Hello Steemit! This is something I put together on Bitcointalk and I thought I would share it here on Steem. I thought that perhaps some of you may be interested in my thought process when speculating in cryptocurrencies. I have been doing so since 2012, so hopefully you can gain some insight if you are new to cryptocurrencies! Although I like Steem, I also find promise in other cryptocurrencies and believe in diversification of one's portfolio.
In a nutshell, I am attempting to formulate the optimum cryptocurrency speculation theory. Your participation is more than welcome!
Next stop... Moon!
The purpose of posting my thoughts on the topic is to seek out dissenting opinions, in hopes that I can improve my own thought process on the topic. Some of this is poorly worded and should be considered a rough draft. Furthermore, I have not finished covering all of the topics that I feel like should be covered, so this post should be viewed as being incomplete. This should not be considered investment advice. Do your own thorough research, and form your own opinions independently.
Words To Live By:
- Never invest more than you can afford to lose.
- Never go "all in" on any certain alternative cryptocurrency.
- Never leave more then you can afford to lose on centralized exchanges.
- Never trust anyone, ever. Do your own thorough research (profitable speculation is not easy.)
- Putting your holdings in cold wallets provides nice peace of mind.
- Diversify your cryptocurrency portfolio as you would diversify a portfolio of stocks.
- Do not purchase a cryptocurrency when it is on a abnormally huge uptrend.
- Do not be greedy, start to take your profits when you're "in the black".
Optimum Speculation Theory:
1. Before speculating in cryptocurrencies, it is important make sure that your are properly hedged outside of cryptocurrencies. Diversification is key to any investment strategy.
1a. The proportions, as to how much or how little you are hedged, can vary depending on your own personal situation and risk tolerance.
1b. A combination of FIAT, commodities, stock, and other investments should be used to hedge your cryptocurrency investments.
1c. Many theorize that if Bitcoin were to fail for some reason, then the entire alternative cryptocurrency industry would die along with it. Whether this is true or not, I personally can see both sides of the argument, it certainly seems plausible that people would have trouble trusting cryptocurrencies if the "flagship" cryptocurrency were to die.
1d. Assuming you are properly hedged, in the event of a prolonged cryptocurrency bear market, you will have a sufficient amount of buying power to bolster your cryptocurrency positions. Which greatly reduces your costs per coin per cryptocurrency, and increases your trading profits when you sell "in the black".
2. Network effects have a very positive effect on the market dynamics of a cryptocurrency. A network effect is something that becomes more valuable as more people use it, talk about it, blog about it, write news articles about it, etc... Thus, I posit that "network effected" coins are "safer" investments than newer (or more speculative) alternative cryptocurrencies that have not yet garnered a network effect of their own.
2a. In my opinion there are only a few "network effected" coins... such as Bitcoin, Litecoin, Dogecoin, and Ethereum, in that specific order. There are several other coins which are debatable to be added to that list, but the power of the network effect drops off exponentially from level to level. Bitcoin's network effect eclipses all other cryptocurrencies' network effects. As you go down the list from "most network effected" cryptocurrencies to "least network effected" cryptocurrencies, the power of the network effect on each cryptocurrency is reduced drastically.
2b. Network effect can be estimated by considering an arbitrary mixture of the following: amount of mainstream news coverage (if a cryptocurrency is in main stream news often, then it is more likely potential buyers/investors will discover it or be reminded to buy some), amount of cryptocurrency-specific news outlets' coverage, cryptocurrency forums presence (number of threads, members, and activity across all forums), respected in the cryptocurrency community (if it's not respected then it is challenging to obtain a large network effect), and size of 24 hours market volume (low volume indicates low popularity or low usage).
2c. Since I consider "network effected" coins as being safer investments, I believe you should put a larger percentage of your cryptocurrency portfolio in them. I personally prefer to have around 50% to 75% of my portfolio in network effected cryptocurrencies, with the rest in a basket of riskier alternative cryptocurrencies that show real promise. However, these proportions obviously should depend on your risk tolerance and personal situation.
2d. Using similar logic regarding "network effected" being safer investments, I also further diversify the "safer" portion of my portfolio. I suggest using similar proportions as you do for your entire cryptocurrency portfolio for your "safe portfolio", which again depends on your risk tolerance. I prefer keeping 50% to 75% of my "safe portfolio" in what I consider the "safest" cryptocurrency investment that exists today (due to the above logic)... Bitcoin, with the other 50% to 25% made up of other highly "network effected" alternative cryptocurrencies.
3. When filling out the "risky" portion of your portfolio, staying away from "scamcoins", "shitcoins", etc. (everyone has their own name for them,) is key to a successful investment strategy. Investing in "scamcoins" is similar to setting money on fire. Unfortunately, separating the "scamcoins" from quality investments that have potential is no easy task and there is no exact science.
3a. It is not easy to speculate in "risky" alternative cryptocurrencies. It takes a lot of work. Whether it be time spent researching, or simply staying on top of the market by watching the values and value trends of each cryptocurrency. As if it is not hard enough to locate a good investment that is not high up in the market capitalization rankings, you then must stay on top of what the market is doing at all times because things change rather quickly. These "risky" cryptocurrencies can be pumped up to 100-300%+ in a matter of days or hours, and fall back down to earth in the same amount of time or less. Missing out on profitable opportunities is simply not a winning proposition, as taking profits is key to profitable speculation.
3a1. If you do not have the time to spend to properly speculate in "riskier" cryptocurrencies, then I suggest only investing in highly "network effected" cryptocurrencies which require much less work to evaluate and stay on top of. Eliminating the "risky" portion of your portfolio is better than blindly investing in "risky" cryptocurrencies if you do not have the time or the will to put in the work.
3b. Cryptocurrencies that are more fairly distributed have a much higher success rate. Premines, instamines, etc... constitute as a permanent black eye on any certain cryptocurrencies, and are not words that you want associated with any cryptocurrency you invest in. Some cryptocurrencies seem to be able to overcome this factor, but it is very rare, and it takes extremely solid marketing, development, or innovation.
3c. For all existing cryptocurrencies, I suggest eliminating all cryptocurrencies under approximately the 125 to 150 mark on market capitalization rankings. 99% of the time there is a reason for the cryptocurrency having such a low market capitalization, and no you and I are not smarter than all of the minds that consist of the free market combined. As you go further down the rankings, the risk becomes greater, but in turn the potential reward increases if you happen to find a diamond in the rough.
3d. Is the cryptocurrency innovative? If you answer no to this question, then it is likely a "scamcoin", and you should stay away from it. It will take truly innovative cryptocurrencies to break the network effects of the more established and "network effected" cryptocurrencies. Be weary of non-descriptive buzzwords such as "secure", "decentralized", "fast confirmations", etc. as all innovative cryptocurrencies that are worth anything share these properties, and this is just marketing-speak. Be weary of gimmicks. How does the cryptocurrency improve upon past iterations, or does it introduce a whole new concept (or market) to the cryptocurrency space?
3e. Does the cryptocurrency fill a market or niche, and how competitive within the cryptocurrency space is that market/niche? If you believe that there will not be one cryptocurrency to rule them all (or even a few), then you should pay attention to what market the cryptocurrency is targeting. Some cryptocurrencies target markets that are already somewhat saturated. The way network effects work, each market realistically can only contain a few successful cryptocurrencies. Really, using the words "a few" in the previous sentence is pushing it.
3e1. Decentralized data storage, programming languages, privacy and anonymity, gaming related, exchanges, markets, social networks, internet, email, voice/video/text chat, VPNs, and "jack-of-all-trades" are all examples of different markets, but that is definitely not a complete list.
3f. Dedicated and skilled developers are key to a successful cryptocurrency. Without them a cryptocurrency does not stand a chance. Taking a peek at a cryptocurrency's github activity can give a great indication as to how dedicated and active the development is. Do not take this point lightly. If a cryptocurrency does not have dedicated and skilled developers then you should not invest in it, as it is fighting an uphill battle.
3g. Consider all dynamics that make a cryptocurrency valuable and/or "speculate-able". A cryptocurrency's value is derived by the public perception of that certain cryptocurrency, since the value is found by the consensus of the free market. I posit that this public perception is a complicated combination of numerous factors. Many people believe that they know the answer, and almost just as many are probably wrong. If you can figure out the answer, or even an answer similar to the correct answer, then you will be a very rich man. Everyone thinks they know the answer, but the truth is that mostly everyone is fooling themselves because most do not. All factors should be considered when weighing whether or not to invest in a cryptocurrency, and each person should figure out how important (or not) each factor is.
3g1. These factors include, but are not limited to (in no certain order): consensus algorithm, network effect, "scalability", transaction speeds, blockchain bloat, voting, programming languages, number of exchanges you can trade it at (and the credibility/volume of the exchanges), liquidity and volume, privacy/anonymity, merge mineable, decentralized exchange, in-wallet block explorer, recurring payments, decentralized markets, atomic transactions, stealth addresses, confidential transactions, ring signatures, telepods, masternodes, self-funding development, "hire-able" employees, merchant acceptance, payment processors, hot wallets, light wallets, mobile wallets, market pegged assets/cryptocurrencies, stable cryptocurrencies/assets, multi-signature addresses, file storage, TOR/I2P compatibility, decentralized application stores/browsers, solid developers, innovative features, fair distribution, large supportive and productive community, and having a target market or plan for establishing network effect.
3h. Be extremely weary of IPOs. Many great cryptocurrencies have come from them, but at the same time there have been a lot of scams. If the developers and/or organizers are anonymous, or even pseudonymous, then it is probably not a good idea to invest. Thoroughly research each developer's/organizer's credentials, experience, and reputation. Make sure there is an exact "road map" (or plan) as to how a cryptocurrency will be further developed, and how the funds from the IPO will be used. Also, pay attention to how the initial distribution will be allocated (some allocate certain percentages to development, giveaways, marketing, etc.)
3i. Be weary of everything really. Price and volume are easily manipulated, as are forums, news outlets, and social media. Be weary of everything and everyone, and do your own thorough research. There is no such thing as doing too much research. Knowledge is power.
3j. Make sure there is a "road map" (or plan) as to how a cryptocurrency will be further developed in the future. Make sure that road map is feasible, including on a technical level and because of time restraints. Make sure that it is possible to conceive in the first place, and that the technology is better (or comparable) to other cryptocurrencies. Also note time restraints. (IE. Can this project be conceived in a reasonable time frame?) Shareholder governance features such as voting may negate these requirements, but then you still need to vett what shareholders are voting, as they are still susceptible to making incorrect decisions (the majority is not always correct, or informed enough to make a correct decision.)
This is much better than the usual comparison of blocktime, language etc. If the technology is in place, the other elements play a significant role in the possible success, as you very well point out.
In 2.b. It looks like you think of bandwagon effect as network effect. The network effect of bitcoin consists of the parties willing to transact with bitcoin. Brand, visibility and marketing contribute to the bandwagon effect. I don't know if it makes any difference, but I just wanted to point it out.
Thanks! I spent quite a while writing all of this. I admit it is still incomplete though. It is quite the complicated subject!
I guess I kind of lump those two together. The more people using the cryptocurrency (willing to transact) results in a bigger the brand, more visibility, and more marketing. I think they are similar, but maybe you are right that the "bandwagon" effect is caused by usership.
Wise words of wisdom from a veteran trader. Nice post. Upvoted.
Thank you very much!
Helpful information coinhoarder, thanks for sharing.
No problem- I am glad you found it helpful! :)