“Generally speaking, the prices of cryptocurrencies are not governed by chance, but they tend to behave like they do.” I don’t exactly recall who said this first, but I think a more apt description would be that perhaps in the short term the prices of securities are indeed governed by chance, but in the long term are governed by fundamentals. But why?
There are a couple of ways of approaching this problem, but I would like to approach it from the perspective of price and value. Prices do not necessarily reflect the reality of value and markets are often inefficient at incorporating events into their long term outlook. I would also argue that short term markets really are irrational because the herd tends to value securities on the most recent available news, so although there can be correlations between fact and pricing, these are never proportional or actually predictable.
Consider an example where a stock with a multi-year growth record trades at nine dollars prior to a missed earnings report, but falls to six dollars immediately afterward. The behavior, price collapse on negative news, is there, but the loss of value is likely out of proportion. This is especially obvious (and common) when negative quarterly financials come from one off expenses, such as litigation, which are not likely to repeat in the future, but which still lead to price deterioration. These are common scenarios in most securities markets.
What conclusions can we draw from this? First of all, it seems that short term price moves are indeed pretty random, its common enough that a stock will move lower on negative quarterly results, regardless of fundamentals such as its cash positions, technology or management team. The same thing applies to crypto, the market consistently undervalues projects which are objectively technically advanced, well funded and led by great teams. Often scamcoins such as the infamous Bitconnect reach stratospheric valuations. But this all tends not to last very long, at least not in multi year periods. Because fundamentals kick in.
Price and value are almost never equal, and when discussing securities, one of the best ways to profit is to exploit these differences by ignoring price and looking at value. In Warren Buffett's immortal words, “Price is what you pay, value is what you get.”
For example, could you argue with a straight face, that if Bitcoin’s price is at 5,000 USD at 9AM on a given wednesday, surges to 8,000 USD by 9PM that same day, that the underlying value of Bitcoin has increased? Is the core team, the quality of peer to peer nodes, even the value of the brand itself, really that radically different than what it was 12 hours prior? This is a hard argument to make.
Under our model, we are essentially looking for assets whose value is high but whose price is low. We are looking for high value components, code, team, innovation, etc. in an asset in which herd mentality has led to price deterioration. This disparity arises because the average investor will tend to judge an investment by its perceived risk, not its objective risk, that is, the actual probability of loss at any given time as described in the examples above.
The crowd is over confident of its estimation of loss in the very near future but highly uncertain of its projections in long term, multi year scenarios. This behaviour is exactly backwards, and can be exploited. If the last hundred years of Wall Street and other highly liquid and developed markets have shown us anything, it is that we should be confident in the generally upward trajectory of long term indices as opposed to trends in short term moves.
If you stop and think about it, this makes a lot of sense. Whether looking at a company or a cryptocurrency, if work is being done, such as continual development of business IP (or a crypto assets code), growth of its team, introduction to new markets, etc. market position and price, over many years, can not help but to increase. This is why I have always encouraged new investors to ignore pricing in crypto assets and focus largely on team and technology.
Each new potential crypto investment comes with a map. This map is comprised of an assets fundamentals and it is the job of the investor to make sure his perception of these fundamentals matches up with reality. If these fundamentals comprise useful technologies with favorable economics, the long term prospects of this asset are as safe a bet as any investor can make.
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