-assets to traditional assets then even the stability projects will increase the fiat outflow from the crypto-markets and putting more downward pressure for the prices.
💸 Capital flight towards fiat cash— The last step of the crypto-chrash will be when more and more people are looking for ways to exit the market completely and withdraw cash from the exchanges or use their crypto-assets to buy real-life assets.
The question to think about is when will the above mentioned processes start, or how long they have been on-going.
Tether Exchanges: How to avoid getting ‘Tethered’. (Jan 31)
Hedge Funds Bet Bitcoin’s Pain Isn’t Over on Cboe Futures Market (Feb 2)
In the next article we’ll examine the different ways to protect yourself or your project from the crash, and how to be in the position to benefit from the crash when it happens.