The biggest risks Bitcoin is facing in the months ahead

Regulatory Impacts

Bitcoin and cryptocurrencies in general have been in the news in recent weeks due to the clamp down China is having on the industry. China has been aiming to shut down the energy-intensive crypto mining operations and ordering businesses not to work with cryptocurrencies.

Further to this, the UK regulators banned Binance, one of the leading exchanges for digital currencies. It should be noted though, that this merely bans Binance from starting regulated activities within the UK. It does not stop UK residents from using Binance.

Last year, Donald Trump’s administration put forward an anti-money laundering rule which meant anyone making transactions of $3,000 or more in a private digital wallet would have to undergo identity checks.

All of these pressures on the regulation of Bitcoin and other cryptocurrencies have led UBS to state that they’ve long been warning that regulatory crackdowns could lead to a bubble pop in the crypto markets.

Environmental Concerns

Elon Musk brought the identification of concerns of Bitcoin’s environmental impact to the forefront. Bitcoin’s critics have long spoken about the negative carbon footprint which vast Bitcoin mining can cause. This has just been emphasised by the fact that Musk’s company, Tesla, backtracked on their $1.5billion investment in utilising Bitcoin as a core payment method, to completely taking it out as an option.

The environmental impact of Bitcoin has certainly been called into question by some asset managers, with a growth in ESG policies in the finance world, many investors are seeking to avoid investments which negatively impact the environment. If this problem isn’t solved for Bitcoin, it could lead to many investors ultimately avoiding it and seeking alternative cryptocurrencies.

Volatility

Bitcoin has seen significant swings in its price, alongside most other coins. Bitcoin saw an all time high this year of $64,829. However, it has been tumbling down since then, and even slid below $30,000.

Looking simply at the gains Bitcoin has made, it is still up more than the S&P 500 year-to-date. However, the significant swings and ability to suddenly drop in a relatively short space of time could lead to some larger investors avoiding it as a significant risk, certainly for those looking for more short term investments.

UBS stated that there is limited real world use, and due to the volatility of the price, it is primarily used by individuals to make speculative gains.

Scams and ‘Meme coins’

Huge levels of speculation in the crypto markets have been seen this year, seemingly with a new coin promising 1,000%+ returns popping up each and every week.

‘Dogecoin’ which started off as a joke surged wildly this year to record highs, even being promoted and pushed by Elon Musk. The level at which these ‘memecoins’ can be manipulated by simple social media posts has led to many staying far away from them, and the negative association of this manipulation has the potential to also spread to Bitcoin.

There was a point this year where Dogecoin was worth more than Ford, amongst other US companies. However, since the price was pumped up by tweets from Musk, it has since depreciated significantly.

The Power of the Modern Retail Investor

Due to the pandemic leaving individuals alone at home, and bored, many amateur investors have ended up seeking excitement in the form of joining retail investment platforms, such as Robinhood. In addition to the hunt for excitement during lockdowns, many could not ignore the onslaught of positive news coming from Sub-Reddits such as Wall Street Bets, where stories could be heard of individuals making hundreds of thousands of dollars in mere days.

Robinhood was set up in 2013 as a mobile trading app, and was recently valued at around $21 billion. The premise is that they provide easy access to trading for retail investors, with zero commissions.

John Marshall, the head of derivatives research at Goldman Sachs commented that “For the largest online brokers, the number of daily trades has tripled since 2019, But this has mainly been driven by a small portion of their customer base. These day traders are less than 10% of their customers, but they represent more than half of their trades.”.

The Growth of ‘Meme Stocks’

The core events which were notable in the news involved stocks such as GameStop and AMC Entertainment, and they are considered as one of the first large scale social media driven buying regimes by retail investors. It led to significant fluctuations of the share prices, and it has been likened to the dotcom bubble around the turn of the century, where prices were just yo-yoing erratically.

The sheer level of volume being traded in January 2021 due to the rise in retail investing popularity was huge. To put perspective on this, on the 27th of January at the height of the GameStop storyline, 24 billion shares were traded on US Exchanges. This surpasses the last record set in 2008 during the financial crisis of 4 billion.

Steal from the Rich to give to the Poor

The story of GameStop essentially arose due to it being heavily shorted by Hedge Funds. During the pandemic, the company as a brick and mortar only store was expected to perform badly. However, retail investors on Reddit realised they could weaponise their involvement on GameStop.

“A co-ordinated and well-informed market manipulation used retail platforms like Robinhood to squeeze shorts on the likes of GameStop and AMC,” says Steve Keslo, head of markets at ITI Capital.

The short squeeze which ensued drove the price higher and higher, which led to Hedge Funds being forced to buy back shares to minimise their losses. This further led to price increases. Overall, it is estimated that there were almost $5 billion worth of losses to Hedge Funds surrounding the GameStop fiasco.

In society, the financial markets, and rather the individuals which historically have worked in the financial markets do not have the best reputation from an outsider’s perspective. This was the driving force for a lot of the GameStop buying. It was a feeling of comradery to steal from the rich (who had been perceived to manipulate it themselves for their own gain), and return the wealth to the normal man. The Reddit Retail Investor.

What is your risk/return profile when trading or investing?

Maybe you have a low-risk approach towards your long-term pension planning, especially if you’re close to retirement. But with a separate pot of money, perhaps you have a higher risk/reward attitude for buying that boat or Lamborghini in the shorter-term.

Of course, doing almost anything in life has a risk / reward ratio. Indeed, not doing anything also has a trade-off. There are many days I have this debate before getting out of bed, for example.

Generally speaking, low risk means you should expect a low return and vice-versa. In investment terms, taking a low-risk approach could mean expecting a small and sometimes even slightly negative return (e.g leaving your money in a savings account vs the current rate of inflation). It does mean you heavily reduce your chances of large losses – But also of large gains.

Allowing inflation to erode the real value of your money (ie Inflation Risk) is a big risk of doing nothing with your money. And with western governments arguably being forced to embrace aspects of *MMT, many commentators are concerned that the risks of inflation could be high in the not-too-distant future.

Any investment advisor worth their salt can help you assess your risk tolerance and discuss what return you should expect (over the long term) from the market and an appropriately diversified portfolio.

In effect, they are helping you measure how much volatility you can emotionally take before you decide to sell, at the worst possible time – and invariably at a loss. However, the other side of that coin is what return you need, or indeed ‘want’, from your money. If these two sides of the risk/reward ratio don’t agree, there needs to be some compromise.

Finally on the point of Risk – Most pilots are human, therefore you suffer from many cognitive biases. One bias particularly attached to investing is ‘Risk Aversion’. In short, it is an irrationality found in humans when it comes to calculating risk.

Another bias relevant to trading is the bandwagon or ‘herd mentality’ effect (have you seen the price of Dogecoin lately?). This is why many inexperienced Retail (ie non-professional) traders / investors lose money in financial markets. They see the price of an asset going up (they might have even heard about it from the Airport shoeshine boy) and they buy in the hope of catching a price increase. However, in many cases the market is over-extended by that point and falls back after the late comers to the party have arrived. The price continues to decline before the inexperienced Retail Trader cuts their losses and sells – And guess who they’re selling to?

At Line Trading Pilots we aim to educate you on both long-term investing for capital growth and short-term trading for income generation. Even though both practices may have similarities, for the Retail Trader / Investor they are poles apart. Yes both involve trading securities, but the big differences lie in the area of risk/reward ratios and time horizons.

If you wish to make money from active trading, it takes many hours of studying, practice, mentorship and on-going work. But the rewards are there if you’re prepared to put the work in.

And that’s where we come in. We will help you analyse the risk/reward ratio of actively trading Forex (or other large volume securities), whilst balancing that out with your long term plan.

*We will cover MMT along with other economic theories in a separate blog

Homework
What asset is generally considered the risk-free return? Would that be ‘risk free’ for you?
Do you know what the low, medium and high-risk asset classes are?
What assets are considered traditional hedges against inflation? Is that changing?

For all the answers and more, register your interest at Line Trading Pilots.com